Teri Loxam - Merck & Co., Inc. Kenneth C. Frazier - Merck & Co., Inc. Robert M. Davis - Merck & Co., Inc. Adam H. Schechter - Merck & Co., Inc. Roger M. Perlmutter - Merck & Co., Inc..

Andrew S. Baum - Citigroup Global Markets Ltd. Alexander Man - Sanford C. Bernstein & Co. LLC Chris Schott - JPMorgan Securities LLC David R. Risinger - Morgan Stanley & Co. LLC Steve Scala - Cowen and Co. LLC Alex Arfaei - BMO Capital Markets (United States) Gregg Gilbert - Deutsche Bank Securities, Inc. Vamil K.

Divan - Credit Suisse Securities (USA) LLC Geoffrey Meacham - Barclays Capital, Inc. Umer Raffat - Evercore ISI Jami Rubin - Goldman Sachs & Co. LLC.

Good morning. My name is Darla, and I will be your conference operator today. At this time, I'd like to welcome everyone to Merck's Q3 2017 Sales and Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. Thank you.

I would now like to turn the call over to Teri Loxam. Please go ahead..

Thank you, Darla, and good morning, everyone. Welcome to Merck's Third Quarter 2017 Conference Call. Today I'm joined by Ken Frazier, our Chairman and Chief Executive Officer; Rob Davis, our Chief Financial Officer; Adam Schechter, President of Global Human Health; and Dr. Roger Perlmutter, President of Merck Research Laboratories.

Before I turn the call over to Ken, I'd like to point out a few items. You will see that we have items in our GAAP results such as acquisition-related charges, restructuring costs, and certain other items. You should note that we have excluded these from our non-GAAP results and provide a reconciliation of these in our press release.

We have also provided a table in our press release to help you understand the sales in the quarter for the business units and products. I would like to remind you that some of the statements that we make during today's call may be considered forward-looking statements within the meetings of the Safe Harbor provision of the U.S.

Private Securities Litigation Reform Act of 1995. Such statements are made based on the current beliefs of Merck's management and are subject to significant risks and uncertainties. If our underlying assumptions prove inaccurate or uncertainties materialize, actual results may differ materially from those set forth in the forward-looking statements.

Our SEC filings, including 1A in the 2016 10-K, identify certain risk factors and cautionary statements that could cause the company's actual results to differ materially from those projected in any of our forward-looking statements made this morning. Merck undertakes no obligation to publicly update any forward-looking statement.

You can see our SEC filings as well as today's earnings release on merck.com. With that, I'd like to turn the call over to Ken..

Thank you, Teri. Good morning, everyone, and thank you all for joining the call today. Our third quarter results again demonstrate the underlying strength of our business. Throughout the year, we've been executing on global launches for new products and delivering growth in our vaccines and Animal Health businesses.

Our strong performance is particularly notable in a year where we've been facing the combined loss of nearly $2.5 billion in patent protected sales, continued pricing pressures, an isolated but meaningful cyber incident, and most recently, several natural disasters.

Our consistent performance also underscores the company's resolve to be the premier research intensive biopharmaceutical company. We measure success based on our ability to sustainably deliver differentiated medicines and vaccines. And we believe that long-term value creation is a direct function of our ability to deliver on the promise of innovation.

To that end, we continue to prioritize our resources to invest in Merck's research laboratories, including our new discovery hubs in Cambridge, Massachusetts, and South San Francisco, to advance the next generation of Merck medicines and vaccines.

At the same time, we're scouring the landscape to find the best external science to augment our portfolio. An example is the newly formed oncology collaboration with AstraZeneca, which involves codeveloping and co-commercializing LYNPARZA.

We're already seeing good progress with LYNPARZA and believe it will add significant strength to our growing leadership in oncology, which is anchored by KEYTRUDA. We're also looking carefully at other potential products in our pipeline, determining which opportunities have the highest potential to address unmet needs.

For instance, we recently made the decision to prioritize certain opportunities in our pipeline for vaccines and for HIV. We believe these represent areas of long-term growth and could sizably add to our other key pillars of growth, namely oncology and animal health.

Recognizing that invention requires significant resources and investment, we remain disciplined in supporting our R&D opportunities, while at the same time reshaping our operating model in line with our changing portfolio and the evolving health care environment.

Going forward, we will build on the momentum of Merck's product launches and pipeline opportunities and seek new or additional ways to maximize long-term growth and sustainable value for society and shareholders. With that, I will now turn the call over to our Chief Financial Officer, Rob Davis, to go through our results in more detail.

Rob?.

Thanks, Ken, and good morning, everyone. Overall, our third quarter results reflect strong operational performance, allowing us to deliver solid bottom-line growth on a non-GAAP basis, despite several challenges in the quarter. Now, starting first with our top-line results. Total company revenues were $10.3 billion, a decrease of 2% year over year.

Excluding the impact of exchange, third quarter revenues declined 3%, with the 4% decline in our Human Health business partially offset by 14% growth in Animal Health.

While Adam will detail Human Health performance in a moment, it's worth highlighting that the quarterly sales of our Animal Health business reached $1 billion for the first time, driven primarily by continued strength in our Companion Animal business, including BRAVECTO, and growth in our Ruminants business, which includes contributions from the Vallée acquisition.

Non-GAAP gross margin was 76% in the quarter, an increase of roughly 70 basis points versus the third quarter of 2016. Favorable product mix, driven by KEYTRUDA and ZEPATIER, was the largest contributor to the year-over-year improvement.

Non-GAAP operating expenses of $4.2 billion increased 4% year over year, primarily driven by higher R&D expense, reflecting increased investment in early drug development. Taken together, we earned $1.11 per share on a non-GAAP basis, up 4% excluding exchange.

Note that our GAAP EPS loss of $0.02 reflects a charge of $2.35 billion related to the formation of the strategic oncology collaboration with AstraZeneca announced earlier in the quarter.

As we had cautioned in July, the June cyber event negatively impacted third quarter results, including an unfavorable revenue impact of approximately $135 million from lost sales and approximately $175 million in costs spread across the cost of goods sold and the operating expense lines.

We anticipate a similar impact to revenue and expenses in the fourth quarter, which is reflected in our updated guidance. In addition, we borrowed $240 million of GARDASIL from the CDC stockpile to fulfill shipments in the quarter.

The borrowing was driven in part by the temporary production shutdown resulting from the cyberattack, as well as overall higher demand than originally planned. The revenue will ultimately be recognized as we replenish the stockpile, which we currently anticipate will occur in the second half of 2018.

It's worth noting that while our reported sales for the third quarter were down $210 million, absent the cyber and stockpile items, we would have had a quarter of growth, even in the face of significant LOEs. Turning to 2017 guidance.

Given our operational strength year to date as well as a more favorable exchange rate environment, we are narrowing and raising our revenue range for the full year. We now expect revenues to be between $40 billion and $40.5 billion. We continue to expect a moderate year-over-year increase in our gross margin.

We also continue to expect our non-GAAP operating expenses to grow at a mid-single digit rate compared to full year 2016, driven by higher R&D cost to support our oncology business, including the AstraZeneca collaboration, as well as vaccines and other pipeline opportunities.

We are also assuming approximately $175 million of business development expenses in the fourth quarter, largely driven by the closing of the Rigontec acquisition. We now expect the full year non-GAAP tax rate to be between 20% and 21%. We continue to project average diluted shares outstanding of approximately 2.75 billion for the year.

Taken together, we are narrowing and raising our expected non-GAAP EPS range for the full year to $3.91 to $3.97. Both our revenue and non-GAAP EPS ranges include a negative impact from foreign exchange of less than 1% using mid-October rates. In summary, we continue to execute well.

We have many opportunities in our pipeline that we believe can drive long term growth, for which we have invested in this year and we will continue to invest in throughout next year as well. We have been reallocating resources wherever possible. And we will continue to remain disciplined to maximize the long term trajectory of our business.

With that, I'll turn the call over to Adam..

Thank you, Rob, and good morning, everyone. This morning I'll provide highlights on the Performance of Global Human Health for the third quarter. And my comments will be on a constant currency basis. Global Human Health delivered sales of $9.2 billion, a decline of 4%, primarily driven by the loss of exclusivity for several products.

We continue to see strong underlying growth from launch products, including KEYTRUDA, ZEPATIER, and BRIDION. Now I'll highlight a few of our key franchises and product launches, and I'll start with oncology. This is an exciting time for Merck as a global leader in immuno-oncology.

We remain focused on executing on the extensive opportunity that we have with KEYTRUDA. And we are also excited about the growth opportunity for LYNPARZA, which we have begun co-marketing globally with AstraZeneca. I'll start with KEYTRUDA.

Worldwide sales for KEYTRUDA in the quarter exceeded $1 billion for the first time, making KEYTRUDA the second-largest product in the Merck portfolio. And in 2017 alone, we have launched six new indications in the U.S., four in Europe, and three in Japan.

In the U.S., more new patients now start on KEYTRUDA than any other I-O agent across all indications. With 10 indications in six tumor types and MSI-high cancers, U.S. KEYTRUDA sales grew to just over $600 million in the quarter.

Although there was some noise in the channel this quarter, as distributors normalized their inventory levels, if you look at the most recent script data, we have seen substantial growth in demand both year over year as well as quarter over quarter.

We continued to build on our leadership position in lung cancer with growth driven by continued adoption of KEYTRUDA monotherapy in high expressers, as well as the uptake of the KEYTRUDA/ALIMTA combination in the first-line setting. Across all of lung cancer, nearly one in three new lung cancer patients in the U.S.

are being started on KEYRUDA, making it the most prescribed treatment for new metastatic lung cancer patients. Lung cancer was our largest tumor type, but indications outside of lung cancer contributed to approximately 45% of U.S. sales.

In addition to continued leadership position in melanoma and head and neck cancer, we have seen strong momentum for the bladder cancer launch. Within just two months in the second line or greater setting, KEYTRUDA achieved I-O leadership in new Rx share, despite being the fifth market entrant.

Outside of the United States, KEYTRUDA continues to maintain a leadership position in the PD-1 class in melanoma. And we are seeing a greater contribution from lung cancer, as reimbursement is established in additional markets in the first-line and second-line settings.

Following our recent 1bladder cancer approval in Europe, we're now also working through the reimbursement process for this indication in each country. Early performance in Japan is also strong, with PD-L1 testing rates in lung cancer consistent with that in the U.S.

Altogether, we see great opportunity for KEYTRUDA around the world, and we remain focused on establishing KEYTRUDA as a foundation for the treatment of cancer. We also began working side by side with our colleagues at AstraZeneca and are ramping up our sales force to support the ongoing launch of LYNPARZA.

We are excited about the opportunity we see with the broader label in ovarian cancer. And we're looking forward to the upcoming opportunity in metastatic breast cancer. Now I'll move to JANUVIA. Global sales for the JANUVIA franchise were $1.5 billion, a decline of 2%.

While we saw volume growth globally, we also experienced continued pricing pressure as we've discussed for the last several years. While we expect pricing pressure to continue, macro trends support volume growth going forward, especially outside of the U.S.

As a result, we view our diabetes franchise as a relatively stable foundation from which to grow our portfolio of new products. Moving now to our Vaccine business. Global sales were $1.9 billion with growth outside of the U.S., including the contribution from the European JV termination. Underlying demand for GARDASIL remains strong.

And increased patient starts are helping to offset the negative impact in the transition to the two-dose regimen in the U.S. GARDASIL worldwide sales would have grown in the quarter absent our borrowing from the stockpile. Based on current trends, we are confident in the continuous supply in the U.S. going forward.

We continue to see opportunities for growth in our Vaccine business, particularly from the continued strength in GARDASIL as we move into the next year. Moving now to Hospital and Specialty. The ZEPATIER launch progressed well in the quarter with growth driven by Europe, Japan, and the U.S.

However, we recognize the evolving marketplace and competitive landscape. And while we remain focused on maximizing its potential, we expect significant pressure on ZEPATIER throughout the remainder of this year and into next year.

Finally, BRIDION delivered another great quarter with growth of more than 30%, driven by strong demand in most markets around the world, including the ongoing launch in the U.S. We have seen nearly 95% repurchasing from top accounts in the U.S., which demonstrates the market's continued positive experience with BRIDION.

In closing, our results show the benefit from our strong execution and the contribution from launches. We have good momentum in our global oncology and Vaccine businesses in addition to others. And we believe these franchises position us well for success heading into 2018. Now I'll turn the call over to Roger..

Thanks, Adam. Progress in the registration of KEYTRUDA continued during the third quarter with accelerated approval by the U.S.

Food and Drug Administration for the treatment of patients with recurrent or advanced gastric or gastroesophageal junction adenocarcinoma, who have previously received two or more lines of chemotherapy and whose tumors express PD-L1.

Also as part of our partnership with AstraZeneca, we received approval in the United States for new uses of LYNPARZA, our poly ADP-ribose polymerase inhibitor, including a new tablet formation – formulation for the fourth line treatment of patients with ovarian cancer, who have deleterious or suspected to be deleterious BRCA alleles.

LYNPARZA also received FDA approval for maintenance treatment of patients regardless of BRCA mutation status with recurrent ovarian, fallopian tube, or primary peritoneal cancer who have responded to platinum based chemotherapy. We're excited by additional data that we've seen for LYNPARZA treatment.

In particular, we announced during the third quarter that the U.S.

Food and Drug Administration accepted for review our supplemental new drug application for the use of LYNPARZA tablets in patients with germline, BRCA-mutated, HER2-negative metastatic breast cancer, who have been previously treated with chemotherapy either in the neoadjuvant, adjuvant, or metastatic setting.

The FDA granted priority review with a PDUFA action date in the first quarter of 2018. LYNPARZA is also undergoing regulatory review in Japan.

During the third quarter at the Congress of the European Society of Cardiology, we presented the results of REVEAL, our 30,000 patient study, testing whether anacetrapib, when added to an effective LDL-cholesterol lowering regimen, could reduce the risk of major cardiovascular events as compared with the placebo control.

Although the REVEAL study met its primary endpoint, after consultation with experts in cardiovascular disease, including those who had advised us through the decade-long prosecution of the anacetrapib development program, we concluded that we would not pursue regulatory filings of this drug.

We are grateful to the patients, families, and physicians who participated in this study and to the Oxford University team that led all aspects of study execution and data analysis.

Separately, after reviewing the evolving hepatitis C therapeutic landscape, we decided not to pursue development of doublet and triplet regimens containing MK-3682, our highly effective nucleoside HCV polymerase inhibitor. This decision was not stimulated by any inadequacies in the antiviral compounds themselves, especially the triplet MK-3682B.

But instead followed directly from prioritization decisions during our portfolio management process. Despite these conclusions regarding our newest HCV therapies, we remain very enthusiastic about ZEPATIER. For example, earlier this month we presented real world data from the U.S. Veterans Administration (sic) [U.S.

Department of Veterans Affairs], demonstrating very high antiviral activity in genotype 1 or 4 HCV infected patients with chronic renal disease, including a 95.6% sustained urologic response in patients with a very severe chronic kidney disease, CKD 4 and 5.

Beyond ZEPATIER, during the third quarter we continued to elaborate a broad program in infectious disease and vaccine research.

Earlier this month, we presented data from our pivotal Phase III study of letermovir, a cytomegalovirus terminase inhibitor for the prophylaxis of CMV infection or reactivation in adult recipients of allogeneic hematopoietic stem cell transplants. These data are currently under review by the FDA with a PDUFA date of November 8.

They're also being evaluated by the Committee on Human Medicinal Products (sic) [Committee for Medicinal Products for Human Use] of the European Medicines Agency.

Returning again to our oncology program, at the World Conference on Lung Cancer in Yokohama earlier this month, Julie Brahmer and colleagues presented long-term follow-up data from KEYNOTE-024, showing that in the first-line treatment of patients with non-small cell lung cancer, in which greater than 50% of tumor cells express PD-L1, the median survival for patients randomized to the KEYTRUDA arm was 30 months, as compared to 14.2 months for those receiving chemotherapy, despite a 62% effective crossover rate.

We also continue to see impressive improvements in overall survival following treatment with KEYTRUDA in combination with traditional chemotherapy.

Data presented at the European Society for Medical Oncology meetings last month documented enhanced separation of the survival curves with longer follow-up in our KEYNOTE-021G study, comparing traditional therapy, that is carboplatin/pemetrexed, with the results achieved when KEYTRUDA was added to this treatment regimen.

While the hazard ratio for overall survival was 0.9 in the primary analysis, after a median of 18.7 months follow-up, the observed hazard ratio for overall survival had fallen to 0.59. This was true despite a 75% crossover rate to anti-PD-1/L1 therapy in the chemotherapy arm.

In other words, early administration of KEYTRUDA in combination with chemotherapy seemed to confer improved overall survival.

With these results in mind, we have elected to revise the statistical analysis plan for KEYNOTE-189, a nearly 600 patient study patterned after KEYNOTE-021G, to include dual endpoints of progression pre-survival and overall survival. This revision has been reviewed and accepted by the FDA.

The timeline for completion of KEYNOTE-189 has therefore been extended to capture longer term survival data, with an estimated completion date, depending upon the underlying event rate, in February of 2019. The study is fully enrolled, as we announced in the second quarter.

And the opportunity exists to conduct interim analyses, again depending upon the underlying event rate that we observe. Lastly, I note that beyond LYNPARZA and selumetinib, in the third quarter we acquired a RIG-I antagonist through the purchase of Munich-based Rigontec.

And beyond these programs, our early oncology pipeline include 20 proprietary molecules, which have either entered the clinic or which have been approved to enter development. We are now beginning to see evidence of activity in a number of these early programs. And details of these studies will be presented in scientific meetings beginning in 2018.

I'll now turn the call back to Teri..

Thanks, Roger. We'll be moving on to our Q&A portion of the call. I would like to remind everyone to please keep to a maximum of two questions to allow us to get as many people on the call as possible this morning. So, Darla, if you can queue everyone up, please..

Certainly. Your first question is from Andrew Baum with Citi..

Thank you. Couple of questions, please.

Roger, could you comment on any differential activity you've seen in KEYNOTE-021G with patients with high versus low baseline TMB [tumor mutational burden]? And whether TMB forms part of the primary endpoint of your recently initiated ipi/pembro [ipilimumab/pembrolizumab] trial? And then second, the market is currently viewing your recent LYNPARZA deal as a play on ovarian and breast cancer.

What opportunity do you see significantly beyond that? Both in patients with germline DNA repair mutations, given the prevalence in refractory cancers, as well as in combination with KEYTRUDA? Thank you..

Right, Andrew, okay. So first of all, the question is differential activity in KEYNOTE-021G as a function of tumor mutational burden. We don't really have those kinds of data specifically. We've done a lot of work on tumor mutational burden in all of our studies. But those we're not – in response to your second question.

We're not including tumor mutational burden as an explicit endpoint within KEYNOTE-189 in part because of course one has to define cut points for tumor mutational burden.

That is, at what point within each tumor type does a tumor mutational burden rise to the point where you believe that's meaningful? And we have a lot of data of course from this from looking at MSI-high populations. And as you know we have a broad label for patients who have MSI-high tumors.

And we can see the magnitude of the tumor mutational burden in that population, where response rates are quite good. And we can look at tumor mutational burden in other populations and stratify. But there's still work to be done to define what those cut points actually are. So that's not part of the KEYNOTE-189 program.

Specifically with regard to LYNPARZA, the opportunities are really quite broad. We have, together with our colleagues at AstraZeneca, more than a dozen potential registration-enabling studies covering a broad range of tumor types.

One of the things that excited us, of course, relevant to the tumor mutational burden question, is that by virtue of the fact that PARP inhibitors have an effect on the salvage mechanism for DNA repair, the accumulation of mutations that could encode neo-androgens might be expected to increase.

And those could provide acceptable targets for T lymphocytes that would be unleashed in the presence of KEYTRUDA. So the combination of KEYTRUDA therapy and LYNPARZA is something that we're really very excited about.

Of course preliminary data along those lines has been generated with niraparib in combination with KEYTRUDA as part of our collaboration with TESARO. And we continue to pursue those studies as well..

Thanks, Roger.

We'll move on to the next question, please?.

It's from Tim Anderson from Sanford Bernstein..

Hi. This is Alex Man on for Tim. Thanks for taking my questions. I have two here, please. First, a high level question. So you guys have threaded the I-O needle very well throughout 2017, yet your stock hasn't done too much. One of the reasons for this is that investors are nervous that I-O is the only growth driver and sometimes surprises can happen.

When you think forward over the next two years to three years, what else outside of I-O can you point to as a potential source of revenue and earnings growth? And then second, on ECHO-305, one of your two newly-posted Phase III IDO combos in first-line lung, this trial only recruits high expressers.

Publicly, we've only seen early clinical data in small sample sets with this combo in lung and not much in first-line patients exclusively. So what drove the rationale to pursue the combo in high expressers only? And is the hypothesis that you really need chemotherapy to unlock IDO combo's potential in all expressers like ECHO-306? Thank you..

Let me start with the first question about our portfolio. So first of all, as a company we believe that a broad and balanced portfolio capitalizes on our strength and best positions the company for long term success.

We are committed to making the necessary investments to optimize KEYTRUDA and LYNPARZA, as you've already heard, in addition to our many other early-stage assets in oncology. At the same time, we have a number of clinical programs across our portfolio outside oncology that we believe will be meaningful growth fillers for the company long term.

For example, we're moving into Phase III with our cough compound that we acquired from Afferent. We also have a number of programs advancing in our Vaccines business. In addition, we have a lot of work going on in other areas of our early pipeline, including the next generation of HIV assets.

So again, we recognize the need to balance delivering in the short term, while making the appropriate investments to drive long term growth. We actively review our portfolio on an ongoing basis to shift resources to those assets that have higher growth potential.

So beyond oncology, we believe we have opportunities in areas like cough, in areas like Vaccines as we move forward. And we're going to continue to augment our pipeline in addition to that..

Roger, do you want to answer the other....

Yeah, so just with respect to the IDO1 combination studies. And there are, as you know, a number of studies that will be posted with respect to IDO1 combinations. We've put a lot of time into evaluating which studies in lung cancer might potentially yield results.

You're quite right, and you have seen the data that exists with respect to IDO1 combinations with KEYTRUDA. We are evaluating this information over time. But we don't have a lot of information to tell us exactly how these would behave.

The fundamental observation remains that by virtue of IDO1 inhibition that one can improve T lymphocyte responsiveness. And it represents a second axis for improvement in T lymphocyte responsiveness beyond checkpoint blockade.

It makes sense to think that you would see that activity best in a circumstance when you know there are a lot of responsive T lymphocytes. And of course we know that occurs in the setting where inflammation is already present, as in the PD-L1 high population. That's just a sort of a high level look at it.

We're looking at a bunch of other ways of trying to evaluate IDO1 inhibition in combination with KEYTRUDA.

But clearly the existence of inflammation, as we've found over the last many years of study, existence – preexistence of inflammation is important, because these molecules, IDO1 inhibitors and checkpoint inhibitors, reveal the preexisting immunity that for one reason or another is inadequate.

And so that the goal is to try and make that immunity visible through tumor reduction. That's what we're trying to get done here..

Great.

We'll move on to the next question, please?.

It's from Chris Schott with JPMorgan..

Great. Thanks very much for the questions. First one is maybe a question for Ken. Just another one of your competitors announced that they are exploring strategic options for their Animal Health business. And I know there's been some debate over time in terms of how core Animal Health is to Merck and just how it fits in the overall portfolio.

So can we just get your updated thoughts on just Animal Health, that business? How it fits within the broader Merck story? Just as we think about kind of different approaches to those franchises from some of your competitors? My second question was on the KEYNOTE-189 endpoint co-primary.

Will we hear from the company on PFS prior to the overall study wrapping up? Or do we really need to wait for both endpoints to hit before we'll get any update from Merck? And then maybe more broadly as part of that discussion, can you just talk about just a little bit more on the confidence that you can show in OS benefit here despite the crossover? I know we had some encouraging data from KEYNOTE-021G.

But just as you're adding that to the – as a primary here, just I guess a little bit more in terms of just your overall confidence on overall survival here. Thank you..

Thanks for the question, Chris. So we are focused on driving long term growth through innovation generally. And we see Animal Health and the innovation that we can create through that portal as a pillar of growth for the company. As we noted this quarter, it surpassed $1 billion for the first time inside our portfolio, which is meaningful.

And we continue to see it going forward as a key growth driver, because it has healthy margins and as well as a strong market outlook. So from our perspective we see it fitting very nicely and augmenting our growth as an overall company. And we intend, where we find opportunities, to further augment that business with additional business development.

So it's an important part of our business, Chris..

And, Chris, regarding KEYNOTE-189, the key issue, as you know, is that when you look at the curves for PFS as opposed to OS, the PFS curves separate essentially at the first time of analysis. So at three months, those curves are already quite different for the combination of KEYTRUDA plus chemotherapy as opposed to chemotherapy alone.

For OS, the curves are separating at 12 months. But in the KEYNOTE-021G study, perhaps in part because of the small size of that study with only 16 patients per group, you're really not seeing meaningful separation of those curves until you get out closer to 18 months and beyond based on what we have right now.

Now with the improved power of the KEYNOTE-189 study, we may be able to see that earlier. But the idea would be, to the extent possible we would like to preserve the overall survival results. And that is – overall survival is of course the gold standard. It's what we're all trying to achieve.

And we see KEYNOTE-189 as really very important in terms of how physicians will manage lung cancer patients for a long time to come.

To the extent that we announce the PFS data when these data become positive, then of course we're going to be driving people who believe that they are not receiving KEYTRUDA, we're going to be driving them out of the study. And we've got to be very careful about that.

So while there will be opportunities for interim analyses in the study, we're going to be careful to preserve the integrity of the study. You can be confident that as soon as we have results that we think are meaningful, you'll be the second to know. We're definitely going to announce these results. It will be very important.

But we want to preserve the integrity of the study in the interest of patient care..

We'll move on to the next question, please..

It's from David Risinger with Morgan Stanley..

Thanks very much. So I wanted to follow up with questions on KEYNOTE-189 and the IDO Phase III trial. So with respect to KEYNOTE-189, Roger, the enrollment completed in February of 2017 according to clinicaltrials.gov.

Just wondering why the primary completion would be two years later in February of 2019 for OS? And related to that, maybe that the event rate is low because the KEYTRUDA combo is keeping patients alive much longer.

But based upon the event numbers that you have in hand, should we assume that the first interim timing is the first half of next year? Or is there any other color you can provide on the first interim look timing? And then separately with respect to the IDO Phase IIIs that have been posted, could you please provide a framework for them? And the expected timing of readouts? Thank you..

Right, David. On KEYNOTE-189, yeah. The study completed a little bit later. I mean it completed enrollment a little bit later, I think in March. But the event rate – based on our prior experience and what we're seeing now, the event rate is low.

And so we simply calculate, well, based on the power of the study and what we expect the hazard ratio to be, we simply calculate how long – how many events we will have, at which times, and how many events we need to see. And that's how we come up with the date. On the other hand, we're going to be following that event rate very closely.

And so it can't have stabilized at this point. And so we do expect that there will be opportunities for interim analyses and that we'll have a chance to see them. I can't give you any clarity about exactly when that will take place.

And again, with IDO1, I think the issue is that across a range of different tumor types, we saw evidence that the combination of IDO1 with KEYTRUDA appeared to provide benefit in terms of response rate. That's what drove the Phase III study design. We announced that there will be a half dozen such studies.

And we were just beginning to post those studies. The information that's on clinicaltrials.gov gives you a feel for what we're trying to get done there.

But I hasten to add we do not know for sure that the combination of IDO1 plus KEYTRUDA in a larger study, where you have randomization and control, that you're actually going to see that improvement in response rate, or that improvement in response rate will translate into durable responses that have a meaningful impact on progression and overall survival.

So those are the things that we're going to be looking at, because clearly we're trying to improve treatment for cancer patients. It's that simple..

Okay. We'll move on to the next question, please..

From Steve Scala with Cowen..

Well, thank you very much. Merck's KEYNOTE-189 and Roche's IMpower-150 had similar primary completions. But IMpower-150 will still read out PFS and OS this year. And then take another look at OS in the first half of next year.

Could you perhaps compare and contrast what Merck is doing relative to PFS and OS readouts versus what Roche is doing? Specifically the simultaneous versus step-wide readouts? I'm not sure I understand why Roche can do a step-wide readout, and Merck believes simultaneous is the way to go. And secondly, consensus is looking for 7% EPS growth in 2018.

Ken, any preliminary thoughts on the outlook for 2018? There are clearly opportunities for growth but also some risks. Any thoughts would be appreciated. Thank you..

Right, Steve. So I can't really comment on IMpower of course and how they've designed their studies and what treatment effect they believe they're seeing. For us, we decided to revise our program in order to put more – to assign more of the study power to the overall survival endpoint. We have dual primary endpoints.

And overall survival is clearly the important thing. KEYNOTE-021G gives us a lot of confidence we had anyway in terms of the improvement of PFS. The issue really is the OS data. That's the thing that's proved to be most important.

And really to us, very impressive that overall survival is continuing to separate as we look further on in the KEYNOTE-021G study, despite the fact that the study is really comparing early versus late KEYTRUDA therapy. Remember, everybody gets chemotherapy and then they get KEYTRUDA.

The crossover numbers are such that anybody who fails on chemotherapy then gets KEYTRUDA. And what that means is you either got KEYTRUDA at the beginning, or you got it late. And because there's such a dramatic decline in PFS, with a median PFS of less than nine months in the chemotherapy arm, everybody gets KEYTRUDA pretty quickly.

So that business of KEYTRUDA versus early versus late becomes very important. And that's the thing we really want to make sure that we understand and that we obtain very solid data on in the KEYNOTE-189 study. Because ultimately that's practice changing. That's crucially important.

That's crucially important for the survival of patients with non-small cell lung cancer. So that's what we've done in that study..

Great. Yeah. Thanks, Roger. Good morning, Steve. And to your second question about EPS growth in 2018, as you know, we don't provide specific guidance for 2018 until we get to our fourth quarter 2017 earnings call, which will be in February. But maybe I can provide to your point some of the headwinds and tailwinds that give a sense of what we're seeing.

I would just start by reiterating the point that Ken made, that we do have several pillars of long term growth. Obviously it starts with KEYTRUDA and what we continue to believe is a real opportunity there for continued growth, not only with KEYTRUDA but expanding with the broader oncology portfolio.

With our vaccines business, we continue to expect to see good growth, especially GARDASIL. And then obviously Adam touched upon what we've seen this year with BRIDION, which has really done quite well. And we continue to believe has great growth opportunities as we look forward. And then finally I'd just highlight Animal Health.

Animal Health grew 14% in the quarter. It's growing double digits year to date. And we continue to see very strong growth in that business. And given the fact that it's now reaching a size, to Ken's point, that it was $1 billion in the quarter, it's meaningful to our overall portfolio.

So we think we have a lot of opportunities to drive good growth on the top line next year. But obviously we do have some pressures with ZEPATIER and ZOSTAVAX, to name a few, as well as obviously continuing LOE pressure, particularly from ZETIA/VYTORIN as that tails off as we move into next year.

And then the only other point I'd make is that Adam highlighted JANUVIA we see as a very stable product, which is really going to be the foundation from which we'll drive growth with the other pillars I mentioned, even given some of the pricing pressure we face there.

And then finally, as you think about investments, clearly we continue to believe we have real opportunity on an R&D front for continued investment. A lot of promise, not only with KEYTRUDA and LYNPARZA but the broader oncology pipeline that we're starting to advance and add to with things like Rigontec that Roger mentioned.

And then beyond that, other products that we continue to want to invest in, vaccines and others in the pipeline. So we are going to make meaningful investment in R&D next year. That will make driving an overall leveraged P&L more challenging as we get into next year. But obviously we remain committed to that long term.

And we will do everything we can to be disciplined and reallocate resources behind those growth opportunities by making the right trade-offs to drive growth. So hopefully that gives you a sense of some of the pushes and pulls. And then we look forward to February, where we'll give you more specifics..

Great. We'll move on to the next question, please..

It's from Alex Arfaei with BMO Capital Markets..

Okay. Good morning, folks. Thank you very much for taking the questions. Roger, first on KEYNOTE-189, I just want to make sure that I heard you correctly.

Is everybody in the chemo arm, once they progress, will they all get KEYTRUDA? And the reason I ask that question is in KEYNOTE-021G with 60% to 70% crossover, you're clearly seeing the chemo arm being lifted and doing much better than traditionally expected.

So with presumably 100% crossover, again I'm just trying to struggle how you're confident about hitting that OS endpoint, given that we know PD-1s are effective in a second-line setting. And my follow-up for Adam.

Since you're basically going to have to promote KEYNOTE-021G for another 1.5 years, what's the feedback you're getting from physicians regarding the latest updates at ESMO? Are they believing your latest 19-month median PFS 70% 18-month OS rate, et cetera? Or are you still getting significant pushback? And could you give us an approximate breakdown of KEYTRUDA sales by indications, please? Thank you very much..

So, Alex, no, there's no mandatory crossover. And you've hit the exact point, which was in response to a different question from (43:56), which is basically if we are – if we look at the study and we announce PFS.

And the study is very positive in PFS at a time when overall survival is immature, the fact that that study behaves in that way will cause patients who are progressing to drop out. They will gain access, of course, to KEYTRUDA in second line.

We've already demonstrated that KEYTRUDA is extremely effective in second-line therapy based on the KEYNOTE-010 data. And so in essence you're going to be looking at crossover.

But the key thing we need to understand in this patient population is really what is the overall survival difference as a result of providing the combination of KEYTRUDA plus chemotherapy early as opposed to KEYTRUDA plus chemotherapy late? And so we want to try and make sure that we can understand that difference, because that's what's important ultimately for physicians and for patients, as they contemplate how best to treat non-small cell lung cancer.

This is the opportunity to do that..

And to answer your question regarding the uptake in lung cancer, I mean in the United States and also in Japan, we're seeing a very strong uptake in lung cancer. And if you look at the high expressers above 50, we're seeing significant utilization of KEYTRUDA monotherapy.

If you look at expressers between 1 and 50, that's where we're seeing increased use of the combination with ALIMTA. We're hearing that now that it's in our label, physicians are being more comfortable to prescribe the combination therapy. We're hearing that a lot in the community sector where they treat most of the lung cancer patients.

And they're used to using chemotherapy, so they feel very comfortable with the combination.

In addition, what we're really trying to work on now is in the non-expressers or in the patients that are not PD-L1 tested to reinforce that we have the indication for the combination to be used in those patients, which we think represents an additional significant opportunity.

And we're spending a lot of time educating physicians on those patient types. To give you a rough estimate, we think about 55% of our sales are coming from lung cancer in the U.S., about 20% melanoma, 10% head and neck, 5% bladder, and then 10% everything else..

Great. Thanks, Adam. We'll go on to the next question, please..

It's from Gregg Gilbert with Deutsche Bank..

Thanks. Have a vaccine question for you. We noticed you were trying to IPR some Prevnar patents.

And was curious how that relates to your pneumococcal vaccine and its status? And when you could take that one into Phase III? And then for Roger, on your pembro/ipi study that was recently posted, have you designed that to answer any questions that will not be answered by [CheckMate] 227 from Bristol, other than the obvious fact that the PD-1 agents are different? Thanks..

Right, Gregg. So the first question is with respect to our pneumococcal conjugate vaccine program. We have a very broad program in pneumococcal conjugate vaccines. We are looking at mechanisms whereby we can expand the set of carbohydrate specificities in order to improve vaccination, improve resistance to invasive pneumococcal disease.

We believe that we have freedom to operate in this area. We've always believed that. And we are moving forward with the first of these opportunities, V-114, which will be advancing into Phase III very shortly.

With respect to the combination of ipilimumab with KEYTRUDA, the study is designed to look to see whether those two agents when combined together really offer meaningful advantage as opposed to KEYTRUDA alone.

I think that comparison, the randomized comparison of the combination of those two agents versus KEYTRUDA alone is a critical one, because of course you do add very substantial toxicity when you add ipilimumab to the therapeutic regimen. And of course we've already demonstrated the impressive results that one gets in combination with chemotherapy.

So that's the comparison that ultimately needs to be made..

Great. Thanks. We'll move on to the next question, please..

It's from Vamil Divan with Credit Suisse..

Hi. Great. Thanks for taking the question. Maybe just shifting a little bit to the diabetes side. And you mentioned you feel that portfolio is stable. We obviously have JANUVIA LOE coming in a few years. You have (48:42) in the glargine biosimilar.

But just curious given what JANUVIA is going to face a few years from now and also the decision on anacetrapib, is that maybe an area that you've looked to sort of boost through business development to kind of have multiple portfolio down the road? Or maybe just more broadly beyond oncology, what areas are you focused on in terms of business development? And then one question, a follow-up just on the oncology side with the MSI-high indication.

Just curious how that's going from a commercial perspective in terms of obviously there's no MSI-high doctors out there. So how you're approaching that from a commercial perspective? And what sort of traction you're getting in people using that biomarker? Thanks..

Okay. Well, thanks, Vamil, for the question. As it relates to our business development strategy, what we're looking for is the opportunity to find the best scientific innovations that will enhance our overall pipeline and help our patients live healthier lives. Diabetes is a very important category for us.

And therefore we will continue to look for opportunities to provide a benefit to diabetic patients. But I think overall, I think the key here is we are agnostic, pretty much, to the therapeutic category. We like the work that we're doing in oncology.

But we'll look beyond oncology to find other partnerships and collaborations and acquisitions that actually provide differentiated drug, regardless of therapeutic area. So I think we have a strong series of opportunities to grow our pillars our Vaccines and oncology and Animal Health. Diabetes remains important to us.

And we'll look for those opportunities in diabetes and elsewhere..

And with regard to MSI-high, obviously having a multitude of indications is very helpful. And it helped establish KEYTRUDA as a new standard of care in oncology. What we're doing right now is working to increase awareness of MSI-high testing and the value of KEYTRUDA across other tumor types.

As you know MSI-high is an established biomarker, but it's primarily used in colorectal cancer or endometrial cancer. Right now if you think about MSI-high, it's available across a wide spectrum of cancers, some that are common like I just mentioned. Others that are uncommon. So it really is a lot of education in the marketplace.

So I do believe over time it will be a meaningful opportunity. But in the short term, it's going to take some time for education as the market will evolve..

Great. We'll move on to the next question, please..

It's from Geoff Meacham with Barclays..

Morning, guys. Thanks for the question. Roger, on the recent ECHO-202 data in melanoma, can you talk a little bit about the PD-L1 negative cohort? I'm just trying to reconcile what we could see in melanoma in Phase III, versus the lung opportunity.

And then on Adam – for Adam, ahead of the potential KEYNOTE-021G approval in Europe, what's your early read on the risk/benefit perceptions from EU docs, versus what you've seen or heard so far in the U.S.? And do you think that the reimbursement or uptake will be influenced by whether or not you have the KEYNOTE-189 data? Thank you..

So, Geoff, on ECHO data, let me just say that we do not have sufficient information at the present time to know whether the combination of IDO1 antagonist and KEYTRUDA actually provides meaningful benefit. We continue to accrue data that is intriguing, that says that there is an improvement in response rate.

And as I've said before, that that relates to both breadth and depth of response. We are hopeful that that will translate in Phase III studies into something really very meaningful. But at the moment we don't have those data in hand. We're pursuing that through a very broad Phase III program, as you know..

And with regard to lung, we continue to see good progress. And in the EU, we've worked really hard to increase the number of patients being tested for PD-L1 status. And as you look across the various countries, we're seeing the pickup very significantly. So in Germany, it's over 60% already. In the UK, it's greater than 90%.

Our focus right now is really continuing to work through the reimbursement process for first-line and second-line lung. And each and every month, we have new countries that are coming on. And we're getting more and more reimbursement. We'll have to wait ultimately to see more about KEYNOTE-021G before we can comment..

Go on to the next question, please?.

It's from Umer Raffat with Evercore..

Hi. Thanks so much for taking my question. So I have a three – I have one question but with three parts. And I want to focus specifically on the new first-line lung trial of KEYTRUDA plus epacadostat, ECHO-306. And here's what I find interesting. The comparator arm in this ECHO-306 is KEYTRUDA plus chemo.

So that's the highest bar we've ever seen in first-line lung to-date. So here's my three-part question.

One, can you confirm you were actively involved in the trial design? Two, I'm just curious how you're thinking about pitting pembro plus IDO versus this KEYTRUDA plus chemo comp? And then finally, the fact that you have this KEYTRUDA plus chemo comp in this trial, is this a further validation of your confidence in this combo, especially as we head into KEYNOTE-189? Thank you..

So, Umer, first of all, the – we are actively involved with our colleagues at [BioPharm] Insight in designing all of these studies. These are not things that are being pursued independently by them.

Secondly, the study design – and we've gone through many, many iterations on study design – we chose this particular study design because we are eager to see the contribution both in terms of efficacy as well as safety. Epacadostat in combination with KEYTRUDA compared to what we now regard as a standard in the non-small cell lung cancer setting.

It is a high bar as you say, because the results of that, as demonstrated by KEYNOTE-021G and some other information we previously reported, are very impressive.

And as I've said I think repeatedly on this call, I just want to make plain, we're doing these Phase III studies because we do not have randomized data that tell us that the combination of KEYTUDA plus epacadostat provides meaningful benefit.

We have single-arm data that are very intriguing, because they imply that we have improved response rates, both breadth and depth. And that may translate into improvements in PFS and overall survival versus monotherapy, or in this case the combination. But it is – we do not have that information. That's the reason we're doing these studies.

And we're optimistic that we will see the benefit that we believe we've seen in single-arm studies. But we just don't know..

All right. We'll take another question. We're running out of time. We're going to try to get through one more at least, and if we can, one other..

And your next question is from Jami Rubin with Goldman Sachs..

Thank you very much. Ken, a question for you. Just reading the company's press release, you do mention very early on in your prepared remarks that BD is expected to be an important growth driver, or you're looking to BD as an important growth driver. We hadn't seen that in previous press releases before.

I'm just wondering if you could talk to that, just the importance of business development as the company sort of moves into the next decade with the JANUVIA patent expiration.

What you think is that – do you think of a large scale acquisition as something that you think will be necessary going forward? And, Rob, you did a really helpful job talking about 2018 without giving guidance.

Can you be a little bit more specific on operating expenses? Clearly R&D is going up, but what about SG&A? Should we assume operating expenses can be maintained next year? Or should we assume that they will be up? And just lastly, Roger, for you on KEYNOTE-189, how will you allocate the statistical analysis between PFS and OS? Thanks very much..

Well, good morning, Jami. Let me first of all say that I'd have to go back and look at the other press releases, because we've tried to talk about the importance of business development consistently. And what I would say is that our perspective on business development is unchanged. And that is that it is an important priority for the company.

We're very actively engaged and looking for the best scientific innovations to enhance our long term growth in our pipeline. As it relates to large transactions, what we've said is that we're primarily looking for those things that enhance the company's ability to innovate. We're not looking at things purely for synergies or consolidation purposes.

And so I would think that our view continues to be that we're going to look for those things, particularly bolt-ons, that will help us as we go further with our innervation strategy..

Great.

Rob, do you want to take the next?.

Yeah. Yeah. Good morning, Jami. Thanks for the question. So to be maybe a little more specific than I was a minute ago. Obviously as we have constantly stated, our goal is to drive operating leverage long term.

So that continues to be where our focus is, through looking at opportunities to make trade-offs and reallocation of resources to drive productivity.

With that being said, we do anticipate operating expenses to increase as we move into next year, primarily driven by R&D with the opportunities we talked about around KEYTRUDA, LYNPARZA, and the broader portfolio. So that is something we expect.

And overall expenses will rise, even though we will do our best to manage on the SG&A line, to make the appropriate trade-offs, and drive those investments in R&D, as well as though to make sure we're continuing to invest appropriately behind some of the key launches. So hopefully that gives a little more clarity than what I said earlier..

And, Jami, with respect to KEYNOTE-189, as you know, we don't provide details of statistical analysis plans and health allocation. So I'm not going to go through that with you. But suffice it to say that we believe the overall survival part of the study is extremely important..

So let me just close the call by saying thank you again for joining us. We are executing well. And we expect topline strength from this year, particularly for KEYTRUDA, GARDASIL, and Animal Health to continue into 2018 and beyond. We're also focusing on delivering a sustainable pipeline to drive our long term growth.

And as a result, we'll continue to invest in R&D. And I'd also like to just take a moment to acknowledge all those who were impacted by the storms in Puerto Rico and Mexico over the past couple of months. I'd just say the courage and resilience that's been demonstrated is notable.

And I want to thank particularly our many dedicated employees who've helped us through that period. Thank you..

Ladies and gentlemen, this concludes today's conference call. You may now disconnect..