As filed with the Securities and Exchange Commission on February 28, 2007

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D. C. 20549

 

 

 

 

FORM 10-K

 

Commission File No. 1-3305

 

 

 

 

Merck & Co., Inc.

One Merck Drive

Whitehouse Station, N. J. 08889-0100

(908) 423-1000

 

 

Securities Registered pursuant to Section 12(b) of the Act:

 

 

Number of shares of Common Stock ($0.01 par value) outstanding as of January 31, 2007: 2,166,483,163.

 

Aggregate market value of Common Stock ($0.01 par value) held by non-affiliates on June 30, 2006 based on closing price on June 30, 2006: $79,306,000,000.

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes þ     No o

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes o     No þ

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes þ     No o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.

Large accelerated filer þ               Accelerated filer o               Non-accelerated filer o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o     No þ

 

Documents Incorporated by Reference:

 

 

 

Table of Contents

 

 

Merck & Co., Inc. (“Merck” or the “Company”) is a global research-driven pharmaceutical company that discovers, develops, manufactures and markets a broad range of innovative products to improve human and animal health. The Company’s operations are principally managed on a products basis and are comprised of two reportable segments: the Pharmaceutical segment and the Vaccines segment. The Pharmaceutical segment includes human health pharmaceutical products marketed either directly or through joint ventures. These products consist of therapeutic and preventive agents, sold by prescription, for the treatment of human disorders. Merck sells these human health pharmaceutical products primarily to drug wholesalers and retailers, hospitals, government agencies and managed health care providers such as health maintenance organizations and other institutions. The Vaccines segment includes human health vaccine products marketed either directly or through a joint venture. These products consist of preventative pediatric, adolescent and adult vaccines, primarily administered at physician offices. Merck sells these human health vaccines primarily to physicians, wholesalers, physician distributors and government entities. The Company’s professional representatives communicate the effectiveness, safety and value of our pharmaceutical and vaccine products to health care professionals in private practice, group practices and managed care organizations.

 

For financial information and other information about the Pharmaceutical segment and the Vaccines segment, see Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Item 8. “Financial Statements and Supplementary Data” below.

 

Overview — During 2006, Merck continued to execute its strategy to reclaim its leadership position in the pharmaceutical industry. This was made evident through the successful launches of five novel medicines and vaccines in areas such as cancer prevention and diabetes, the advancement of drug candidates through every phase of the Company’s pipeline and the continued success of its newer and in-line products. Additionally, the Company is developing a new commercial model which is designed to broaden its engagement with customers and scientific leaders, leverage alternative channels to complement the effectiveness of its sales force, and drive growth in key markets.

 

During 2006, five products received U.S. Food and Drug Administration (“FDA”) approval: Gardasil [Quadrivalent Human Papillomavirus (Types 6, 11, 16, 18) Recombinant Vaccine], the first vaccine for the prevention of cervical cancer and genital warts caused by certain types of human papillomavirus (“HPV”); Januvia (sitagliptin phosphate), the first medicine of its class that enhances a natural body system to improve blood sugar control in patients with type 2 diabetes; Zostavax [Zoster Vaccine Live (Oka/Merck)], the first vaccine for adults 60 years of age and older to reduce the incidence of shingles, a disease which every year afflicts an estimated one million people in the United States alone; RotaTeq (rotavirus vaccine, live, oral pentavalent), a pediatric vaccine to help prevent rotavirus gastroenteritis in infants and children, the effects of which take the lives of nearly 600,000 children under the age of five worldwide every year; and Zolinza (vorinostat), a novel medicine to treat patients suffering from advanced cutaneous T-cell lymphoma (“CTCL”).

 

In addition, the Company has three drug candidates currently under FDA review: Janumet (previously referred to as MK-0431A), an investigational oral medicine combining sitagliptin phosphate with metformin for type 2 diabetes that is designed to provide an additional treatment option for patients who need more than one oral agent to help control their blood sugar; Emend For Injection (MK-0517), an intravenous therapy for chemotherapy-induced nausea and vomiting (“CINV”); and Arcoxia, Merck’s selective Cox-2 inhibitor for osteoarthritis. Additionally, the Company anticipates filing three New Drug Applications (“NDA”) with the FDA in 2007: MK-0518, a first-in-class HIV integrase inhibitor; gaboxadol, a novel compound from Merck’s alliance with H. Lundbeck A/S for the treatment of insomnia; and MK-0524A, an extended-release (“ER”) niacin combined with laropiprant (a novel flushing pathway inhibitor) for cholesterol management. In addition, by mid-year 2007, Merck expects to have four products in Phase III development.

 

Additionally, targeted acquisitions made during the year of Sirna Therapeutics, Inc. (“Sirna”), GlycoFi, Inc. (“GlycoFi”) and Abmaxis, Inc. (“Abmaxis”), as well as other alliances and collaborations, will complement

Merck’s strong internal research capabilities and should continue to help the Company build a pipeline that will support its long-term growth.

 

Merck is working to deliver innovative and differentiated products to the market faster and more efficiently. The Company has successfully reduced late development product cycle times and anticipates further reductions in the coming year. Additionally, Merck’s new commercial model is expected to lower spending per primary care brand by 15% to 20% in the United States from 2005 through 2010 (an interim targeted 9% reduction is expected to be achieved through the end of 2007) while still appropriately supporting product launches, as illustrated in the successful launch of five new products in 2006. Through redeployment, the launches were achieved with no increase in sales force.

 

The initial phase of a global restructuring program designed to reduce the Company’s cost structure, increase efficiency and enhance competitiveness is underway. The initial steps include the implementation of a new supply strategy by the Merck Manufacturing Division, which is intended to create a leaner, more cost-effective and customer-focused manufacturing model over a three-year period. As part of this program, in 2005, Merck announced plans to sell or close five manufacturing sites and two preclinical sites by the end of 2008 (three of the manufacturing sites were closed, sold or had ceased operations and the two preclinical sites were closed by the end of 2006), and eliminate approximately 7,000 positions company-wide (of which approximately 4,800 positions were eliminated by the end of 2006 comprised of actual headcount reductions, and the elimination of contractors and vacant positions). However, the Company continues to hire new employees as the Company’s business requires it. The Company has also sold certain other facilities and related assets in connection with the restructuring program. The pre-tax costs of this restructuring program were $935.5 million in 2006 (comprised of $793.2 million primarily representing accelerated depreciation and asset impairment costs and $142.3 million of separation and other restructuring related costs) and are expected to be $300 million to $500 million in 2007. Through the end of 2008, when the initial phase of the restructuring program relating to the manufacturing strategy is expected to be substantially complete, the cumulative pre-tax costs of the program are expected to range from $1.9 billion to $2.2 billion. Merck continues to expect the initial phase of its cost reduction program to yield cumulative pre-tax savings of $4.5 to $5.0 billion from 2006 through 2010.

 

With respect to the Vioxx litigation, to date in the Vioxx Product Liability Lawsuits, of the 29 plaintiffs whose claims have been scheduled for trial, the claims of seven were dismissed, the claims of seven were withdrawn from the trial calendar by plaintiffs, and juries have decided in Merck’s favor nine times and in plaintiffs’ favor four times. In addition, in the recent California trial involving two plaintiffs, the jury could not reach a verdict for either plaintiff and a mistrial was declared. A New Jersey state judge set aside one of the nine Merck verdicts. With respect to the four plaintiffs’ verdicts, Merck already has filed an appeal or sought judicial review in each of those cases, and in one of those four, a federal judge overturned the damage award shortly after trial. In addition, a consolidated trial with two plaintiffs is currently ongoing in the coordinated proceeding in New Jersey Superior Court before Judge Carol E. Higbee and another trial has commenced in state court in Illinois. During 2006, the Company spent $500 million in the aggregate, including $175 million in the fourth quarter, in Vioxx legal defense costs worldwide. During 2006, the Company recorded charges of $673 million to increase the reserve solely for its future legal defense costs related to Vioxx litigation and at December 31, 2006 the balance of the reserve was $858 million. This reserve is based on certain assumptions and is the best estimate of the amount the Company believes, at this time, will be spent through 2008. The Vioxx litigation is more fully discussed in Item 3. “Legal Proceedings” below.

 

Earnings per common share assuming dilution for 2006 were $2.03, including the impact of the global restructuring program of $0.28 per share, the acquired research charge related to the acquisition of Sirna of $0.21 per share and the acquired research charge related to the acquisition of GlycoFi of $0.14 per share (as discussed in “Acquisitions” below), additional reserves established solely for future legal defense costs for Vioxx litigation (as discussed in Item 3. “Legal Proceedings” below) and the impact of adopting a new accounting standard requiring the expensing of stock options (as discussed in Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” below).

 

Product Sales

 

Sales¹ of the Company’s products were as follows:

 

 

 

The Company’s pharmaceutical products include therapeutic and preventive agents, generally sold by prescription, for the treatment of human disorders. Among these are Singulair (montelukast sodium), a leukotriene receptor antagonist respiratory product for the chronic treatment of asthma and for the relief of symptoms of allergic rhinitis; Cozaar (losartan potassium)/Hyzaar (losartan potassium and hydrochlorothiazide) and Vasotec (enalapril maleate), the Company’s most significant hypertension and/or heart failure products; Fosamax (alendronate sodium) and Fosamax Plus D (alendronate sodium/cholecalciferol), Merck’s osteoporosis products for treatment and, in the case of Fosamax, prevention of osteoporosis; Zocor (simvastatin), Merck’s atherosclerosis product; Primaxin (imipenem and cilastatin sodium) and Cancidas (caspofungin acetate), anti-bacterial/anti-fungal products; Cosopt (dorzolamide hydrochloride and timolol maleate ophthalmic solution) and Trusopt (dorzolamide hydrochloride ophthalmic solution), the largest-selling ophthalmological products; Proscar (finasteride), a urology product for the treatment of symptomatic benign prostate enlargement; Maxalt (rizatriptan benzoate), an acute migraine product; and Propecia (finasteride), a product for the treatment of male pattern hair loss.

 

Among the products included within vaccines/biologicals are Varivax (varicella virus vaccine live [Oka/Merck]), a vaccine to help prevent chickenpox, M-M-R II (measles, mumps and rubella virus vaccine live), a vaccine against measles, mumps and rubella, ProQuad [measles, mumps, rubella, varicella (Oka/Merck) virus vaccine live], a pediatric combination vaccine against measles, mumps, rubella and varicella, Gardasil, a vaccine for the prevention of cervical cancer and genital warts caused by certain types of HPV, Pneumovax (pneumococcal vaccine polyvalent), a vaccine for the prevention of pneumococcal disease, RotaTeq, a vaccine to help protect against rotavirus gastroenteritis in infants and children, and Zostavax, a vaccine to help prevent shingles (herpes zoster).

 

Other primarily includes sales of other human pharmaceuticals, pharmaceutical and animal health supply sales to the Company’s joint ventures and revenue from the Company’s relationship with AstraZeneca LP, primarily relating to sales of Nexium (esomeprazole magnesium) and Prilosec (omeprazole).

 

U.S. Product Approvals — On February 3, 2006, the FDA approved RotaTeq, a pediatric vaccine to prevent rotavirus gastroenteritis in infants and children. RotaTeq is an oral pentavalent three-dose liquid vaccine that

contains five reassortant rotaviruses. Merck has also submitted applications for licensure of RotaTeq in more than 100 countries including Australia, Canada and countries in Asia and Latin America and, through Sanofi Pasteur MSD (“SPMSD”), Merck’s vaccine joint venture with Sanofi Pasteur, in the European Union (“EU”). RotaTeq also received regulatory approval in Mexico in November 2005.

 

On May 26, 2006, the FDA approved Zostavax for the prevention of herpes zoster (shingles) in individuals 60 years of age and older. It was also approved by regulatory authorities in the EU and Australia in May. Zostavax is the first and only medical option approved for the prevention of shingles.

 

On June 8, 2006, the FDA approved Gardasil, the first and only vaccine to prevent cervical cancer and vulvar and vaginal pre-cancers caused by HPV types 16 and 18 and to prevent low-grade and pre-cancerous lesions and genital warts caused by HPV types 6, 11, 16 and 18. In the United States, it is estimated that approximately 9,700 women will be diagnosed with cervical cancer this year, and approximately 3,700 women will die.

 

On October 6, 2006, the FDA approved oral Zolinza for the treatment of cutaneous manifestations in patients with CTCL, a form of non-Hodgkin’s lymphoma, who have progressive, persistent or recurrent disease on or following two systemic therapies. CTCL is a cancer of the T-cells, a type of white blood cell, which affects the skin.

 

On October 17, 2006, the FDA approved Januvia, the first and only dipeptidyl peptidase-4 (“DPP-4”) inhibitor available in the United States for the treatment of type 2 diabetes. Januvia has been approved as monotherapy and as add-on therapy to either of two other types of oral diabetes medications, metformin or thiazolidinediones, to improve blood sugar (glucose) control in patients with type 2 diabetes when diet and exercise is not enough.

 

On June 29, 2006, the U.S. Centers for Disease Control and Prevention’s (“CDC”) Advisory Committee on Immunization Practices (“ACIP”) unanimously voted to recommend that children 4 to 6 years of age routinely receive a second dose of varicella-containing vaccine to help protect against chickenpox. The Committee also recommended that children, adolescents and adults who received only one dose of varicella-containing vaccine receive a second, “catch-up” dose, which can be accomplished through routine health-care visits and school- and college-entry requirements. Merck’s Varivax and its combination vaccine ProQuad are the only vaccines to help protect against chickenpox available in the United States.

 

Voluntary Withdrawal of Vioxx — On September 30, 2004, Merck announced a voluntary worldwide withdrawal of Vioxx, its arthritis and acute pain medication. The Company’s decision, which was effective immediately, was based on new three-year data from a prospective, randomized, placebo-controlled clinical trial, APPROVe (Adenomatous Polyp Prevention on Vioxx).

 

The trial, which was stopped, was designed to evaluate the efficacy of Vioxx 25 mg in preventing the recurrence of colorectal polyps in patients with a history of colorectal adenomas and, in combination with two other trials, to further assess the cardiovascular safety of Vioxx. In this study, there was an increased relative risk for confirmed cardiovascular events, such as heart attack and stroke, which became apparent beginning after about 18 months of treatment in the patients taking Vioxx compared to those taking placebo. For approximately the first 18 months of the APPROVe study the Vioxx and placebo curves appeared to be similar and, in this respect, the APPROVe results were similar to the results of two placebo-controlled studies described in the U.S. labeling for Vioxx as of the time of withdrawal.

 

The Company estimates that there were 105 million U.S. prescriptions written for Vioxx from May 1999 through August 2004. Based on this estimate, the Company estimates that the number of patients who have taken Vioxx in the United States since its 1999 launch is approximately 20 million. The number of patients outside the United States who have taken Vioxx is undetermined at this time.

 

In October 2004, the Company received a letter from Senator Charles Grassley, Chairman of the Senate Committee on Finance, requesting certain documents and information related to Vioxx. The Company also received requests for information from other Congressional committees. The Company has cooperated with these inquiries and has continued to describe the reasons for the Company’s voluntary withdrawal of Vioxx and to answer any

questions related to the Company’s development and extensive testing of the medicine and its disclosures of the results of its studies.

 

On February 16-18, 2005, the FDA held a joint meeting of the Arthritis Advisory Committee and the Drug Safety and Risk Management Advisory Committee. The committees discussed the overall benefit-to-risk considerations (including cardiovascular and gastrointestinal safety concerns) for COX-2 selective nonsteroidal anti-inflammatory drugs and related agents. On February 18, 2005, the members of the committees were asked to vote on whether the overall risk versus benefit profile for Vioxx supports marketing in the United States. The members of the committees voted 17 to 15 in support of the marketing of Vioxx in the United States. The Company looks forward to further discussions with the FDA and other regulatory authorities about Vioxx.

 

As previously announced, the Board of Directors of the Company appointed a Special Committee to review the Company’s actions prior to its voluntary withdrawal of Vioxx, to act for the Board in responding to shareholder litigation matters related to the withdrawal of Vioxx and to advise the Board with respect to any action that should be taken as a result of the review. In December 2004, the Special Committee retained the Honorable John S. Martin, Jr. of Debevoise & Plimpton LLP to conduct an independent investigation of senior management’s conduct with respect to the cardiovascular safety profile of Vioxx during the period Vioxx was developed and marketed. The review was completed in the third quarter of 2006 and the full report (including appendices) was made public in September 2006. The Company has provided a copy of the full report and appendices at its website at www.merck.com/newsroom/vioxx/martin_report.html. The Company has included its website address only as an inactive textual reference and does not intend it to be an active link to its website nor does it incorporate by reference the information contained therein.

 

Acquisitions — In May 2006, Merck acquired Abmaxis, a privately-held biopharmaceutical company dedicated to the discovery and optimization of monoclonal antibody (MAb) products for human therapeutics and diagnostics, for approximately $80 million.

 

In June 2006, Merck acquired GlycoFi, a privately-held biotechnology company, a leader in the field of yeast glycoengineering, which is the addition of specific carbohydrate modifications to the proteins in yeast, and optimization of biologic drug molecules, for approximately $373 million.

 

In December 2006, Merck acquired Sirna, a publicly-held biotechnology company and a leader in developing a new class of medicines based on RNA interference (“RNAi”) technology for a total value of approximately $1.1 billion. The acquisition of Sirna is expected to increase Merck’s ability to use RNAi technology to turn off a targeted gene in a human cell, potentially rendering inoperative a gene responsible for triggering a specific disease.

 

Joint Ventures — The Company has a number of joint ventures relating to its Pharmaceutical and Vaccines segments.

 

Pharmaceutical

In 2000, the Company and Schering-Plough Corporation (“Schering-Plough”) entered into agreements to create separate equally-owned partnerships to develop and market in the United States new prescription medicines in the cholesterol-management and respiratory therapeutic areas. In December 2001, the cholesterol-management partnership agreements were expanded to include all the countries of the world, excluding Japan. In October 2002, Zetia (ezetimibe) (marketed as Ezetrol outside the United States), the first in a new class of cholesterol-lowering agents, was launched in the United States. In July 2004, Vytorin (marketed as Inegy outside the United States), a combination product containing the active ingredients of both Zetia and Zocor, was approved in the United States.

 

In 1982, the Company entered into an agreement with Astra AB (“Astra”) to develop and market Astra products in the United States. In 1994, the Company and Astra formed an equally owned joint venture that developed and marketed most of Astra’s new prescription medicines in the United States including Prilosec, the first in a class of medications known as proton pump inhibitors, which slows the production of acid from the cells of the stomach lining.

 

In 1998, the Company and Astra restructured the joint venture whereby the Company acquired Astra’s interest in the joint venture, renamed KBI Inc. (“KBI”), and contributed KBI’s operating assets to a new U.S. limited partnership named Astra Pharmaceuticals, L.P. (the “Partnership”), in which the Company maintains a limited

partner interest. The Partnership, renamed AstraZeneca LP, became the exclusive distributor of the products for which KBI retained rights. The Company earns certain Partnership returns as well as ongoing revenue based on sales of current and future KBI products. The Partnership returns include a priority return provided for in the Partnership Agreement, variable returns based, in part, upon sales of certain former Astra USA, Inc. products, and a preferential return representing the Company’s share of undistributed Partnership GAAP earnings. In conjunction with the 1998 restructuring, for a payment of $443.0 million, Astra purchased an option to buy the Company’s interest in the KBI products, excluding the Company’s interest in the gastrointestinal medicines Nexium and Prilosec. The Company also granted Astra an option (the “Shares Option”) to buy the Company’s common stock interest in KBI, at an exercise price based on the present value of estimated future net sales of Nexium and Prilosec.

 

In April 1999, Astra merged with Zeneca Group Plc, forming AstraZeneca AB (“AstraZeneca”). As a result of the merger, in exchange for the Company’s relinquishment of rights to future Astra products with no existing or pending U.S. patents at the time of the merger, Astra paid $967.4 million, which is subject to a true-up calculation in 2008 that may require repayment of all or a portion of this amount. The merger also triggers a partial redemption of the Company’s limited partner interest in 2008. Furthermore, as a result of the merger, AstraZeneca’s option to buy the Company’s interest in the KBI products is exercisable in 2010 and the Company has the right to require AstraZeneca to purchase such interest in 2008. In addition, the Shares Option is exercisable two years after Astra’s purchase of the Company’s interest in the KBI products. The exercise of this option by Astra is also provided for in the year 2017 or if combined annual sales of the two products fall below a minimum amount provided, in each case, only so long as either the Merck option in 2008 or AstraZeneca’s option in 2010 has been exercised. The exercise price is based on the present value of estimated future net sales of Nexium and Prilosec as determined at the time of exercise.

 

In 1989, the Company formed a joint venture with Johnson & Johnson to develop and market a broad range of nonprescription medicines for U.S. consumers. This 50% owned joint venture was expanded into Europe in 1993, and into Canada in 1996. Significant joint venture products are Pepcid AC (famotidine), an over-the-counter form of the Company’s ulcer medication Pepcid (famotidine), as well as Pepcid Complete, an over-the-counter product which combines the Company’s ulcer medication with antacids (calcium carbonate and magnesium hydroxide). In March 2004, the Company sold to Johnson & Johnson its interest in the European joint venture.

 

Vaccines

In 1992, the Company and Connaught Laboratories, Inc. (now Sanofi Pasteur S.A.) agreed to collaborate on the development and marketing of combination pediatric vaccines and to promote selected vaccines in the United States. While combination vaccine development efforts continue under this agreement, no vaccines are currently being promoted.

 

In 1994, the Company and Pasteur Mérieux Connaught (now Sanofi Pasteur S.A.) formed a joint venture to market human vaccines in Europe and to collaborate in the development of combination vaccines for distribution in the then existing EU and the European Free Trade Association. The Company and Sanofi Pasteur contributed, among other things, their European vaccine businesses for equal shares in the joint venture, known as Pasteur Mérieux MSD, S.N.C. (now Sanofi Pasteur MSD, S.N.C.). The joint venture maintains a presence, directly or through affiliates or branches in Belgium, Italy, Germany, Spain, France, Austria, Ireland, Sweden, Portugal, the Netherlands, Switzerland and the United Kingdom, and through distributors in the rest of its territory.

 

Other

In 1997, the Company and Rhône-Poulenc S.A. (now Sanofi-Aventis S.A.) combined their respective animal health and poultry genetics businesses to form Merial Limited (“Merial”), a fully integrated animal health company, which is a stand-alone joint venture, equally owned by each party. Merial provides a comprehensive range of pharmaceuticals and vaccines to enhance the health, well-being and performance of a wide range of animal species.

 

Competition — The markets in which the Company conducts its business are highly competitive and often highly regulated. Global efforts toward health care cost containment continue to exert pressure on product pricing and access.

 

Such competition involves an intensive search for technological innovations and the ability to market these innovations effectively. With its long-standing emphasis on research and development, the Company is well prepared to compete in the search for technological innovations. Additional resources to meet competition include quality control, flexibility to meet customer specifications, an efficient distribution system and a strong technical information service. The Company is active in acquiring and marketing products through joint ventures and licenses and has been refining its sales and marketing efforts to further address changing industry conditions. To enhance its product portfolio, the Company continues to pursue external alliances, from early-stage to late-stage product opportunities, including joint ventures and targeted acquisitions. However, the introduction of new products and processes by competitors may result in price reductions and product replacements, even for products protected by patents. For example, the number of compounds available to treat diseases typically increases over time and has resulted in slowing the growth in sales of certain of the Company’s products.

 

Legislation enacted in all states in the United States, particularly in the area of human pharmaceutical products, allows, encourages or, in a few instances, in the absence of specific instructions from the prescribing physician, mandates the use of “generic” products (those containing the same active chemical as an innovator’s product) rather than “brand-name” products. Governmental and other pressures toward the dispensing of generic products have significantly reduced the sales of certain of the Company’s products no longer protected by patents, such as Zocor, which lost market exclusivity in the U.S. in 2006 and the Company experienced a significant decline in Zocor sales thereafter.

 

Distribution — The Company sells its human health pharmaceutical products primarily to drug wholesalers and retailers, hospitals, government agencies and managed health care providers such as health maintenance organizations and other institutions. Human health vaccines are sold primarily to physicians, wholesalers, physician distributors and government entities. The Company’s professional representatives communicate the effectiveness, safety and value of the Company’s pharmaceutical and vaccine products to health care professionals in private practice, group practices and managed care organizations.

 

In the fourth quarter of 2003, the Company implemented a new distribution program for U.S. wholesalers to moderate the fluctuations in sales caused by wholesaler investment buying and improve efficiencies in the distribution of Company pharmaceutical products. The new program lowered previous limits on average monthly purchases of Company pharmaceutical products by U.S. customers. Following the implementation of the program, fluctuations in sales caused by wholesaler investment buying significantly moderated.

 

Raw Materials — Raw materials and supplies, which are generally available from multiple sources, are purchased worldwide and are normally available in quantities adequate to meet the needs of the Company’s Pharmaceutical and Vaccines segments.

 

Government Regulation and Investigation — The pharmaceutical industry is subject to global regulation by regional, country, state and local agencies. Of particular importance is the FDA in the United States, which administers requirements covering the testing, approval, safety, effectiveness, manufacturing, labeling and marketing of prescription pharmaceuticals. In many cases, the FDA requirements have increased the amount of time and money necessary to develop new products and bring them to market in the United States. In 1997, the Food and Drug Administration Modernization Act (the “FDA Modernization Act”) was passed and was the culmination of a comprehensive legislative reform effort designed to streamline regulatory procedures within the FDA and to improve the regulation of drugs, medical devices and food. The legislation was principally designed to ensure the timely availability of safe and effective drugs and biologics by expediting the premarket review process for new products. A key provision of the legislation is the re-authorization of the Prescription Drug User Fee Act of 1992, which permits the continued collection of user fees from prescription drug manufacturers to augment FDA resources earmarked for the review of human drug applications. This helps provide the resources necessary to ensure the prompt approval of safe and effective new drugs.

 

In the United States, the government expanded health care access by enacting the Medicare Prescription Drug Improvement and Modernization Act of 2003, which was signed into law in December 2003. Prescription drug coverage began on January 1, 2006. This legislation supports the Company’s goal of improving access to medicines by expanding insurance coverage, while preserving market-based incentives for pharmaceutical innovation. At the same time, the legislation will ensure that prescription drug costs will be controlled by competitive

pressures and by encouraging the appropriate use of medicines. In addressing cost-containment pressure, the Company has made a continuing effort to demonstrate that its medicines can help save costs in overall patient health care.

 

For many years, the pharmaceutical industry has been under federal and state oversight with the approval process for new drugs, drug safety, advertising and promotion, drug purchasing and reimbursement programs and formularies variously under review. The Company believes that it will continue to be able to conduct its operations, including the introduction of new drugs to the market, in this regulatory environment. One type of federal initiative to contain federal health care spending is the prospective or “capitated” payment system, first implemented to reduce the rate of growth in Medicare reimbursement to hospitals. Such a system establishes in advance a flat rate for reimbursement for health care for those patients for whom the payor is fiscally responsible. This type of payment system and other cost containment systems are now widely used by public and private payors and have caused hospitals, health maintenance organizations and other customers of the Company to be more cost-conscious in their treatment decisions, including decisions regarding the medicines to be made available to their patients. The Company continues to work with private and federal employers to slow increases in health care costs. Further, the Company’s efforts to demonstrate that its medicines can help save costs in other areas have encouraged the use of the Company’s medicines and have helped offset the effects of increasing cost pressures.

 

Also, federal and state governments have pursued methods to directly reduce the cost of drugs and vaccines for which they pay. For example, federal laws require the Company to pay specified rebates for medicines reimbursed by Medicaid, to provide discounts for outpatient medicines purchased by certain Public Health Service entities and “disproportionate share” hospitals (hospitals meeting certain criteria), and to provide minimum discounts of 24% off of a defined “non-federal average manufacturer price” for purchases by certain components of the federal government such as the Department of Veterans Affairs and the Department of Defense.

 

Initiatives in some states seek rebates beyond the minimum required by Medicaid legislation, in some cases for patients beyond those who are eligible for Medicaid. Under the Federal Vaccines for Children entitlement program, the CDC funds and purchases recommended pediatric vaccines at a public sector price for the immunization of Medicaid-eligible, uninsured, Native American and certain underinsured children. The Company was awarded a CDC contract in April 2006 which is in effect until March 2007 for the supply of pediatric vaccines for the Vaccines for Children program that had an aggregate estimated value of $550 million at signing. As of January 1, 2006, patients previously eligible for Medicaid who are also Medicare beneficiaries (65 years and older or disabled) left the state-administered Medicaid system to be covered by the new Medicare prescription drug benefit.

 

Outside the United States, the Company encounters similar regulatory and legislative issues in most of the countries where it does business. There, too, the primary thrust of governmental inquiry and action is toward determining drug safety and effectiveness, often with mechanisms for controlling the prices of or reimbursement for prescription drugs and the profits of prescription drug companies. The EU has adopted directives concerning the classification, labeling, advertising, wholesale distribution and approval for marketing of medicinal products for human use. The Company’s policies and procedures are already consistent with the substance of these directives; consequently, it is believed that they will not have any material effect on the Company’s business.

 

The Company is subject to the jurisdiction of various regulatory agencies and is, therefore, subject to potential administrative actions. Such actions may include seizures of products and other civil and criminal sanctions. Under certain circumstances, the Company on its own may deem it advisable to initiate product recalls. The Company believes that it should be able to compete effectively within this environment.

 

In addition, certain countries within the EU, recognizing the economic importance of the research-based pharmaceutical industry and the value of innovative medicines to society, are working with industry representatives and the European Commission (“EC”) on proposals to complete the “Single Market” in pharmaceuticals and improve the competitive climate through a variety of means including market deregulation.

 

The Company is subject to a number of privacy and data protection laws and regulations globally. The legislative and regulatory landscape for privacy and data protection continues to evolve, and there has been an increasing amount of focus on privacy and data protection issues with the potential to affect directly the Company’s business.

 

Patents, Trademarks and Licenses — Patent protection is considered, in the aggregate, to be of material importance in the Company’s marketing of human health products in the United States and in most major foreign markets. Patents may cover products per se, pharmaceutical formulations, processes for or intermediates useful in the manufacture of products or the uses of products. Protection for individual products extends for varying periods in accordance with the legal life of patents in the various countries. The protection afforded, which may also vary from country to country, depends upon the type of patent and its scope of coverage.

 

Patent portfolios developed for products introduced by the Company normally provide market exclusivity. Basic patents are in effect for the following major products in the United States: Cancidas, Comvax (Haemophilus b conjugate and hepatitis B [recombinant] vaccine), Cosopt, Cozaar, Crixivan, Emend, Fosamax, Gardasil, Hyzaar, Invanz (ertapenem sodium), Maxalt, Primaxin, Propecia, Recombivax HB (hepatitis B vaccine [recombinant]), RotaTeq, Singulair, Januvia, Trusopt, Zolinza and Zostavax. Basic patents are also in effect in the United States for Zetia and Vytorin, which were developed by the Merck/Schering-Plough partnership. A basic patent is also in effect for Sustiva/Stocrin (efavirenz). Bristol-Myers Squibb (“BMS”), under an exclusive license from the Company, sells Sustiva in the United States, Canada and certain European countries. The Company markets Stocrin in other countries throughout the world. The basic patent for Aggrastat (tirofiban hydrochloride) in the United States was divested with the product in 2003. The Company retains basic patents for Aggrastat outside the United States.

 

The FDA Modernization Act includes a Pediatric Exclusivity Provision that may provide an additional six months of market exclusivity in the United States for indications of new or currently marketed drugs if certain agreed upon pediatric studies are completed by the applicant. These exclusivity provisions were re-authorized until October 1, 2007 by the “Best Pharmaceuticals for Children Act” passed in January 2002. In 2005, the FDA granted an additional six months of market exclusivity in the United States to Invanz until August 2013. In 2004, the FDA granted an additional six months of market exclusivity in the United States to Trusopt until October 2008. In 2002, the FDA granted an additional six months of market exclusivity in the United States to Cozaar/Hyzaar until February 2010. In 2005, the FDA granted an additional six months of market exclusivity in the United States to Singulair until August 2012. For further information with respect to the Company’s patents, see “Patent Litigation” on page 32.

 

While the expiration of a product patent normally results in a loss of market exclusivity for the covered pharmaceutical product, commercial benefits may continue to be derived from: (i) later-granted patents on processes and intermediates related to the most economical method of manufacture of the active ingredient of such product; (ii) patents relating to the use of such product; (iii) patents relating to novel compositions and formulations; and (iv) in the United States, market exclusivity that may be available under federal law. The effect of product patent expiration on pharmaceutical products also depends upon many other factors such as the nature of the market and the position of the product in it, the growth of the market, the complexities and economics of the process for manufacture of the active ingredient of the product and the requirements of new drug provisions of the Federal Food, Drug and Cosmetic Act or similar laws and regulations in other countries.

 

Additions to market exclusivity are sought in the United States and other countries through all relevant laws, including laws increasing patent life. Some of the benefits of increases in patent life have been partially offset by a general increase in the number of, incentives for and use of generic products. Additionally, improvements in intellectual property laws are sought in the United States and other countries through reform of patent and other relevant laws and implementation of international treaties.

 

In June 2006, Zocor lost its market exclusivity in the United States and the Company experienced a significant decline in U.S. Zocor sales after that time.

 

In June 2006, the basic patent in the United States covering Proscar expired. As a result, the Company experienced a significant decline in U.S. Proscar sales after that time. The basic patent for Proscar also covers Propecia; however, Propecia is protected by additional patents which expire in October 2013.

 

In 2003, the FDA granted an additional six months of market exclusivity in the United States to Fosamax until February 2008, and Fosamax Once Weekly until January 2019. However, on January 28, 2005, the U.S. Court of Appeals for the Federal Circuit in Washington, D.C. found the Company’s patent claims for once-weekly administration of Fosamax to be invalid. The Company exhausted all options to appeal this decision in 2005. Based on the Court of Appeals’ decision, Fosamax will lose its market exclusivity in the United States in February 2008.

Fosamax Plus D will lose its U.S. market exclusivity in April 2008. The Company expects significant declines in each product’s sales after each product’s respective loss of market exclusivity.

 

Worldwide, all of the Company’s important products are sold under trademarks that are considered in the aggregate to be of material importance. Trademark protection continues in some countries as long as used; in other countries, as long as registered. Registration is for fixed terms and can be renewed indefinitely.

 

Royalties received during 2006 on patent and know-how licenses and other rights amounted to $83.8 million. The Company also paid royalties amounting to $900.5 million in 2006 under patent and know-how licenses it holds.

 

Research and Development

 

The Company’s business is characterized by the introduction of new products or new uses for existing products through a strong research and development program. Approximately 11,400 people are employed in the Company’s research activities. Expenditures for the Company’s research and development programs were $4.8 billion in 2006, $3.8 billion in 2005 and $4.0 billion in 2004. The Company maintains its ongoing commitment to research over a broad range of therapeutic areas and clinical development in support of new products.

 

The Company maintains a number of long-term exploratory and fundamental research programs in biology and chemistry as well as research programs directed toward product development. Merck’s new research and development model is designed to increase productivity and improve the probability of success by prioritizing the Company’s research and development resources on nine priority disease areas — Alzheimer’s disease, atherosclerosis, cardiovascular disease, diabetes, novel vaccines, obesity, oncology (targeted therapies), pain and sleep disorders. These therapeutic areas were carefully chosen based on a set of criteria including unmet medical needs, scientific opportunity and commercial opportunity. Within these therapeutic areas, Merck will commit resources to achieve research breadth and depth and to develop best-in-class targeted and differentiated products that are valued highly by patients, payers and physicians.

 

The Company will also make focused investments to pursue specific mechanisms in the following selected disease areas: antibiotics, antifungals, antivirals (hepatitis C virus, human immunodeficiency virus), asthma, chronic obstructive pulmonary disease, neurodegeneration, ophthalmology, osteoporosis, schizophrenia and stroke. In addition, the Company will capitalize on selected opportunities outside these areas by continuing to commercialize attractive clinical development candidates in the pipeline and by pursuing appropriate external licensing opportunities.

 

In the development of human health products, industry practice and government regulations in the United States and most foreign countries provide for the determination of effectiveness and safety of new chemical compounds through preclinical tests and controlled clinical evaluation. Before a new drug may be marketed in the United States, recorded data on preclinical and clinical experience are included in the NDA or the Biologics License Application to the FDA for the required approval. The development of certain other products is also subject to government regulations covering safety and efficacy in the United States and many foreign countries.

 

Once the Company’s scientists discover a new compound that they believe has promise to treat a medical condition, the Company commences preclinical testing with that compound. Preclinical testing includes laboratory testing and animal safety studies to gather data on chemistry, pharmacology and toxicology. Pending acceptable preclinical data, the Company will initiate clinical testing in accordance with established regulatory requirements. The clinical testing begins with Phase I studies, which are designed to assess safety, tolerability, pharmacokinetics, and preliminary pharmacodynamic activity of the compound in humans. If favorable, additional, larger Phase II studies are initiated to determine the efficacy of the compound in the affected population, define appropriate dosing for the compound, as well as identify any adverse effects that could limit the compound’s usefulness. If data from the Phase II trials are satisfactory, the Company commences large-scale Phase III trials to confirm the compound’s efficacy and safety. Upon completion of those trials, if satisfactory, the Company submits regulatory filings with the appropriate regulatory agencies around the world to have the product candidate approved for marketing. There can be no assurance that a compound that is the result of any particular program will obtain the regulatory approvals necessary for it to be marketed.

 

In the United States, the FDA approval process begins once a complete NDA is submitted and received by the FDA. Pursuant to the Prescription Drug User Fee Act, the FDA review period targets for NDAs or supplemental NDAs is either six months, for priority review, or ten months, for a standard review. Within 60 days after receipt of an NDA, the FDA determines if the application is sufficiently complete to permit a substantive review. The FDA also assesses, at that time, whether the application will be granted a priority review or standard review. Once the review timelines are defined, the FDA will act upon the application within those timelines, unless a major amendment has been submitted (either at the Company’s own initiative or the FDA’s request) to the pending application. If this occurs, the FDA may extend the review period to allow for review of the new information, but by no more than 180 days. Extensions to the review period are communicated to the Company. The FDA can act on an application by issuing an approval letter, a non-approvable letter, or an approvable letter. Based on FDA statistics, drug development time from initiation of preclinical testing to NDA approval can range from 5 to 20 years with an average of 8.5 years.

 

The Company has three drug candidates currently under FDA review:

 

In June 2006, the FDA accepted for standard review an NDA for MK-0517, the intravenous prodrug of Emend, for the treatment of CINV. The Company anticipates a decision on the NDA in the second quarter of 2007.

 

In July 2006, the FDA accepted for standard review the NDA for Janumet, the Company’s investigational oral medicine combining Januvia with metformin, which is designed to provide an additional treatment for patients needing more than one oral agent to help control blood sugar for treatment of type 2 diabetes. The Company expects FDA action on the NDA by the end of March 2007. The Company is also moving forward as planned with regulatory filings in countries outside the United States.

 

Arcoxia, the Company’s investigational selective COX-2 inhibitor, remains under standard review by the FDA in the United States. In response to the FDA’s approvable letter, Merck included results of the MEDAL (Multinational Etoricoxib and Diclofenac Arthritis Long-Term) Program that showed the rate of confirmed thrombotic cardiovascular events was similar between Arcoxia and diclofenac, the most widely used nonsteroidal anti-inflammatory drug in the world. The Company anticipates FDA action in April 2007. The Company expects that an FDA Advisory Committee meeting will be held prior to FDA action. Arcoxia is currently available in more than 60 countries in Europe, Latin America, the Asia-Pacific region and Middle East/Northern Africa.

 

The Company anticipates filing three NDAs with the FDA in 2007:

 

The Company plans to file an NDA for MK-0518 with the FDA in the second quarter of 2007 and has received fast track designation for an indication in treatment-experienced patients.

 

Interim 16-week data from the dose-ranging Phase II trial of MK-0518, the Company’s investigational HIV integrase inhibitor, in patients with advanced HIV infection were presented at the 13^th Annual Conference on Retroviruses and Opportunistic Infections in February 2006. The results showed that the oral investigational medication at all three doses studied in combination with optimized background therapy (“OBT”) had greater antiretroviral activity than OBT alone. Study results also showed that MK-0518 in combination with OBT was generally well tolerated in these patients who were failing antiretroviral therapy (“ART”), who were resistant to at least one drug of each of the three available classes of oral ARTs, and who had limited active ARTs as options for treatment. At the American Society for Microbiology’s 46th Annual International Conference on Antimicrobial Agents and Chemotherapy in September 2006, the Company presented interim 24-week data from this ongoing study in treatment-experienced patients, which demonstrated MK-0518 maintaining viral load regression.

 

In August 2006 at the 16^th International AIDS conference, the Company presented interim 24-week data from the Phase II dose-ranging trial of MK-0518 conducted in treatment-naïve, HIV-infected patients. The data showed that MK-0518 twice daily, when used in combination with tenofovir and lamivudine, achieved a comparable viral load reduction to efavirenz combined with the same agents in previously untreated patients. In September 2006 at the American Society for Microbiology’s 46th Annual International Conference on Antimicrobial Agents and Chemotherapy, the Company presented additional interim 24-week data from this Phase II dose-ranging study in treatment-naïve patients that demonstrated no increase in lipid levels in patients taking MK-0518 with tenofovir and lamivudine.

 

The Company has entered into Phase III clinical trials with MK-0524A and to support MK-0524B, investigational therapies for lipid management. MK-0524A represents a novel approach to lowering LDL-C, raising HDL-C and lowering triglycerides. MK-0524B combines MK-0524A with the proven benefits of simvastatin to potentially reduce the risk of coronary heart disease beyond what statins provide alone. The Company plans to file MK-0524A with the FDA in 2007 and to file MK-0524B in 2008.

 

In November 2006, the Company presented data from a Phase II study at the American Heart Association’s Scientific Sessions 2006 in Chicago that showed co-administration of MK-0524 with ER niacin significantly reduced flushing in patients with dyslipidemia compared to those patients who took ER niacin alone. Flushing, characterized by redness of the skin with warming or burning on the face and neck caused by the dilation of blood vessels near the skin, is a common niacin-induced side effect that can cause discomfort to patients and is a significant factor leading to discontinuation of niacin therapy.

 

In October 2006, the Company and H. Lundbeck A/S of Denmark announced that the submission of an NDA for gaboxadol, a novel investigational drug in Phase III development for the treatment of insomnia, will occur in mid-2007. Phase II clinical studies of gaboxadol showed improved sleep quality as well as increased slow-wave sleep without suppressing REM sleep. In December 2006, Merck announced that gaboxadol will likely be a scheduled compound.

 

Also, by mid-year 2007, Merck expects to have four products in Phase III development (including MK-0524B discussed above):

 

The Company has initiated a targeted Phase III program with its investigational compound for the treatment of obesity, MK-0364, which is an investigational cannabinoid-1 receptor inverse agonist. Results of early clinical studies indicate that MK-0364 demonstrated significant weight-loss efficacy versus placebo and was generally safe and well-tolerated, however, as reported with another cannabinoid-1 receptor inverse agonist, some psychiatric adverse experiences have been observed.

 

As announced in December 2006, the Company plans to start Phase III testing of MK-0974, the calcitonin gene related peptide receptor antagonist for the treatment of migraine headaches. The Phase III program is expected to commence in first quarter 2007.

 

Also announced in December 2006, the Company anticipates that MK-0822, a Cathepsin K inhibitor for the treatment of osteoporosis, will enter Phase III testing in mid-2007.

 

The Company’s clinical pipeline includes candidates in each of the following areas: arthritis, atherosclerosis, cancer, cardiovascular disease, diabetes, endocrine disorders, glaucoma, infectious diseases, insomnia, neurodegenerative disease, obesity, osteoporosis, psychiatric disease, pain, respiratory disease and urogenital disorders. The Company supplements its internal research with an aggressive licensing and external alliance strategy focused on the entire spectrum of collaborations from early research to late-stage compounds, as well as new technologies. The Company completed 53 transactions in 2006, including targeted acquisitions, research collaborations, preclinical and clinical compounds, and technology transactions across a broad range of therapeutic categories.

 

In March 2006, Neuromed Pharmaceuticals Ltd. (“Neuromed”) and Merck signed a research collaboration and license agreement to research, develop and commercialize novel compounds for the treatment of pain and other neurological disorders, including Neuromed’s lead compound, NMED-160 (MK-6721), which is currently in Phase II development for the treatment of pain.

 

Also in March 2006, Merck signed an agreement with NicOx S.A. (“NicOx”) to collaborate on the development of new antihypertensive drugs using NicOx’s proprietary nitric oxide-donating technology.

 

In September 2006, the Company announced that it had expanded the scope of its existing strategic collaboration with FoxHollow Technologies, Inc. (“FoxHollow”) for atherosclerotic plaque analysis. In addition, Merck acquired a stake in FoxHollow with the purchase of $95 million in common stock.

 

In October 2006, Ambrilia Biopharma Inc. (“Ambrilia”), a biopharmaceutical company developing innovative therapeutics in the fields of cancer and infectious diseases, and Merck announced that Ambrilia has entered into an exclusive licensing agreement granting Merck the worldwide rights to Ambrilia’s HIV/AIDS protease inhibitor program.

 

In November 2006, the J. David Gladstone Institutes and Merck announced a major collaboration and license agreement for research and development of drugs to treat neurodegenerative diseases, including Alzheimer’s disease, that are linked to apoE-regulated mechanisms in the body.

 

Also in November 2006, Advinus Therapeutics (P) Ltd. (“Advinus”) and Merck announced that they have formed a drug discovery and clinical development collaboration in the area of metabolic disorders. Advinus and Merck will work together to develop clinically validated drug candidates for metabolic disorders, with Merck retaining the right to advance the most promising of these candidates into late-stage clinical trials.

 

In December 2006, Merck and Idera Pharmaceuticals (“Idera”) announced that they have formed a broad collaboration to research, develop and commercialize Idera’s Toll-like Receptor agonists by incorporating them in therapeutic and prophylactic vaccines being developed by Merck for oncology, infectious diseases and Alzheimer’s disease.

 

The chart below reflects the Company’s current research pipeline as of February 15, 2007. Candidates shown in Phase III include specific products. Candidates shown in Phase I and II include the most advanced compound with a specific mechanism in a given therapeutic area. Back-up compounds, regardless of their phase of development, additional indications in the same therapeutic area and additional line extensions or formulations for in-line products are not shown.

 

 

 

 

 

All product or service marks appearing in type form different from that of the surrounding text are trademarks or service marks owned by or licensed to Merck, its subsidiaries or affiliates (including Zetia and Vytorin, trademarks owned by entities of the Merck/Schering-Plough partnership), except as noted. Cozaar and Hyzaar are registered trademarks of E.I. du Pont de Nemours and Company, Wilmington, DE and Prilosec and Nexium are trademarks of the AstraZeneca group. The U.S. trademarks for Vasotec and Vaseretic are owned by Biovail Laboratories Incorporated. The U.S. trademark for Aggrastat is owned by Guilford Pharmaceuticals Inc.

 

Employees

 

At the end of 2006, the Company had approximately 60,000 employees worldwide, with approximately 31,800 employed in the United States, including Puerto Rico. Approximately 21% of worldwide employees of the Company are represented by various collective bargaining groups.

 

As part of a cost-reduction initiative announced in October 2003 and completed at the end of 2004, the Company had eliminated 5,100 positions. The Company completed a similar program in 2005 with 900 positions being eliminated through December 31, 2005.

 

On November 28, 2005, the Company announced the first phase of a global restructuring program designed to reduce the Company’s cost structure, increase efficiency, and enhance competitiveness. The initial steps will include the implementation of a new supply strategy by the Merck Manufacturing Division, which is intended to create a leaner, more cost-effective and customer-focused manufacturing model over a three-year period.

 

As a result, Merck will incur certain costs associated with exit or disposal activities. As part of the global restructuring program, the Company expects to eliminate approximately 7,000 positions in manufacturing and other divisions worldwide, representing about 11% of its global work force, by the end of 2008. About half of the position reductions are expected to occur in the United States, with the remainder in other countries. As of December 31, 2006, there have been approximately 4,800 positions eliminated throughout the Company since inception of the program (approximately 3,700 of which were eliminated during 2006 comprised of actual headcount reductions, and the elimination of contractors and vacant positions). However, the Company continues to hire new employees as the Company’s business requires it. Merck intends to sell or close five of its 31 manufacturing facilities worldwide and two preclinical sites and to reduce operations at a number of other sites. Through the end of 2006, three of the manufacturing facilities have been closed, sold, or had ceased operations, and the two preclinical sites were closed. The Company has also sold certain other facilities and related assets in connection with the restructuring program. The remaining sites identified for sale/closure are expected to be closed by the end of 2008, subject to compliance with legal obligations.

 

The pretax costs of the restructuring were $935.5 million in 2006, $401.2 million in 2005 and are expected to be $300 million to $500 million in 2007. Through the end of 2008, when the initial phase of the restructuring program is substantially complete, the cumulative pretax costs of the restructuring activities announced on November 28, 2005 are expected to range from $1.9 billion to $2.2 billion. Approximately 70% of the cumulative pretax costs are non-cash, relating primarily to accelerated depreciation for those facilities scheduled for closure.

 

Environmental Matters

 

The Company believes that it is in compliance in all material respects with applicable environmental laws and regulations. In 2006, the Company incurred capital expenditures of approximately $7.9 million for environmental protection facilities. The Company is also remediating environmental contamination resulting from past industrial activity at certain of its sites. Expenditures for remediation and environmental liabilities were $12.6 million in 2006, and are estimated at $94.2 million for the years 2007 through 2011. These amounts do not consider potential recoveries from insurers or other parties. The Company has taken an active role in identifying and providing for these costs and, in management’s opinion, the liabilities for all environmental matters which are probable and reasonably estimable have been accrued and totaled $129.0 million at December 31, 2006. Although it is not possible to predict with certainty the outcome of these environmental matters, or the ultimate costs of remediation, management does not believe that any reasonably possible expenditures that may be incurred in excess of the liabilities accrued should exceed $62.0 million in the aggregate. Management also does not believe that these

expenditures should result in a material adverse effect on the Company’s financial position, results of operations, liquidity or capital resources for any year.

 

Geographic Area Information

 

The Company’s operations outside the United States are conducted primarily through subsidiaries. Sales worldwide by subsidiaries outside the United States were 39% of sales in 2006, 42% of sales in 2005 and 41% of sales in 2004.

 

The Company’s worldwide business is subject to risks of currency fluctuations, governmental actions and other governmental proceedings abroad. The Company does not regard these risks as a deterrent to further expansion of its operations abroad. However, the Company closely reviews its methods of operations and adopts strategies responsive to changing economic and political conditions.

 

In recent years, the Company has been expanding its operations in countries located in Latin America, the Middle East, Africa, Eastern Europe and Asia Pacific where changes in government policies and economic conditions are making it possible for the Company to earn fair returns. Business in these developing areas, while sometimes less stable, offers important opportunities for growth over time.

 

Financial information about geographic areas of the Company’s business is discussed in Item 8. “Financial Statements and Supplementary Data” below.

 

Available Information

 

The Company’s Internet website address is www.merck.com. The Company will make available, free of charge at the “Investor Information” portion of its website, its Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and all amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, as soon as reasonably practicable after such reports are electronically filed with, or furnished to, the Securities and Exchange Commission (“SEC”).

 

The Company’s corporate governance guidelines and the charters of the Board of Directors’ seven standing committees are available on the Company’s website at www.merck.com/about/corporategovernance and all such information is available in print to any stockholder who requests it from the Company.

 

You should carefully consider all of the information set forth in this Form 10-K, including the following risk factors, before deciding to invest in any of the Company’s securities. The risks below are not the only ones the Company faces. Additional risks not currently known to the Company or that the Company presently deems immaterial may also impair its business operations. The Company’s business, financial condition, results of operations or prospects could be materially adversely affected by any of these risks. This Form 10-K also contains forward-looking statements that involve risks and uncertainties. The Company’s results could materially differ from those anticipated in these forward-looking statements as a result of certain factors, including the risks it faces as described below and elsewhere. See “Cautionary Factors that May Affect Future Results” on page 21.

 

The Company faces significant litigation related to Vioxx.

 

On September 30, 2004, the Company voluntarily withdrew Vioxx, its arthritis and acute pain medication, from the market worldwide. As of December 31, 2006, approximately 27,400 product liability lawsuits, involving approximately 46,100 plaintiff groups, alleging personal injuries resulting from the use of Vioxx, have been filed against the Company in state and federal courts in the United States. The Company is also a defendant in approximately 264 purported class actions related to the use of Vioxx. (All of these suits are referred to as the “Vioxx Product Liability Lawsuits”.) In addition to the Vioxx Product Liability Lawsuits, various purported class actions and individual lawsuits have been brought against the Company and several current and former officers and directors of the Company alleging that the Company made false and misleading statements regarding Vioxx in violation of the federal and state securities laws (all of these suits are referred to as the “Vioxx Securities Lawsuits”). In addition, various putative class actions have been brought against the Company and several current and former

employees, officers, and directors of the Company alleging violations of the Employee Retirement Income Security Act (“ERISA”). (All of these suits are referred to as the “Vioxx ERISA Lawsuits”.) In addition, shareholder derivative suits that were previously filed and dismissed are now on appeal and several shareholders have filed demands with the Company asserting claims against the Board members and Company officers. (All of these suits and demands are referred to as the “Vioxx Derivative Lawsuits” and, together with the Vioxx Securities Lawsuits and the Vioxx ERISA Lawsuits, the “Vioxx Shareholder Lawsuits”.) The Company has also been named as a defendant in actions in various countries outside the United States. (All of these suits are referred to as the “Vioxx Foreign Lawsuits”.) The Company has also been sued by four states with respect to the marketing of Vioxx. The Company anticipates that additional lawsuits relating to Vioxx will be filed against it and/or certain of its current and former officers and directors in the future.

 

The SEC is conducting a formal investigation of the Company concerning Vioxx. The U.S. Department of Justice has issued a subpoena requesting information relating to the Company’s research, marketing and selling activities with respect to Vioxx in a federal health care investigation under criminal statutes. There are also ongoing investigations by certain Congressional committees and local authorities in Europe. A group of Attorneys General from thirty-one states and the District of Columbia are conducting an investigation of the Company’s sales and marketing of Vioxx. The Company is cooperating with authorities in all of these investigations. (All of these investigations are referred to as the “Vioxx Investigations”.) The Company can not predict the outcome of any of these investigations; however, they could result in potential civil and/or criminal liability.

 

To date, in the Vioxx Product Liability litigation, of the 29 plaintiffs whose claims have been scheduled for trial, the claims of seven were dismissed, the claims of seven were withdrawn from the trial calendar by plaintiffs, and juries have decided in Merck’s favor nine times and in plaintiffs’ favor four times. In addition, in the recent California trial involving two plaintiffs, the jury could not reach a verdict for either plaintiff and a mistrial was declared. A New Jersey state judge set aside one of the nine Merck verdicts. With respect to the four plaintiffs’ verdicts, Merck already has filed an appeal or sought judicial review in each of those cases, and in one of those four, a federal judge overturned the damage award shortly after trial. In addition, a consolidated trial with two plaintiffs is currently ongoing in the coordinated proceeding in New Jersey Superior Court before Judge Higbee and another trial has commenced in state court in Illinois. The Vioxx Product Liability litigation is discussed more fully below in Item 3. “Legal Proceedings” below.

 

The outcomes of these Vioxx Product Liability trials should not be interpreted to indicate any trend or what outcome may be likely in future Vioxx trials.

 

The Company currently anticipates that a number of Vioxx Product Liability Lawsuits will be tried in 2007. A trial in the Oregon securities case is scheduled for 2007, but the Company cannot predict whether this trial will proceed on schedule or the timing of any of the other Vioxx Shareholder Lawsuit trials. The Company believes that it has meritorious defenses to the Vioxx Product Liability Lawsuits, Vioxx Shareholder Lawsuits and Vioxx Foreign Lawsuits (collectively, the “Vioxx Lawsuits”) and will vigorously defend against them. The Company’s insurance coverage with respect to the Vioxx Lawsuits will not be adequate to cover its defense costs and any losses.

 

During 2006, the Company spent $500 million, including $175 million in the fourth quarter, in the aggregate in legal defense costs worldwide related to (i) the Vioxx Product Liability Lawsuits, (ii) the Vioxx Shareholder Lawsuits, (iii) the Vioxx Foreign Lawsuits, and (iv) the Vioxx Investigations (collectively, the “Vioxx Litigation”). In the third quarter of 2006, the Company recorded a charge of $598 million and in the fourth quarter it recorded another charge of $75 million, to increase the reserve solely for its future legal defense costs related to the Vioxx Litigation from $685 million at December 31, 2005 to $858 million at December 31, 2006. This reserve is based on certain assumptions, described below under “Legal Proceedings”, and is the best estimate of the amount that the Company believes, at this time, will be spent through 2008.

 

The Company is not currently able to estimate any amount of damages that it may be required to pay in connection with the Vioxx Lawsuits or Vioxx Investigations. These proceedings, which are expected to continue for years, are currently at an early stage and the Company has very little information as to the course the proceedings will take. In view of the inherent difficulty of predicting the outcome of litigation, particularly where there are many claimants and the claimants seek unspecified damages, the Company is unable to predict the outcome of these matters, and at this time cannot reasonably estimate the possible loss or range of loss with respect to the Vioxx

Lawsuits. The Company has not established any reserves for any potential liability relating to the Vioxx Lawsuits or the Vioxx Investigations.

 

A series of unfavorable outcomes in the Vioxx Lawsuits or the Vioxx Investigations, resulting in the payment of substantial damages or fines or resulting in criminal penalties, could have a material adverse effect on the Company’s business, cash flow, results of operations, financial position and prospects.

 

Certain of the Company’s major products are going to lose patent protection in the near future and, when that occurs, the Company expects a significant decline in sales of those products.

 

The Company depends upon patents to provide it with exclusive marketing rights for its products for some period of time. As product patents for several of the Company’s products have recently expired, or are about to expire, in the United States and in other countries, the Company faces strong competition from lower price generic drugs. Loss of patent protection for one of the Company’s products typically leads to a rapid loss of sales for that product, as lower priced generic versions of that drug become available. In the case of products that contribute significantly to the Company’s sales, the loss of patent protection can have a material adverse effect on the Company’s results of operations.

 

In June 2006, Zocor, the Company’s statin for modifying cholesterol, lost its market exclusivity in the United States. Zocor had already lost its basic patent protection in many markets throughout the world. The Company has experienced a significant decline in Zocor sales. Worldwide sales of Zocor were $2.8 billion in 2006, compared to $4.4 billion in 2005. Worldwide sales of Zocor are expected to be $0.6 billion to $0.9 billion in 2007.

 

In September 2004, the Company appealed a decision of the Opposition Division (the “Opposition Division”) of the European Patent Office (the “EPO”) that revoked the Company’s patent in Europe that covers the once-weekly administration of alendronate. That decision was upheld and, therefore, presently the Company is not entitled to market exclusivity for Fosamax in most major European markets after 2007. In addition, Merck’s basic patent covering the use of alendronate has been challenged in several European countries. The Company has received adverse decisions in Germany, Holland and the United Kingdom. The decision in the United Kingdom was upheld on appeal. The Company has appealed the decisions in Germany and Holland. The Company expects a significant decline in European sales of Fosamax after loss of exclusivity. Sales of Fosamax outside the United States in 2006 have already been adversely affected by the availability of generic alendronate sodium products in some markets, including the United Kingdom, Canada and Germany.

 

On January 28, 2005, the U.S. Court of Appeals for the Federal Circuit in Washington, D.C. found the Company’s patent claims for once-weekly administration of Fosamax to be invalid. The Company exhausted all options to appeal this decision in 2005. Based on the Court of Appeals decision, Fosamax and Fosamax Plus D will lose market exclusivity in the United States in February 2008 and April 2008, respectively, and the Company expects a significant decline in Fosamax and Fosamax Plus D sales in the United States after each product’s respective loss of market exclusivity.

 

The Company’s research and development efforts may not succeed in developing commercially successful products and the Company may not be able to acquire commercially successful products in other ways; in consequence, the Company may not be able to replace sales of successful products that have lost patent protection.

 

Like other major pharmaceutical companies, in order to remain competitive, the Company must continue to launch new products each year. Declines in sales of products such as Zocor and Fosamax mean that the Company’s future success is dependent on its pipeline of new products, including new products which it develops through joint ventures and products which it is able to obtain through license or acquisition. To accomplish this, the Company commits substantial effort, funds and other resources to research and development, both through its own dedicated resources, and through various collaborations with third parties. To support its research and development efforts the Company must make ongoing, substantial expenditures, without any assurance that the efforts it is funding will result in a commercially successful product. The Company must also commit substantial efforts, funds and other resources to recruiting and retaining high quality scientists and other personnel with pharmaceutical research and development expertise.

 

Based on FDA statistics, drug development time from initiation of preclinical testing to NDA approval can range from 5 to 20 years with an average of 8.5 years. For a description of the research and development process, see “Research and Development” above. Each phase of testing is highly regulated, and during each phase there is a substantial risk that the Company will encounter serious obstacles or will not achieve its goals, and accordingly the Company may abandon a product in which it has invested substantial amounts of time and money. Some of the risks encountered in the research and development process include the following: pre-clinical testing of a new compound may yield disappointing results; clinical trials of a new drug may not be successful; a new drug may not be effective or may have harmful side effects; a new drug may not be approved by the FDA for its intended use; it may not be possible to obtain a patent for a new drug; or sales of a new product may be disappointing.

 

The Company cannot state with certainty when or whether any of its products now under development will be launched; whether it will be able to develop, license or otherwise acquire compounds, product candidates or products; or whether any products, once launched, will be commercially successful. The Company must maintain a continuous flow of successful new products and successful new indications or brand extensions for existing products sufficient both to cover its substantial research and development costs and to replace sales that are lost as profitable products, such as Zocor and Fosamax, lose patent protection or are displaced by competing products or therapies. Failure to do so in the short term or long term would have a material adverse effect on the Company’s business, results of operations, cash flow, financial position and prospects.

 

The Company’s products, including products in development, can not be marketed unless the Company obtains and maintains regulatory approval.

 

The Company’s activities, including research, preclinical testing, clinical trials and manufacturing and marketing its products, are subject to extensive regulation by numerous federal, state and local governmental authorities in the United States, including the FDA, and by foreign regulatory authorities, including the European Commission. In the United States, the FDA is of particular importance to the Company, as it administers requirements covering the testing, approval, safety, effectiveness, manufacturing, labeling and marketing of prescription pharmaceuticals. In many cases, the FDA requirements have increased the amount of time and money necessary to develop new products and bring them to market in the United States. Regulation outside the United States also is primarily focused on drug safety and effectiveness and, in many cases, cost reduction. The FDA and foreign regulatory authorities have substantial discretion to require additional testing, to delay or withhold registration and marketing approval and to mandate product withdrawals.

 

Even if the Company is successful in developing new products, it will not be able to market any of those products unless and until it has obtained all required regulatory approvals in each jurisdiction where it proposes to market the new products. Once obtained, the Company must maintain approval as long as it plans to market its new products in each jurisdiction where approval is required. The Company’s failure to obtain approval, significant delays in the approval process, or its failure to maintain approval in any jurisdiction will prevent it from selling the new products in that jurisdiction until approval is obtained, if ever. The Company would not be able to realize revenues for those new products in any jurisdiction where it does not have approval.

 

The Company is dependent on its patent rights, and if its patent rights are invalidated or circumvented, its business would be adversely affected.

 

Patent protection is considered, in the aggregate, to be of material importance in the Company’s marketing of human health products in the United States and in most major foreign markets. Patents covering products that it has introduced normally provide market exclusivity, which is important for the successful marketing and sale of its products. The Company seeks patents covering each of its products in each of the markets where it intends to sell the products and where meaningful patent protection is available.

 

Even if the Company succeeds in obtaining patents covering its products, third parties or government authorities may challenge or seek to invalidate or circumvent its patents and patent applications. It is important for the Company’s business to defend successfully the patent rights that provide market exclusivity for its products. The Company is often involved in patent disputes relating to challenges to its patents or infringement and similar claims against the Company. The Company aggressively defends its important patents both within and outside the United States, including by filing claims of infringement against other parties. See Item 3. “Legal Proceedings — Patent

Litigation” below. In particular, manufacturers of generic pharmaceutical products from time to time file Abbreviated New Drug Applications (“ANDA”) with the FDA seeking to market generic forms of the Company’s products prior to the expiration of relevant patents owned by the Company. The Company normally responds by vigorously defending its patent, including by filing lawsuits alleging patent infringement. Patent litigation and other challenges to the Company’s patents are costly and unpredictable and may deprive the Company of market exclusivity for a patented product or, in some cases, third party patents may prevent the Company from marketing and selling a product in a particular geographic area.

 

If one or more important products lose patent protection in profitable markets, sales of those products are likely to decline significantly as a result of generic versions of those products becoming available. The Company’s results of operations may be adversely affected by the lost sales unless and until the Company has successfully launched commercially successful replacement products.

 

The Company faces intense competition from lower-cost generic products.

 

In general, the Company faces increasing competition from lower-cost generic products. The patent rights that protect its products are of varying strengths and durations. In addition, in some countries, patent protection is significantly weaker than in the United States or the EU. In the United States, political pressure to reduce spending on prescription drugs has led to legislation which encourages the use of generic products. Although it is the Company’s policy to actively protect its patent rights, generic challenges to the Company’s products can arise at any time, and it may not be able to prevent the emergence of generic competition for its products.

 

Loss of patent protection for a product typically is followed promptly by generic substitutes, reducing the Company’s sales of that product. Availability of generic substitutes for the Company’s drugs may adversely affect its results of operations and cash flow. In addition, proposals emerge from time to time in the United States and other countries for legislation to further encourage the early and rapid approval of generic drugs. Any such proposal that is enacted into law could worsen this substantial negative effect on the Company’s sales and, potentially, its results of operations and cash flow.

 

The Company faces intense competition from new products.

 

The Company’s products face intense competition from competitors’ products. This competition may increase as new products enter the market. In such an event, the competitors’ products may be safer or more effective or more effectively marketed and sold than the Company’s products. Alternatively, in the case of generic competition, they may be equally safe and effective products which are sold at a substantially lower price than the Company’s products. As a result, if the Company fails to maintain its competitive position, this could have a material adverse effect on its business and results of operations.

 

The Company faces pricing pressure with respect to its products.

 

The Company’s products are subject to increasing price pressures and other restrictions worldwide, including in the United States. These include (i) practices of managed care groups and institutional and governmental purchasers and (ii) U.S. federal laws and regulations related to Medicare and Medicaid, including the Medicare Prescription Drug Improvement and Modernization Act of 2003 (the “2003 Act”).

 

The 2003 Act included a prescription drug benefit for individuals which first went into effect on January 1, 2006. The increased purchasing power of entities that negotiate on behalf of Medicare beneficiaries could result in further pricing pressures. The Company expects pricing pressures to increase in the future.

 

Changes in laws and regulations could adversely affect the Company’s business.

 

All aspects of the Company’s business, including research and development, manufacturing, marketing, pricing, sales, litigation and intellectual property rights, are subject to extensive legislation and regulation. Changes in applicable federal and state laws and agency regulations could have a material adverse effect on the Company’s business.

(Cautionary Statements Under the Private Securities Litigation Reform Act of 1995)

 

This report and other written reports and oral statements made from time to time by the Company may contain so-called “forward-looking statements,” all of which are based on management’s current expectations and are subject to risks and uncertainties which may cause results to differ materially from those set forth in the statements. One can identify these forward-looking statements by their use of words such as “expects,” “plans,” “will,” “estimates,” “forecasts,” “projects” and other words of similar meaning. One can also identify them by the fact that they do not relate strictly to historical or current facts. These statements are likely to address the Company’s growth strategy, financial results, product development, product approvals, product potential, and development programs. One must carefully consider any such statement and should understand that many factors could cause actual results to differ materially from the Company’s forward-looking statements. These factors include inaccurate assumptions and a broad variety of other risks and uncertainties, including some that are known and some that are not. No forward-looking statement can be guaranteed and actual future results may vary materially. The Company does not assume the obligation to update any forward-looking statement. The Company cautions you not to place undue reliance on these forward-looking statements. Although it is not possible to predict or identify all such factors, they may include the following:

 

 

 

This list should not be considered an exhaustive statement of all potential risks and uncertainties. See “Risk Factors” on page 16.

 

None

 

The Company’s corporate headquarters is located in Whitehouse Station, New Jersey. The Company’s U.S. pharmaceutical business is conducted through divisional headquarters located in Upper Gwynedd and West Point, Pennsylvania. The Company’s vaccines business is conducted through divisional headquarters located in West Point. Principal research facilities for human health products are located in Rahway, New Jersey and West Point. The Company also has production facilities for human health products at nine locations in the United States and Puerto Rico. Branch warehouses provide services throughout the country. Outside the United States, through subsidiaries, the Company owns or has an interest in manufacturing plants or other properties in Australia, Canada, Japan, Singapore, South Africa, and other countries in Western Europe, Central and South America, and Asia.

 

Capital expenditures for 2006 were $980.2 million compared with $1.4 billion for 2005. In the United States, these amounted to $714.7 million for 2006 and $938.7 million for 2005. Abroad, such expenditures amounted to $265.5 million for 2006 and $464.0 million for 2005.

 

The Company and its subsidiaries own their principal facilities and manufacturing plants under titles which they consider to be satisfactory. The Company considers that its properties are in good operating condition and that its machinery and equipment have been well maintained. Plants for the manufacture of products are suitable for their intended purposes and have capacities and projected capacities adequate for current and projected needs for existing Company products. Some capacity of the plants is being converted, with any needed modification, to the requirements of newly introduced and future products.

 

The Company is involved in various claims and legal proceedings of a nature considered normal to its business, including product liability, intellectual property, and commercial litigation, as well as additional matters such as antitrust actions.

 

Vioxx Litigation

 

Product Liability Lawsuits

As previously disclosed, individual and putative class actions have been filed against the Company in state and federal courts alleging personal injury and/or economic loss with respect to the purchase or use of Vioxx. All such actions filed in federal court are coordinated in a multidistrict litigation in the U.S. District Court for the Eastern District of Louisiana (the “MDL”) before District Judge Eldon E. Fallon. A number of such actions filed in state court are coordinated in separate coordinated proceedings in state courts in New Jersey, California and Texas, and the counties of Philadelphia, Pennsylvania and Clark County, Nevada. As of December 31, 2006, the Company had been served or was aware that it had been named as a defendant in approximately 27,400 lawsuits, which include approximately 46,100 plaintiff groups, alleging personal injuries resulting from the use of Vioxx, and in approximately 264 putative class actions alleging personal injuries and/or economic loss. (All of the actions discussed in this paragraph are collectively referred to as the “Vioxx Product Liability Lawsuits”.) Of these lawsuits, approximately 8,300 lawsuits representing approximately 23,700 plaintiff groups are or are slated to be in the federal MDL and approximately 16,800 lawsuits representing approximately 16,800 plaintiff groups are included in a coordinated proceeding in New Jersey Superior Court before Judge Carol E. Higbee.

 

In addition to the Vioxx Product Liability Lawsuits discussed above, the claims of over 4,025 plaintiffs had been dismissed as of December 31, 2006. Of these, there have been over 1,225 plaintiffs whose claims were

dismissed with prejudice (i.e., they cannot be brought again) either by plaintiffs themselves or by the courts. Over 2,800 additional plaintiffs have had their claims dismissed without prejudice (i.e., they can be brought again).

 

In the MDL, Judge Fallon in July 2005 indicated that he would schedule for trial a series of cases during the period November 2005 through 2006, in the following categories: (i) heart attack with short term use; (ii) heart attack with long term use; (iii) stroke; and (iv) cardiovascular injury involving a prescription written after April 2002 when the labeling for Vioxx was revised to include the results of the VIGOR trial. These trials began in November 2005 and concluded in December 2006. The next scheduled trial in the MDL is a re-trial in Barnett v. Merck on the issue of damages as discussed below.

 

Several Vioxx Product Liability Lawsuits are currently scheduled for trial in 2007. The Company has provided a list of such trials at its website at www.merck.com which it will periodically update as appropriate. The Company has included its website address only as an inactive textual reference and does not intend it to be an active link to its website nor does it incorporate by reference the information contained therein.

 

Merck has entered into a tolling agreement (the “Tolling Agreement”) with the MDL Plaintiffs’ Steering Committee that establishes a procedure to halt the running of the statute of limitations (tolling) as to certain categories of claims allegedly arising from the use of Vioxx by non-New Jersey citizens. The Tolling Agreement applies to individuals who have not filed lawsuits and may or may not eventually file lawsuits and only to those claimants who seek to toll claims alleging injuries resulting from a thrombotic cardiovascular event that results in a myocardial infarction or ischemic stroke. The Tolling Agreement provides counsel additional time to evaluate potential claims. The Tolling Agreement requires any tolled claims to be filed in federal court. As of December 31, 2006, approximately 14,180 claimants had entered into Tolling Agreements.

 

Merck voluntarily withdrew Vioxx from the market on September 30, 2004. Many states have a two-year statute of limitations for product liability claims, requiring that claims must be filed within two years after the plaintiffs learned or could have learned of their potential cause of action. As a result, some may view September 30, 2006 as a deadline for filing Vioxx cases. It is important to note, however, that the law regarding statutes of limitations can be complex, varies from state to state, can be fact-specific, and in some cases, might be affected by the existence of pending class actions. For example, some states have three year statutes of limitations and, in some instances, the statute of limitations is even longer. Merck expects that there will be legal arguments concerning the proper application of these statutes, and the decisions will be up to the judges presiding in individual cases in state and federal proceedings.

 

The Company has previously disclosed the outcomes of several Vioxx Product Liability Lawsuits that were tried prior to September 30, 2006 (see chart below).

 

In August 2006, in Barnett v. Merck, a case before Judge Fallon in the MDL, a jury in New Orleans, Louisiana returned a plaintiff verdict in the second federal Vioxx case to go to trial. The jury awarded $50 million in compensatory damages and $1 million in punitive damages. On August 30, 2006, Judge Fallon overturned as excessive the damages portion of the verdict and ordered a new trial on damages. Judge Fallon has set re-trial for October 29, 2007 on the issue of damages. Merck has filed motions for a new trial on all issues and for Judgment as a Matter of Law, both of which are currently pending before the Court. Plaintiff has opposed Merck’s motion and has asked the Judge to reduce the amount of the award rather than re-try the case.

 

Juries found in favor of Merck on all counts in the fourth and fifth cases to go to trial in the MDL. The jury returned its verdict for Merck in Mason v. Merck on November 8, 2006 and in Dedrick v. Merck on December 13, 2006.

 

On November 22, 2006, Judge Fallon denied a motion filed in the MDL to certify a nationwide class of all persons who allegedly suffered personal injury as a result of taking Vioxx.

 

On December 15, 2006, the jury in Albright v. Merck, a case tried in state court in Birmingham, Alabama, returned a verdict for Merck on all counts.

 

The Company previously disclosed that in April 2006, in Garza v. Merck, a jury in Rio Grande City, Texas returned a verdict in favor of the plaintiff. In September 2006, the Texas state court granted the Company’s request to investigate possible jury bias because a juror admitted that he had, prior to the trial, on several occasions

borrowed money from the plaintiff. On December 21, 2006, the court entered judgment for plaintiff in the amount of $7.75 million, plus interest, reduced from the original award of $32 million because of the Texas state cap on punitive damages. The Company is seeking a new trial and will appeal the verdict if the court does not grant a new trial.

 

On October 31, 2006, in California Superior Court in Los Angeles, a consolidated trial began in the cases Appell v. Merck and Arrigale v. Merck. On January 18, 2007, Judge Victoria Chaney declared a mistrial as to both plaintiffs after the jury reported that it was deadlocked.

 

On October 5, 2006, in the coordinated proceeding in New Jersey Superior Court, Judge Higbee dismissed claims of the United Kingdom plaintiffs. These plaintiffs have appealed.

 

The first case scheduled for trial in the Texas coordinated proceeding, Rigby v. Merck, was scheduled to begin trial on November 7, 2006. The Rigby case was voluntarily dismissed on October 23, 2006 when the plaintiff filed a notice of non-suit with the Court.

 

A consolidated trial, Hermans v. Merck and Humeston v. Merck, began on January 17, 2007, in the coordinated proceeding in New Jersey Superior Court before Judge Higbee. Humeston v. Merck was first tried in 2005, but Judge Higbee set aside the November 2005 jury verdict in favor of Merck and ordered a new trial on the grounds of newly discovered evidence. The Hermans/Humeston trial is separated into two phases: a general phase regarding Merck’s conduct and a plaintiff-specific phase. There will be jury questions and a deliberation after phase I regarding Merck’s conduct. If the jury answers any of the questions in the affirmative, the case will move to phase II. In phase II each plaintiff will present his or her specific case. At the end of phase II, the jury will deliberate and will answer questions with respect to each of the two plaintiffs. The jury will answer separate verdict sheets but in the course of only one deliberation. If the case moves to a punitive phase, there will be a single presentation for each side and one jury deliberation for both plaintiffs.

 

The first case scheduled for trial in the Philadelphia coordinated proceeding, McCool v. Merck, was scheduled to begin trial on February 26, 2007. The plaintiff voluntarily dismissed with prejudice her case on January 16, 2007.

 

On September 28, 2006, the New Jersey Superior Court, Appellate Division, heard argument on plaintiffs’ appeal of Judge Higbee’s dismissal of the Sinclair v. Merck case. This putative class action was originally filed in December 2004 and sought the creation of a medical monitoring fund. Judge Higbee had granted the Company’s motion to dismiss in May 2005. On January 16, 2007, the Appellate Division reversed the decision and remanded the case back to Judge Higbee for further factual inquiry. The Company has petitioned the New Jersey Supreme Court for review of the Appellate Division’s decision.

 

To date in the Vioxx Product Liability Lawsuits, of the 29 plaintiffs whose claims have been scheduled for trial, the claims of seven were dismissed, the claims of seven were withdrawn from the trial calendar by plaintiffs, and juries have decided in Merck’s favor nine times and in plaintiffs’ favor four times. In addition, in the recent California trial involving two plaintiffs, the jury could not reach a verdict for either plaintiff and a mistrial was declared. A New Jersey state judge set aside one of the nine Merck verdicts. With respect to the four plaintiffs’ verdicts, Merck already has filed an appeal or sought judicial review in each of those cases, and in one of those four, a federal judge overturned the damage award shortly after trial. In addition, a consolidated trial with two plaintiffs is currently ongoing in the coordinated proceeding in New Jersey Superior Court before Judge Higbee and another trial, Schwaller v. Merck, has commenced in state court in Madison County, Illinois.

 

The following chart sets forth the results of all U.S. Vioxx Product Liability trials to date.

 

 

 

Other Lawsuits

 

As previously disclosed, on July 29, 2005, a New Jersey state trial court certified a nationwide class of third-party payors (such as unions and health insurance plans) that paid in whole or in part for the Vioxx used by their plan members or insureds. The named plaintiff in that case seeks recovery of certain Vioxx purchase costs (plus penalties) based on allegations that the purported class members paid more for Vioxx than they would have had they known of the product’s alleged risks. Merck believes that the class was improperly certified. The trial court’s ruling is procedural only; it does not address the merits of plaintiffs’ allegations, which the Company intends to defend vigorously. On March 31, 2006, the New Jersey Superior Court, Appellate Division, affirmed the class certification order. On July 19, 2006, the New Jersey Supreme Court decided to exercise its discretion to hear the Company’s appeal of the Appellate Division’s decision. On August 24, 2006, the Appellate Division ordered a stay of the proceedings in Superior Court pending a ruling by the Supreme Court. Oral argument before the New Jersey Supreme Court is scheduled to take place in March 2007.

 

As previously reported, the Company has also been named as a defendant in separate lawsuits brought by the Attorneys General of Alaska, Louisiana, Mississippi, Montana, Texas and Utah. These actions allege that the Company misrepresented the safety of Vioxx and seek (i) recovery of the cost of Vioxx purchased or reimbursed by the state and its agencies; (ii) reimbursement of all sums paid by the state and its agencies for medical services for the treatment of persons injured by Vioxx; (iii) damages under various common law theories; and/or (iv) remedies under various state statutory theories, including state consumer fraud and/or fair business practices or Medicaid fraud statutes, including civil penalties.

 

Shareholder Lawsuits

As previously disclosed, in addition to the Vioxx Product Liability Lawsuits, the Company and various current and former officers and directors are defendants in various putative class actions and individual lawsuits under the federal securities laws and state securities laws (the “Vioxx Securities Lawsuits”). All of the Vioxx Securities Lawsuits pending in federal court have been transferred by the Judicial Panel on Multidistrict Litigation (the “JPML”) to the United States District Court for the District of New Jersey before District Judge Stanley R. Chesler for inclusion in a nationwide MDL (the “Shareholder MDL”). Judge Chesler has consolidated the Vioxx Securities Lawsuits for all purposes. Plaintiffs request certification of a class of purchasers of Company stock between May 21, 1999 and October 29, 2004. The complaint alleges that the defendants made false and misleading statements regarding Vioxx in violation of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, and seeks unspecified compensatory damages and the costs of suit, including attorneys’ fees. The complaint also asserts a claim under Section 20A of the Securities and Exchange Act against certain defendants relating to their sales of Merck stock. In addition, the complaint includes allegations under Sections 11, 12 and 15 of the Securities Act of 1933 that certain defendants made incomplete and misleading statements in a registration statement and certain prospectuses filed in connection with the Merck Stock Investment Plan, a dividend reinvestment plan. Defendants have filed a motion to dismiss the complaint. Oral argument on the motion to dismiss is scheduled to take place in March 2007.

 

As previously disclosed, on August 15, 2005, a complaint was filed in Oregon state court by the State of Oregon through the Oregon state treasurer on behalf of the Oregon Public Employee Retirement Fund against the Company and certain current and former officers and directors. The complaint, which was brought under Oregon securities law, alleges that plaintiff has suffered damages in connection with its purchases of Merck common stock at artificially inflated prices due to the Company’s alleged violations of law related to disclosures about Vioxx. The current and former officers and directors have entered into a tolling agreement and, on June 30, 2006, were dismissed without prejudice from the case. On July 19, 2006, the Court denied the Company’s motion to dismiss the complaint, but required plaintiff to amend the complaint. Plaintiff filed an amended complaint on September 21, 2006. Merck filed a motion to require plaintiffs to make the complaint more definite and certain, which was denied by the Court. Merck filed an answer to the complaint in January 2007.

 

As previously disclosed, various shareholder derivative actions filed in federal court were transferred to the Shareholder MDL and consolidated for all purposes by Judge Chesler (the “Vioxx Derivative Lawsuits”). The consolidated complaint arose out of substantially the same factual allegations that are made in the Vioxx Securities Lawsuits. The Vioxx Derivative Lawsuits, which were purportedly brought to assert rights of the Company, assert claims against certain members of the Board past and present and certain executive officers for breach of fiduciary

duty, waste of corporate assets, unjust enrichment, abuse of control and gross mismanagement. On May 5, 2006, Judge Chesler granted defendants’ motion to dismiss and denied plaintiffs’ request for leave to amend their complaint. Plaintiffs’ appeal of the District Court’s decision refusing them leave to amend the complaint is currently pending before the United States Court of Appeals for the Third Circuit.

 

As previously disclosed, on October 29, 2004, two individual shareholders made a demand on the Board of Directors of the Company to take legal action against Mr. Raymond Gilmartin, former Chairman, President and Chief Executive Officer and other individuals for allegedly causing damage to the Company with respect to the allegedly improper marketing of Vioxx. In July 2006, the Board received another shareholder letter demanding that the Board take legal action against the Board and management of Merck for allegedly causing damage to the Company relating to the Company’s allegedly improper marketing of Vioxx. In December 2006, each of these demands was rejected by the Board of Directors.

 

As previously announced, the Board of Directors appointed a Special Committee to review the Company’s actions prior to its voluntary withdrawal of Vioxx, to act for the Board in responding to shareholder litigation matters related to the withdrawal of Vioxx, and to advise the Board with respect to any action that should be taken as a result of the review. In December 2004, the Special Committee retained the Honorable John S. Martin, Jr. of Debevoise & Plimpton LLP to conduct an independent investigation of senior management’s conduct with respect to the cardiovascular safety profile of Vioxx during the period Vioxx was developed and marketed. The review was completed in the third quarter of 2006 and the full report (including appendices) was made public in September 2006. The Company has provided a copy of the full report and appendices at its website at www.merck.com/newsroom/vioxx/martin_report.html. The Company has included its website address only as an inactive textual reference and does not intend it to be an active link to its website nor does it incorporate by reference the information contained therein.

 

In addition, as previously disclosed, various putative class actions filed in federal court under the Employee Retirement Income Security Act (“ERISA”) against the Company and certain current and former officers and directors (the “Vioxx ERISA Lawsuits” and, together with the Vioxx Securities Lawsuits and the Vioxx Derivative Lawsuits, the “Vioxx Shareholder Lawsuits”) have been transferred to the Shareholder MDL and consolidated for all purposes. The consolidated complaint asserts claims on behalf of certain of the Company’s current and former employees who are participants in certain of the Company’s retirement plans for breach of fiduciary duty. The lawsuits make similar allegations to the allegations contained in the Vioxx Securities Lawsuits. On October 7, 2005, defendants moved to dismiss the ERISA complaint. On July 11, 2006, Judge Chesler granted in part and denied in part defendants’ motion to dismiss.

 

International Lawsuits

As previously disclosed, in addition to the lawsuits discussed above, the Company has been named as a defendant in litigation relating to Vioxx in various countries (collectively, the “Vioxx Foreign Lawsuits”) in Europe, as well as Canada, Brazil, Argentina, Australia, Turkey, and Israel.

 

Additional Lawsuits

Based on media reports and other sources, the Company anticipates that additional Vioxx Product Liability Lawsuits, Vioxx Shareholder Lawsuits and Vioxx Foreign Lawsuits (collectively, the “Vioxx Lawsuits”) will be filed against it and/or certain of its current and former officers and directors in the future.

 

Insurance

As previously disclosed, the Company has product liability insurance for claims brought in the Vioxx Product Liability Lawsuits with stated upper limits of approximately $630 million after deductibles and co-insurance. This insurance provides coverage for legal defense costs and potential damage amounts that have been or will be incurred in connection with the Vioxx Product Liability Lawsuits. The Company believes that this insurance coverage extends to additional Vioxx Product Liability Lawsuits that may be filed in the future. The Company has Directors and Officers insurance coverage applicable to the Vioxx Securities Lawsuits and Vioxx Derivative Lawsuits with stated upper limits of approximately $190 million. The Company has fiduciary and other insurance for the Vioxx ERISA Lawsuits with stated upper limits of approximately $275 million. Additional insurance coverage for these claims may also be available under upper-level excess policies that provide coverage for a variety

of risks. There are disputes with certain insurers about the availability of some or all of this insurance coverage and there are likely to be additional disputes. The Company’s insurance coverage with respect to the Vioxx Lawsuits will not be adequate to cover its defense costs and any losses.

 

As previously disclosed, the Company’s upper level excess insurers (which provide excess insurance potentially applicable to all of the Vioxx Lawsuits) have commenced an arbitration seeking, among other things, to cancel those policies, to void all of their obligations under those policies and to raise other coverage issues with respect to the Vioxx Lawsuits. Merck intends to contest vigorously the insurers’ claims and will attempt to enforce its rights under applicable insurance policies. The amounts actually recovered under the policies discussed in this section may be less than the amounts specified in the preceding paragraph.

 

Investigations

As previously disclosed, in November 2004, the Company was advised by the staff of the SEC that it was commencing an informal inquiry concerning Vioxx. On January 28, 2005, the Company announced that it received notice that the SEC issued a formal notice of investigation. Also, the Company has received subpoenas from the U.S. Department of Justice (the “DOJ”) requesting information related to the Company’s research, marketing and selling activities with respect to Vioxx in a federal health care investigation under criminal statutes. In addition, as previously disclosed, investigations are being conducted by local authorities in certain cities in Europe in order to determine whether any criminal charges should be brought concerning Vioxx. The Company is cooperating with these governmental entities in their respective investigations (the “Vioxx Investigations”). The Company cannot predict the outcome of these inquiries; however, they could result in potential civil and/or criminal dispositions.

 

As previously disclosed, the Company has received a number of Civil Investigative Demands (“CID”) from a group of Attorneys General from 31 states and the District of Columbia who are investigating whether the Company violated state consumer protection laws when marketing Vioxx. The Company is cooperating with the Attorneys General in responding to the CIDs.

 

In addition, the Company received a subpoena in September 2006 from the State of California Attorney General seeking documents and information related to the placement of Vioxx on California’s Medi-Cal formulary. The Company is cooperating with the Attorney General in responding to the subpoena.

 

Reserves

The Company currently anticipates that a number of Vioxx Product Liability Lawsuits will be tried throughout 2007. A trial in the Oregon securities case is scheduled for 2007, but the Company cannot predict whether this trial will proceed on schedule or the timing of any of the other Vioxx Shareholder Lawsuit trials. The Company believes that it has meritorious defenses to the Vioxx Lawsuits and will vigorously defend against them. In view of the inherent difficulty of predicting the outcome of litigation, particularly where there are many claimants and the claimants seek indeterminate damages, the Company is unable to predict the outcome of these matters, and at this time cannot reasonably estimate the possible loss or range of loss with respect to the Vioxx Lawsuits. The Company has not established any reserves for any potential liability relating to the Vioxx Lawsuits or the Vioxx Investigations, including for those cases in which verdicts or judgments have been entered against the Company, and are now in post-verdict proceedings or on appeal. In each of those cases the Company believes it has strong points to raise on appeal and therefore that unfavorable outcomes in such cases are not probable. Unfavorable outcomes in the Vioxx Litigation (as defined below) could have a material adverse effect on the Company’s financial position, liquidity and results of operations.

 

Legal defense costs expected to be incurred in connection with a loss contingency are accrued when probable and reasonably estimable. As of December 31, 2005, the Company had a reserve of $685 million solely for its future legal defense costs related to the Vioxx Litigation.

 

During 2006, the Company spent $500 million in the aggregate, including $175 million in the fourth quarter, in legal defense costs worldwide related to (i) the Vioxx Product Liability Lawsuits, (ii) the Vioxx Shareholder Lawsuits, (iii) the Vioxx Foreign Lawsuits, and (iv) the Vioxx Investigations (collectively, the “Vioxx Litigation”). In the third quarter and fourth quarter of 2006, the Company recorded charges of $598 million and $75 million, respectively, to increase the reserve solely for its future legal defense costs related to the Vioxx

Litigation to $858 million at December 31, 2006. In increasing the reserve, the Company considered the same factors that it considered when it previously established reserves for the Vioxx Litigation. Management now believes it has a better estimate of the Company’s expenses and can reasonably estimate such costs through 2008. Some of the significant factors considered in the establishment and ongoing review of the reserve for the Vioxx legal defense costs were as follows: the actual costs incurred by the Company; the development of the Company’s legal defense strategy and structure in light of the scope of the Vioxx Litigation; the number of cases being brought against the Company; the costs and outcomes of completed trials and the most current information regarding anticipated timing, progression, and related costs of pre-trial activities and trials in the Vioxx Product Liability Lawsuits. Events such as scheduled trials, that are expected to occur throughout 2007 and into 2008, and the inherent inability to predict the ultimate outcomes of such trials, limit the Company’s ability to reasonably estimate its legal costs beyond the end of 2008. While the Company does not anticipate that it will need to increase the reserve every quarter, it will continue to monitor its legal defense costs and review the adequacy of the associated reserves and may determine to increase its reserves for legal defense costs at any time in the future if, based upon the factors set forth, it believes it would be appropriate to do so.

 

Other Product Liability Litigation

 

As previously disclosed, the Company is a defendant in product liability lawsuits in the United States involving Fosamax (the “Fosamax Litigation”). As of December 31, 2006, 104 cases had been filed against Merck in either federal or state court, including 4 cases which seek class action certification, as well as damages and medical monitoring. In these actions, plaintiffs allege, among other things, that they have suffered osteonecrosis of the jaw, generally subsequent to invasive dental procedures such as tooth extraction or dental implants, and/or delayed healing, in association with the use of Fosamax. On August 16, 2006, the JPML ordered that the Fosamax product liability cases pending in federal courts nationwide should be transferred and consolidated into one multidistrict litigation (the “Fosamax MDL”) for coordinated pre-trial proceedings. The Fosamax MDL has been transferred to Judge John Keenan in the United States District Court for the Southern District of New York. As a result of the JPML order, over 80 cases are before Judge Keenan. Judge Keenan has issued a Case Management Order setting forth a schedule governing the proceedings which focuses primarily upon resolving the class action certification motions in 2007. The Company intends to defend against these lawsuits.

 

As of December 31, 2006, the Company established a reserve of approximately $48 million solely for its future legal defense costs for the Fosamax Litigation. Some of the significant factors considered in the establishment of the reserve for the Fosamax Litigation legal defense costs were as follows: the actual costs incurred by the Company thus far; the development of the Company’s legal defense strategy and structure in light of the creation of the Fosamax MDL; the number of cases being brought against the Company; and the anticipated timing, progression, and related costs of pre-trial activities in the Fosamax Litigation. The Company will continue to monitor its legal defense costs and review the adequacy of the associated reserves. Due to the uncertain nature of litigation, the Company is unable to estimate its costs beyond the end of 2008. Unfavorable outcomes in the Fosamax Litigation could have a material adverse effect on the Company’s financial position, liquidity and results of operations.

 

Commercial Litigation

 

Beginning in 1993, the Company was named in a number of antitrust suits, certain of which were certified as class actions, instituted by most of the nation’s retail pharmacies and consumers in several states. The Company settled the federal class action, which represented the single largest group of claims and has settled substantially all of the remaining cases on satisfactory terms. The few remaining cases have been inactive for several years. The Company has not engaged in any conspiracy and no admission of wrongdoing was made or included in any settlement agreements.

 

As previously disclosed, the Company was joined in ongoing litigation alleging manipulation by pharmaceutical manufacturers of Average Wholesale Prices (“AWP”), which are sometimes used in calculations that determine public and private sector reimbursement levels. In 2002, the JPML ordered the transfer and consolidation of all pending federal AWP cases to federal court in Boston, Massachusetts. Plaintiffs filed one consolidated class action complaint, which aggregated the claims previously filed in various federal district court

actions and also expanded the number of manufacturers to include some which, like the Company, had not been defendants in any prior pending case. In May 2003, the court granted the Company’s motion to dismiss the consolidated class action and dismissed the Company from the class action case. Subsequent to the Company’s dismissal, the plaintiffs filed an amended consolidated class action complaint, which did not name the Company as a defendant. The Company and many other pharmaceutical manufacturers are defendants in similar complaints pending in federal and state court brought individually by a number of counties in the State of New York. The Company and the other defendants are awaiting the final ruling on their motion to dismiss in the Suffolk County case, which was the first of the New York county cases to be filed. In addition, as of December 31, 2006, the Company was a defendant in state cases brought by the Attorneys General of Kentucky, Illinois, Alabama, Wisconsin, Mississippi, Arizona, Hawaii and Alaska, all of which are being defended.

 

As previously disclosed, the Company has been named as a defendant in antitrust cases in federal court in Minnesota and in state court in California, each alleging an unlawful conspiracy among different sets of pharmaceutical manufacturers to protect high prices in the United States by impeding importation into the United States of lower-priced pharmaceuticals from Canada. The court dismissed the federal claims in the Minnesota case with prejudice and the plaintiffs filed a Notice of Appeal. The Federal Court of Appeals for the Eighth Circuit affirmed the dismissal of the federal claims. The state claims in that action were dismissed without prejudice, but have not been refiled in any jurisdiction.

 

In the California antitrust action, the parties engaged in discovery and the defendant manufacturers filed for summary judgment. In December 2006, the court granted summary judgment in favor of Merck and the other defendants and dismissed the case. The plaintiffs have filed a Notice of Appeal in the California state appeals court.

 

As previously disclosed, a suit in federal court in Alabama by two providers of health services to needy patients alleges that 15 pharmaceutical companies overcharged the plaintiffs and a class of those similarly situated, for pharmaceuticals purchased by the plaintiffs under the program established by Section 340B of the Public Health Service Act. The Company and the other defendants filed a motion to dismiss the complaint on numerous grounds which was recently denied by the court. After denial of the motion to dismiss, the case was dismissed voluntarily by the parties.

 

As previously disclosed, in January 2003, the DOJ notified the federal court in New Orleans, Louisiana that it was not going to intervene at that time in a pending Federal False Claims Act case that was filed under seal in December 1999 against the Company. The court issued an order unsealing the complaint, which was filed by a physician in Louisiana, and ordered that the complaint be served. The complaint, which alleged that the Company’s discounting of Pepcid in certain Louisiana hospitals led to increases in costs to Medicaid, was dismissed. An amended complaint was filed under seal and the case has been administratively closed by the Court until the seal is lifted. The State of Louisiana has filed its own amended complaint, incorporating the allegations contained in the sealed amended complaint. The allegations contained in the sealed amended complaint are unknown.

 

In April 2005, the Company was named in a qui tam lawsuit under the Nevada False Claims Act. The suit, in which the Nevada Attorney General has intervened, alleges that the Company inappropriately offered nominal pricing and other marketing and pricing inducements to certain customers and also failed to comply with its obligations under the Medicaid Best Price scheme related to such arrangements. In May 2006, the Company’s motion to dismiss this action was denied by the district court. The Company is defending against this lawsuit.

 

Governmental Proceedings

 

As previously disclosed, the Company has received a subpoena from the DOJ in connection with its investigation of the Company’s marketing and selling activities, including nominal pricing programs and samples. The Company has also reported that it has received a CID from the Attorney General of Texas regarding the Company’s marketing and selling activities relating to Texas. As previously disclosed, the Company received another CID from the Attorney General of Texas asking for additional information regarding the Company’s marketing and selling activities related to Texas, including with respect to certain of its nominal pricing programs and samples. In April 2004, the Company received a subpoena from the office of the Inspector General for the District of Columbia in connection with an investigation of the Company’s interactions with physicians in the District of Columbia, Maryland, and Virginia. In November 2004, the Company received a letter request from the

DOJ in connection with its investigation of the Company’s pricing of Pepcid. In September 2005, the Company received a subpoena from the Illinois Attorney General. The subpoena seeks information related to repackaging of prescription drugs. There was no activity relating to Merck in the Illinois matter in 2006.

 

As previously disclosed, the Company has received a letter from the DOJ advising it of the existence of a qui tam complaint alleging that the Company violated certain rules related to its calculations of best price and other federal pricing benchmark calculations, certain of which may affect the Company’s Medicaid rebate obligation. The DOJ has informed the Company that it does not intend to intervene in this action and has closed its investigation. The lawsuit continues, however.

 

The Company is cooperating with all of these investigations. The Company cannot predict the outcome of these investigations; however, it is possible that unfavorable outcomes could have a material adverse effect on the Company’s financial position, liquidity and results of operations. In addition, from time to time, other federal, state or foreign regulators or authorities may seek information about practices in the pharmaceutical industry or the Company’s business practices in inquiries other than the investigations discussed in this section. It is not feasible to predict the outcome of any such inquiries.

 

As previously disclosed, on February 23, 2004, the Italian Antitrust Authority (“ICA”) adopted a measure commencing a formal investigation of Merck Sharp & Dohme (Italia) S.p.A. (“MSD Italy”) and the Company under Article 14 of the Italian Competition Law and Article 82 EC to ascertain whether the Company and MSD Italy committed an abuse of a dominant position by refusing to grant to ACS Dobfar S.p.A. (“Dobfar”), an Italian company, a voluntary license under the Company’s Italian Supplementary Protection Certificate (“SPC”), pursuant to domestic legislation passed in 2002, to permit Dobfar to manufacture imipenem and cilastatin (“I&C”), the active ingredients in Tienam, in Italy for sale outside Italy in countries where patent protection had expired or never existed. A hearing before the ICA was held on May 2, 2005 and on June 17, 2005, the ICA found, on a preliminary basis, that the Company’s refusal to grant the license was an abuse of a dominant position, and imposed interim measures requiring the Company to grant a license to manufacture I&C in Italy for stockpiling purposes only, until expiration of the SPC. On November 16, 2005, the Italian Administrative court denied the Company’s appeal of the ICA’s order. The Company’s SPC expired in January 2006. Proceedings before the ICA continued on the merits of the Article 82 investigation and, in an effort to resolve the matter, the Company offered a commitment to the ICA pursuant to which the Company would grant non-exclusive licenses under its Italian SPC for finasteride with respect to finasteride 5 mg for the treatment of benign prostate hyperplasia. The deadline for the ICA to adopt its final decision as to whether the Company’s commitment warrants the closure of the case is March 16, 2007.

 

Vaccine Litigation

 

As previously disclosed, the Company is a party in claims brought under the Consumer Protection Act of 1987 in the United Kingdom, which allege that certain children suffer from a variety of conditions as a result of being vaccinated with various bivalent vaccines for measles and rubella and/or trivalent vaccines for measles, mumps and rubella, including the Company’s M-M-R II. The conditions include autism, with or without inflammatory bowel disease, epilepsy, encephalitis, encephalopathy, Guillain-Barre syndrome and transverse myelitis. There are now 6 claimants proceeding or, to the Company’s knowledge, intending to proceed against the Company. The Company will defend against these lawsuits.

 

As previously disclosed, the Company is also a party to individual and class action product liability lawsuits and claims in the United States involving pediatric vaccines (e.g., hepatitis B vaccine) that contained thimerosal, a preservative used in vaccines. Merck has not distributed thimerosal-containing pediatric vaccines in the United States since the fall of 2001. As of December 31, 2006, there were approximately 250 active thimerosal related lawsuits with approximately 670 plaintiffs. Other defendants include other vaccine manufacturers who produced pediatric vaccines containing thimerosal as well as manufacturers of thimerosal. In these actions, the plaintiffs allege, among other things, that they have suffered neurological injuries as a result of exposure to thimerosal from pediatric vaccines. Two cases scheduled for trial in 2006 were dismissed – one, a state court case in Ohio voluntarily dismissed by the plaintiffs, and the second, a Federal District Court case in Texas in which the Court entered summary judgment in favor of defendants in 2005 and plaintiffs ultimately voluntarily dismissed

their appeal. The Company will defend against these lawsuits; however, it is possible that unfavorable outcomes could have a material adverse effect on the Company’s financial position, liquidity and results of operations.

 

The Company has been successful in having cases of this type either dismissed or stayed on the ground that the action is prohibited under the National Childhood Vaccine Injury Act (the “Vaccine Act”). The Vaccine Act prohibits any person from filing or maintaining a civil action (in state or federal court) seeking damages against a vaccine manufacturer for vaccine-related injuries unless a petition is first filed in the United States Court of Federal Claims (hereinafter the “Vaccine Court”). Under the Vaccine Act, before filing a civil action against a vaccine manufacturer, the petitioner must either (a) pursue his or her petition to conclusion in Vaccine Court and then timely file an election to proceed with a civil action in lieu of accepting the Vaccine Court’s adjudication of the petition or (b) timely exercise a right to withdraw the petition prior to Vaccine Court adjudication in accordance with certain statutorily prescribed time periods. The Company is not a party to Vaccine Court proceedings because the petitions are brought against the United States Department of Health and Human Services. The cases with trial dates referred to in the preceding paragraph as having been dismissed were brought by plaintiffs who claimed to have made a timely withdrawal of their Vaccine Court petitions.

 

The Company is aware that there are approximately 4,700 cases pending in the Vaccine Court involving allegations that thimerosal-containing vaccines and/or the M-M-R II vaccine cause autism spectrum disorders. Not all of the thimerosal-containing vaccines involved in the Vaccine Court proceeding are Company vaccines. The Company is the sole source of the M-M-R II vaccine domestically. In June 2007, the Special Masters presiding over the Vaccine Court proceedings are scheduled to begin a hearing in which both petitioners and the government will present evidence on the issue of whether these vaccines can cause autism spectrum disorders. That hearing is expected to last a number of weeks. Since it is not a party, the Company will not participate in the proceedings.

 

Patent Litigation

 

From time to time, generic manufacturers of pharmaceutical products file ANDA’s with the FDA seeking to market generic forms of the Company’s products prior to the expiration of relevant patents owned by the Company. Generic pharmaceutical manufacturers have submitted ANDA’s to the FDA seeking to market in the United States a generic form of Fosamax, Prilosec, Nexium, Propecia, Trusopt and Cosopt prior to the expiration of the Company’s (and AstraZeneca’s in the case of Prilosec and Nexium) patents concerning these products. The generic companies’ ANDA’s generally include allegations of non-infringement, invalidity and unenforceability of the patents. Generic manufacturers have received FDA approval to market a generic form of Prilosec. The Company has filed patent infringement suits in federal court against companies filing ANDA’s for generic alendronate (Fosamax), finasteride (Propecia), dorzolamide (Trusopt) and dorzolamide/timolol (Cosopt), and AstraZeneca and the Company have filed patent infringement suits in federal court against companies filing ANDA’s for generic omeprazole (Prilosec) and esomeprazole (Nexium). Similar patent challenges exist in certain foreign jurisdictions. The Company intends to vigorously defend its patents, which it believes are valid, against infringement by generic companies attempting to market products prior to the expiration dates of such patents. As with any litigation, there can be no assurance of the outcomes, which, if adverse, could result in significantly shortened periods of exclusivity for these products.

 

In February 2007, Schering Plough received a notice from a generic company indicating that it had filed an ANDA for Zetia and that it is challenging the U.S. patents that are listed for Zetia. Merck and Schering Plough market Zetia through a joint venture and they are considering the appropriate response.

 

On February 22, 2007, the Company received a notice from a generic company indicating that it had filed an ANDA for montelukast and that it is challenging the U.S. patent that is listed for Singulair. The Company is considering the appropriate response.

 

As previously disclosed, on January 28, 2005, the U.S. Court of Appeals for the Federal Circuit in Washington, D.C. found the Company’s patent claims for once-weekly administration of Fosamax to be invalid. The Company exhausted all options to appeal this decision in 2005. Based on the Court of Appeals’ decision, Fosamax and Fosamax Plus D will lose market exclusivity in the United States in February 2008 and April 2008, respectively and the Company expects a significant decline in U.S. Fosamax and Fosamax Plus D sales after each product’s respective loss of market exclusivity.

 

In May 2005, the Federal Court of Canada Trial Division issued a decision refusing to bar the approval of generic alendronate on the ground that Merck’s patent for weekly alendronate was likely invalid. This decision cannot be appealed and generic alendronate was launched in Canada in June 2005. In July 2005, Merck was sued in the Federal Court of Canada by Apotex seeking damages for lost sales of generic weekly alendronate due to the patent proceeding.

 

As previously disclosed, in September 2004, the Company appealed a decision of the Opposition Division of the EPO that revoked the Company’s patent in Europe that covers the once-weekly administration of alendronate. On March 14, 2006, the Board of Appeal of the EPO upheld the decision of the Opposition Division. Thus, presently the Company is not entitled to market exclusivity for Fosamax in most major European markets after 2007. In addition, Merck’s basic patent covering the use of alendronate has been challenged in several European countries. The Company has received adverse decisions in Germany, Holland and the United Kingdom. The decision in the United Kingdom was upheld on appeal. The Company has appealed the decisions in Germany and Holland.

 

In June 2006, the Company filed lawsuits in federal court against Barr Laboratories, Inc. and Teva Pharmaceutical Industries Ltd. (“Teva”) asserting that their respective manufacturing processes for making their alendronate products would infringe one or more process patents of the Company.

 

On October 5, 2004, in an action in Australia challenging the validity of the Company’s Australian patent for the once-weekly administration of alendronate, the patent was found to be invalid. That decision was upheld on appeal.

 

In addition, as previously disclosed, in Japan a proceeding has been filed challenging the validity of the Company’s Japanese patent for the once-weekly administration of alendronate.

 

On January 18, 2006, the Company sued Hi-Tech Pharmacal Co., Inc. (“Hi-Tech”) of Amityville, New York for patent infringement in response to Hi-Tech’s application to the FDA seeking approval of a generic version of Merck’s ophthalmic drugs Trusopt and Cosopt, which are used for treating elevated intraocular pressure in people with ocular hypertension or glaucoma. In the lawsuit, Merck sued to enforce a patent covering an active ingredient dorzolamide, which is present in both Trusopt and Cosopt. In that case, the District Court entered judgment in Merck’s favor and Hi-Tech appealed. A hearing of the appeal was conducted in December 2006 and a decision is pending. Merck has elected not to enforce two U.S. patents listed with the FDA which cover the combination of dorzolamide and timolol, the two active ingredients in Cosopt. This lawsuit automatically stays FDA approval of Hi-Tech’s ANDA’s for 30 months from January 2006 or until an adverse court decision, whichever may occur earlier. The patent covering dorzolamide provides exclusivity for Trusopt and Cosopt until October 2008 (including six months of pediatric exclusivity). After such time, the Company expects sales of these products to decline.

 

In the case of omeprazole, the trial court in the United States rendered an opinion in October 2002 upholding the validity of the Company’s and AstraZeneca’s patents covering the stabilized formulation of omeprazole and ruling that one defendant’s omeprazole product did not infringe those patents. The other three defendants’ products were found to infringe the formulation patents. In December 2003, the U.S. Court of Appeals for the Federal Circuit affirmed the decision of the trial court. With respect to the Company’s patent infringement claims against certain other generic manufacturers’ omeprazole products, the trial concluded in June 2006 and a decision is pending.

 

The Company and AstraZeneca received notice in October 2005 that Ranbaxy Laboratories Limited (“Ranbaxy”) has filed an ANDA for esomeprazole magnesium. The ANDA contains Paragraph IV challenges to patents on Nexium. On November 21, 2005, the Company and AstraZeneca sued Ranbaxy in the United States District Court in New Jersey. Accordingly, FDA approval of Ranbaxy’s ANDA is stayed for 30 months until April 2008 or until an adverse court decision, if any, whichever may occur earlier. The Company and AstraZeneca received notice in January 2006 that IVAX Pharmaceuticals, Inc., subsequently acquired by Teva, had filed an ANDA for esomeprazole magnesium. The ANDA contains Paragraph IV challenges to patents on Nexium. On March 8, 2006. the Company and AstraZeneca sued Teva in the United States District Court in New Jersey. Accordingly, FDA approval of Teva’s ANDA is stayed for 30 months until September 2008 or until an adverse court decision, if any, whichever may occur earlier.

 

In the case of finasteride, an ANDA has been filed seeking approval of a generic version of Propecia and alleging invalidity of the Company’s patents. The Company filed a patent infringement lawsuit in the District Court of Delaware in September 2004. In 2006, the Company reached a settlement with the generic company, Dr. Reddy’s Laboratories (“DRL”), under which DRL may sell a generic 1 mg finasteride product beginning in January 2013.

 

In Europe, the Company is aware of various companies seeking registration for generic losartan (the active ingredient for Cozaar). The Company has patent rights to losartan via license from E.I. du Pont de Nemours and Company (“du Pont”). The Company and du Pont have filed patent infringement proceedings against various companies in Portugal, Spain and Norway.

 

Other Litigation

 

On July 27, 2005, Merck was served with a further shareholder derivative suit filed in the New Jersey Superior Court for Hunterdon County against the Company and certain current and former officers and directors. This lawsuit seeks to recover or cancel compensation awarded to the Company’s executive officers in 2004, and asserts claims for breach of fiduciary duty, waste and unjust enrichment. On July 21, 2006, the Court granted defendants’ motion to dismiss based on plaintiff’s failure to make pre-suit demand on Merck’s Board of Directors and denied plaintiff’s request for leave to amend. Thus, this case has been terminated.

 

In November 2005, an individual shareholder delivered a letter to the Board alleging that the Company had sustained damages through the Company’s adoption of its Change in Control Separation Benefits Plan (the “CIC Plan”) in November 2004. The shareholder made a demand on the Board to take legal action against the Board’s current or former members for allegedly causing damage to the Company with respect to the adoption of the CIC Plan. In response to that demand letter, the independent members of the Board determined at the November 22, 2005 Board meeting that the Board would take the shareholder’s request under consideration and it remains under consideration.

 

As previously disclosed, on August 20, 2004, the United States District Court for the District of New Jersey granted a motion by the Company, Medco Health Solutions, Inc. (“Medco Health”) and certain officers and directors to dismiss a shareholder derivative action involving claims related to the Company’s revenue recognition practice for retail co-payments paid by individuals to whom Medco Health provides pharmaceutical benefits as well as other allegations. The complaint was dismissed with prejudice. Plaintiffs appealed the decision. On December 15, 2005, the U.S. Court of Appeals for the Third Circuit upheld most of the District Court’s decision dismissing the suit, and sent the issue of whether the Company’s Board of Directors properly refused the shareholder demand relating to the Company’s treatment of retail co-payments back to the District Court for reconsideration under a different legal standard. Plaintiffs moved to remand their action to state court on August 18, 2006, and the District Court granted that motion on February 1, 2007. The shareholder derivative suit is currently pending before the Superior Court of New Jersey, Chancery Division, Hunterdon County.

 

As previously disclosed, prior to the spin-off of Medco Health, the Company and Medco Health agreed to settle, on a class action basis, a series of lawsuits asserting violations of ERISA (the “Gruer Cases”). The Company, Medco Health and certain plaintiffs’ counsel filed the settlement agreement with the federal district court in New York, where cases commenced by a number of plaintiffs, including participants in a number of pharmaceutical benefit plans for which Medco Health is the pharmacy benefit manager, as well as trustees of such plans, have been consolidated. Medco Health and the Company agreed to the proposed settlement in order to avoid the significant cost and distraction of prolonged litigation. The proposed class settlement has been agreed to by plaintiffs in five of the cases filed against Medco Health and the Company. Under the proposed settlement, the Company and Medco Health have agreed to pay a total of $42.5 million, and Medco Health has agreed to modify certain business practices or to continue certain specified business practices for a period of five years. The financial compensation is intended to benefit members of the settlement class, which includes ERISA plans for which Medco Health administered a pharmacy benefit at any time since December 17, 1994. The district court held hearings to hear objections to the fairness of the proposed settlement and approved the settlement in 2004, but has not yet determined the number of class member plans that have properly elected not to participate in the settlement. The settlement becomes final only if and when all appeals have been resolved. Certain class member plans have indicated that they will not participate in the settlement. Cases initiated by three such plans and two individuals remain pending in the

Southern District of New York. Plaintiffs in these cases have asserted claims based on ERISA as well as other federal and state laws that are the same as or similar to the claims that had been asserted by settling class members in the Gruer Cases. The Company and Medco Health are named as defendants in these cases.

 

Three notices of appeal were filed and the appellate court heard oral argument in May 2005. On December 8, 2005, the appellate court issued a decision vacating the district court’s judgment and remanding the cases to the district court to allow the district court to resolve certain jurisdictional issues. A hearing was held to address such issues on February 24, 2006. The District Court issued a ruling on August 10, 2006 resolving such jurisdictional issues in favor of the settling plaintiffs. The class members and other party that had previously appealed the District Court’s judgment have renewed their appeals. The renewed appeals are presently being briefed.

 

After the spin-off of Medco Health, Medco Health assumed substantially all of the liability exposure for the matters discussed in the foregoing two paragraphs. These cases are being defended by Medco Health.

 

There are various other legal proceedings, principally product liability and intellectual property suits involving the Company, which are pending. While it is not feasible to predict the outcome of such proceedings or the proceedings discussed in this Item, in the opinion of the Company, all such proceedings are either adequately covered by insurance or, if not so covered, should not ultimately result in any liability that would have a material adverse effect on the financial position, liquidity or results of operations of the Company, other than proceedings for which a separate assessment is provided in this Item.

 

Environmental Matters

 

The Company is a party to a number of proceedings brought under the Comprehensive Environmental Response, Compensation and Liability Act, commonly known as Superfund, and other federal and state equivalents. These proceedings seek to require the operators of hazardous waste disposal facilities, transporters of waste to the sites and generators of hazardous waste disposed of at the sites to clean up the sites or to reimburse the government for cleanup costs. The Company has been made a party to these proceedings as an alleged generator of waste disposed of at the sites. In each case, the government alleges that the defendants are jointly and severally liable for the cleanup costs. Although joint and several liability is alleged, these proceedings are frequently resolved so that the allocation of cleanup costs among the parties more nearly reflects the relative contributions of the parties to the site situation. The Company’s potential liability varies greatly from site to site. For some sites the potential liability is de minimis and for others the costs of cleanup have not yet been determined. While it is not feasible to predict the outcome of many of these proceedings brought by federal or state agencies or private litigants, in the opinion of the Company, such proceedings should not ultimately result in any liability which would have a material adverse effect on the financial position, results of operations, liquidity or capital resources of the Company. The Company has taken an active role in identifying and providing for these costs and such amounts do not include any reduction for anticipated recoveries of cleanup costs from insurers, former site owners or operators or other recalcitrant potentially responsible parties.

 

On June 13, 2006, potassium thiocyanate was accidentally discharged from the Company’s plant in West Point, Pennsylvania through the Upper Gwynedd Township Authority’s wastewater treatment plant into the Wissahickon Creek, causing a fishkill. Federal and State agencies are investigating the discharge and the Company is currently cooperating with the investigations.

 

Not applicable.

 

 

 

RICHARD T. CLARK — Age 60

 

April, 2007 — Chairman, Chief Executive Officer and President

 

May, 2005 — Chief Executive Officer and President

 

June, 2003 — President, Merck Manufacturing Division — responsible for the Company’s manufacturing, information services and operational excellence organizations worldwide

 

January, 2003 — Chairman, President and Chief Executive Officer, Medco Health Solutions, Inc. (Medco Health), formerly a wholly-owned subsidiary of the Company

 

January, 2000 — President, Medco Health

 

DAVID W. ANSTICE — Age 58

 

September, 2006 — Executive Vice President, Strategy Initiatives — responsible for the End-to-End and global support function initiatives and for providing strategic direction in key pharmaceutical emerging markets (China and India)

 

August, 2005 — President, Human Health-Asia Pacific — responsible for the Company’s prescription drug business in the Asia Pacific region, Japan, Australia, New Zealand and the Company’s joint venture relationship with Schering-Plough

 

January, 2003 — President, Human Health — responsible for the Company’s prescription drug business in Japan, Latin America, Canada, Australia, New Zealand and the Company’s joint venture relationship with Schering-Plough

 

March, 2001 — President, The Americas and U.S. Human Health — responsible for one of the two prescription drug divisions comprising U.S. Human Health, as well as the Company’s prescription drug business in Canada and Latin America, and the Company’s joint venture relationship with Schering-Plough

 

JOHN CANAN — Age 50

 

September, 2006 — Vice President, Controller — responsible for the Corporate Controller’s Group

 

June, 2003 — Vice President, Corporate Audit & Assurance Services

 

September, 2002 — Vice President and Controller, Asia and Joint Ventures — responsible for financial and operational oversight of Asia Human Health and several of the Company’s joint ventures

 

August, 1999 — Controller, Asia Pacific Human Health

 

CELIA A. COLBERT — Age 50

 

January, 1997 — Vice President, Secretary (since September, 1993) and Assistant General Counsel (since November, 1993)

 

WILLIE A. DEESE — Age 51

 

May, 2005 — President, Merck Manufacturing Division — responsible for the Company’s global manufacturing, procurement, and operational excellence functions

 

January, 2004 — Senior Vice President, Global Procurement

 

Prior to January 2004, Mr. Deese was Senior Vice President, Global Procurement and Logistics (2001 to 2003) for GlaxoSmithKline plc.

 

KENNETH C. FRAZIER — Age 52

 

November, 2006 — Executive Vice President and General Counsel — responsible for legal and public affairs functions and The Merck Company Foundation (a not-for-profit charitable organization affiliated with the Company)

 

December, 1999 — Senior Vice President and General Counsel — responsible for legal and public affairs functions and The Merck Company Foundation (a not-for-profit charitable organization affiliated with the Company)

 

MIRIAN M. GRADDICK-WEIR — Age 52

 

September, 2006 — Senior Vice President, Human Resources

 

Prior to September 2006, Dr. Graddick-Weir was Executive Vice President of Human Resources and Employee Communications at AT&T, and has held several other senior Human Resources leadership positions at AT&T for more than 20 years (communications services provider).

 

STEVEN B. KELMAR — Age 53

 

August, 2006 — Vice President, Public Affairs

 

Prior to August 2006, Mr. Kelmar led the global public affairs and communications function at Novartis AG since 2002.

 

PETER S. KIM — Age 48

 

January, 2003 — President, Merck Research Laboratories (“MRL”)

 

February, 2001 — Executive Vice President, Research and Development, MRL

 

JUDY C. LEWENT — Age 58

 

August, 2005 — Executive Vice President and Chief Financial Officer — responsible for the Company’s strategic planning, financial and corporate development functions, internal auditing, corporate licensing, the Company’s joint venture relationships, and Merck Capital Ventures, LLC, a subsidiary of the Company

 

January, 2003 — Executive Vice President, Chief Financial Officer and President, Human Health Asia — responsible for financial and corporate development functions, internal auditing, corporate licensing, the Company’s prescription drug business in Asia North and Asia South, the Company’s joint venture relationships, and Merck Capital Ventures, LLC

 

February, 2001 — Executive Vice President and Chief Financial Officer (since April, 1990) — responsible for financial and corporate development functions, internal auditing, corporate licensing, the Company’s joint venture relationships, and Merck Capital Ventures, LLC

 

On February 20, 2007, the Company announced that Ms. Lewent intends to retire in July 2007.

 

PETER LOESCHER — Age 49

 

May, 2006 — President, Global Human Health — responsible for the Company’s four marketing and sales divisions: U.S. Human Health, Human Health Asia Pacific, Human Health Intercontinental (Europe, Middle East, Africa, Canada and Latin America), and Merck Vaccines

 

Prior to May 2006, Mr. Loescher served as President and Chief Executive Officer of GE Healthcare Bio-Sciences (medical diagnostics and life sciences business) since 2004, after it acquired Amersham Health. Mr. Loescher was President of Amersham Health (2002 — 2004) before becoming its Chief Operating Officer in 2004.

 

MARK E. MCDONOUGH — Age 42

 

February, 2007 — Vice President and Treasurer — responsible for the Company’s treasury function, and for providing financial support for Human Resources

 

January, 2004 — Assistant Treasurer, Global Capital Markets — responsible for managing the Company’s investment and financing portfolios and the treasury share repurchase program

 

September, 2000 — Senior Director, Human Health Finance — responsible for providing global franchise-based financial reporting and analytics to key customers

 

MARGARET G. MCGLYNN — Age 47

 

August, 2005 — President, Merck Vaccines — global responsibilities for the vaccines business including the Company’s Sanofi-Pasteur joint venture

 

January, 2003 — President, U.S. Human Health — responsible for one of the two prescription drug divisions (hospital and specialty product franchises) comprising U.S. Human Health (USHH), and the Managed Care Group of USHH

 

August, 2001 — Executive Vice President, Customer Marketing and Sales, USHH

 

STEFAN OSCHMANN — Age 49

 

September, 2006 — President, Europe, Middle East, Africa & Canada

 

April, 2006 — Senior Vice President, Worldwide Human Health Marketing

 

October, 2005 — Executive Vice President, Worldwide Marketing

 

January, 2001 — Managing Director, MSD Germany, a subsidiary of the Company

 

J. CHRIS SCALET — Age 48

 

January, 2006 — Senior Vice President, Global Services, and Chief Information Officer (CIO) — responsible for Global Shared Services across the human resources, finance, site services and information services function; and the enterprise business process redesign initiative

 

March, 2003 — Senior Vice President, Information Services, and CIO — responsible for all areas of information technology and services including application development, technical support, voice and data communications, and computer operations worldwide

 

Prior to March 2003, Mr. Scalet was Senior Vice President, Information Technology & CIO (1997 to 2003) for International Paper Company (global forest products, paper and packaging company).

 

ADAM H. SCHECHTER — Age 42

 

July, 2006 — President, U.S. Human Health — commercial responsibility in the United States for the Company’s portfolio of prescription medicines

 

October, 2005 — General Manager, U.S. Human Health Division — responsible for the Neuro-Psychiatry, Osteoporosis, Migraine, Respiratory, and New Products franchises

 

February, 2004 — Vice President/General Manager, Merck/Schering-Plough Pharmaceuticals U.S. Joint Venture

 

August, 2002 — Vice President, Merck Human Health Division, Arthritis & Analgesia Franchise Business Group

 

WENDY L. YARNO — Age 52

 

September, 2006 — Chief Marketing Officer — responsible for Global Marketing Services, Global Alliance Management and Global Pricing, Global Human Health Business Practices & Compliance and three franchises: Oncology, Specialty and Neuroscience; Respiratory, Bone and Arthritis and Analgesia; and Infectious Diseases and Hospital Products

 

November, 2005 — General Manager, Business Unit 3, U.S. Human Health

 

January, 2003 — Executive Vice President, Worldwide Human Health Marketing

 

December, 1999 — Senior Vice President, Human Resources

 

All officers listed above serve at the pleasure of the Board of Directors. None of these officers was elected pursuant to any arrangement or understanding between the officer and the Board.

 

The principal market for trading of the Company’s Common Stock is the New York Stock Exchange (“NYSE”) under the symbol MRK. The Common Stock market price information set forth in the table below is based on historical NYSE market prices.

 

The following table also sets forth, for the calendar periods indicated, the dividend per share information.

 

Cash Dividends Paid per Common Share

 

 

Common Stock Market Prices

 

 

As of January 31, 2007, there were approximately 183,132 stockholders of record.

 

Equity Compensation Plan Information

 

The following table summarizes information about the options, warrants and rights and other equity compensation under the Company’s equity plans as of the close of business on December 31, 2006. The table does not include information about tax qualified plans such as the Merck & Co., Inc. Employee Savings and Security Plan.

 

 

 

Performance Graph

 

The following graph compares the cumulative total stockholder return (stock price appreciation plus reinvested dividends) on the Company’s Common Stock with the cumulative total return (including reinvested dividends) of the Dow Jones US Pharmaceutical Index (“DJUSPR”), formerly referred to as the Dow Jones Pharmaceutical Index — United States Owned Companies, and the Standard & Poor’s 500 Index (“S&P 500 Index”) for the five years ended December 31, 2006. Amounts below have been rounded to the nearest dollar or percent.

 

Comparison of Five-Year Cumulative Total Return*

Merck & Co., Inc., Dow Jones US Pharmaceutical Index and S&P 500 Index

 

 

 

 

 

Issuer purchases of equity securities for the three month period ended December 31, 2006 are as follows:

 

Issuer Purchases of Equity Securities

 

 

 

The following selected financial data should be read in conjunction with Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and consolidated financial statements and notes thereto contained in Item 8. “Financial Statements and Supplementary Data” of this report.

 

Merck & Co., Inc. and Subsidiaries
($ in millions except per share amounts)

 

 

 

Description of Merck’s Business

 

Merck is a global research-driven pharmaceutical company that discovers, develops, manufactures and markets a broad range of innovative products to improve human and animal health. The Company’s operations are principally managed on a products basis and are comprised of two reportable segments: the Pharmaceutical segment and the Vaccines segment. The Pharmaceutical segment includes human health pharmaceutical products marketed either directly or through joint ventures. These products consist of therapeutic and preventive agents, sold by prescription, for the treatment of human disorders. Merck sells these human health pharmaceutical products primarily to drug wholesalers and retailers, hospitals, government agencies and managed health care providers such as health maintenance organizations and other institutions. The Vaccines segment includes human health vaccine products marketed either directly or through a joint venture. These products consist of preventative pediatric, adolescent and adult vaccines, primarily administered at physician offices. Merck sells these human health vaccines primarily to physicians, wholesalers, physician distributors and government entities. The Company’s professional representatives communicate the effectiveness, safety and value of our pharmaceutical and vaccine products to health care professionals in private practice, group practices and managed care organizations.

 

Overview

 

During 2006, Merck continued to execute its strategy to reclaim its leadership position in the pharmaceutical industry. This was made evident through the successful launches of five novel medicines and vaccines in areas such as cancer prevention and diabetes, the advancement of drug candidates through every phase of the Company’s pipeline and the continued success of its newer and in-line products. Additionally, the Company is developing a new commercial model which is designed to broaden its engagement with customers and scientific leaders, leverage alternative channels to complement the effectiveness of its sales force, and drive growth in key markets.

 

During 2006, five products received U.S. Food and Drug Administration (“FDA”) approval: Gardasil, the first vaccine for the prevention of cervical cancer and genital warts caused by certain types of human papillomavirus (“HPV”); Januvia, the first medicine of its class that enhances a natural body system to improve blood sugar control in patients with type 2 diabetes; Zostavax, the first vaccine for adults 60 years of age and older to reduce the incidence of shingles, a disease which every year afflicts an estimated one million people in the United States alone; RotaTeq, a pediatric vaccine to help prevent rotavirus gastroenteritis in infants and children, the effects of which take the lives of nearly 600,000 children under the age of five worldwide every year; and Zolinza, a novel medicine to treat patients suffering from advanced cutaneous T-cell lymphoma (“CTCL”).

 

In addition, the Company has three drug candidates currently under FDA review: Janumet (previously referred to as MK-0431A), an investigational oral medicine combining sitagliptin phosphate with metformin for type 2 diabetes that is designed to provide an additional treatment option for patients who need more than one oral agent to help control their blood sugar; Emend For Injection (MK-0517), an intravenous therapy for chemotherapy-induced nausea and vomiting (“CINV”); and Arcoxia, Merck’s selective Cox-2 inhibitor for osteoarthritis. Additionally, the Company anticipates filing three New Drug Applications (“NDA”) with the FDA in 2007: MK-0518, a first-in-class HIV integrase inhibitor; gaboxadol, a novel compound from Merck’s alliance with H. Lundbeck A/S for the treatment of insomnia; and MK-0524A, an extended-release (“ER”) niacin combined with laropiprant (a novel flushing pathway inhibitor) for cholesterol management. In addition, by mid-year 2007, Merck expects to have four products in Phase III development.

 

Additionally, targeted acquisitions made during the year of Sirna Therapeutics, Inc. (“Sirna”), GlycoFi, Inc. (“GlycoFi”) and Abmaxis, Inc. (“Abmaxis”), as well as other alliances and collaborations, will complement Merck’s strong internal research capabilities and should continue to help the Company build a pipeline that will support its long-term growth.

 

Merck is working to deliver innovative and differentiated products to the market faster and more efficiently. The Company has successfully reduced late development product cycle times and anticipates further reductions in the coming year. Additionally, Merck’s new commercial model is expected to lower spending per

primary care brand by 15% to 20% in the United States from 2005 through 2010 (an interim targeted 9% reduction is expected to be achieved through the end of 2007) while still appropriately supporting product launches, as illustrated in the successful launch of five new products in 2006. Through redeployment, the launches were achieved with no increase in sales force.

 

The initial phase of a global restructuring program designed to reduce the Company’s cost structure, increase efficiency and enhance competitiveness is underway. The initial steps include the implementation of a new supply strategy by the Merck Manufacturing Division, which is intended to create a leaner, more cost-effective and customer-focused manufacturing model over a three-year period. As part of this program, in 2005, Merck announced plans to sell or close five manufacturing sites and two preclinical sites by the end of 2008 (three of the manufacturing sites were closed, sold or had ceased operations and the two preclinical sites were closed by the end of 2006), and eliminate approximately 7,000 positions company-wide (of which approximately 4,800 positions were eliminated by the end of 2006 comprised of actual headcount reductions, and the elimination of contractors and vacant positions). However, the Company continues to hire new employees as the Company’s business requires it. The Company has also sold certain other facilities and related assets in connection with the restructuring program. The pre-tax costs of this restructuring program were $935.5 million in 2006 (comprised of $793.2 million primarily representing accelerated depreciation and asset impairment costs and $142.3 million of separation and other restructuring related costs) and are expected to be $300 million to $500 million in 2007. Through the end of 2008, when the initial phase of the restructuring program relating to the manufacturing strategy is expected to be substantially complete, the cumulative pre-tax costs of the program are expected to range from $1.9 billion to $2.2 billion. Merck continues to expect the initial phase of its cost reduction program to yield cumulative pre-tax savings of $4.5 to $5.0 billion from 2006 through 2010.

 

With respect to the Vioxx litigation, to date in the Vioxx Product Liability Lawsuits, of the 29 plaintiffs whose claims have been scheduled for trial, the claims of seven were dismissed, the claims of seven were withdrawn from the trial calendar by plaintiffs, and juries have decided in Merck’s favor nine times and in plaintiffs’ favor four times. In addition, in the recent California trial involving two plaintiffs, the jury could not reach a verdict for either plaintiff and a mistrial was declared. A New Jersey state judge set aside one of the nine Merck verdicts. With respect to the four plaintiffs’ verdicts, Merck already has filed an appeal or sought judicial review in each of those cases, and in one of those four, a federal judge overturned the damage award shortly after trial. In addition, a consolidated trial with two plaintiffs is currently ongoing in the coordinated proceeding in New Jersey Superior Court before Judge Carol E. Higbee and another trial has commenced in state court in Illinois. During 2006, the Company spent $500 million in the aggregate, including $175 million in the fourth quarter, in Vioxx legal defense costs worldwide. During 2006, the Company recorded charges of $673 million to increase the reserve solely for its future legal defense costs related to Vioxx litigation and at December 31, 2006 the balance of the reserve was $858 million. This reserve is based on certain assumptions and is the best estimate of the amount the Company believes, at this time, will be spent through 2008. The Vioxx litigation is more fully discussed in Note 11 to the consolidated financial statements.

 

Earnings per common share assuming dilution for 2006 were $2.03, including the impact of the global restructuring program of $0.28 per share, the acquired research charge related to the acquisition of Sirna of $0.21 per share and the acquired research charge related to the acquisition of GlycoFi of $0.14 per share (as discussed in “Acquisitions” below), additional reserves established solely for future legal defense costs for Vioxx litigation (as discussed above) and the impact of adopting a new accounting standard requiring the expensing of stock options (as discussed in “Share-Based Compensation” below).

 

Competition and the Health Care Environment

 

The markets in which the Company conducts its business are highly competitive and often highly regulated. Global efforts toward health care cost containment continue to exert pressure on product pricing and access.

 

In the United States, the government expanded health care access by enacting the Medicare Prescription Drug Improvement and Modernization Act of 2003, which was signed into law in December 2003. Prescription drug coverage began on January 1, 2006. This legislation supports the Company’s goal of improving access to

medicines by expanding insurance coverage, while preserving market-based incentives for pharmaceutical innovation. At the same time, the legislation will ensure that prescription drug costs will be controlled by competitive pressures and by encouraging the appropriate use of medicines.

 

In addressing cost-containment pressure, the Company has made a continuing effort to demonstrate that its medicines can help save costs in overall patient health care. In addition, pricing flexibility across the Company’s product portfolio has encouraged growing use of its medicines and mitigated the effects of increasing cost pressures.

 

Outside the United States, in difficult environments encumbered by government cost-containment actions, the Company has worked in partnership with payers on allocating scarce resources to optimize health care outcomes, limiting the potentially detrimental effects of government policies on sales growth and access to innovative medicines and vaccines, and to support the discovery and development of innovative products to benefit patients. The Company also is working with governments in many emerging markets in Eastern Europe, Latin America and Asia to encourage them to increase their investments in health and thereby improve their citizens’ access to medicines. Within Europe, European institutions such as the European Commission (“EC”) have recognized the economic importance of the research-based pharmaceutical industry and the value of innovative medicines to society. As a result, they are working with industry representatives to complete the “Single Market” in pharmaceuticals and improve the competitive climate through a variety of means including market deregulation. In order to advance the related policy debate, the EC launched the High Level Pharmaceutical Forum (“HLPF”) at the end of 2005. This initiative aims at improving the prospects of the research-based pharmaceutical industry in Europe and thus the health prospects of all patients who will benefit from innovative therapies. Through an active dialogue among all stakeholders in the health care system (from payers to patients), this initiative is an attempt to tackle key policy issues in Europe: (i) promoting greater pricing flexibility for medicines; (ii) ensuring that health authorities apply best practices for the evaluation of the relative effectiveness of medicines; and (iii) improving greater access to information on medicines for patients in Europe. The Company has been actively engaged with the EC and other stakeholders in order to achieve a successful outcome for the HLPF that would help European patients gain greater and quicker access to its medicines.

 

The Company is committed to improving access to medicines and enhancing the quality of life for people around the world. The African Comprehensive HIV/AIDS Partnerships (“ACHAP”) in Botswana, a partnership between the government of Botswana, the Bill & Melinda Gates Foundation and The Merck Company Foundation/Merck & Co., Inc., is supporting Botswana’s response to HIV/AIDS through a comprehensive and sustainable approach to HIV prevention, care, treatment and support. In May 2005, the Company initiated a similar partnership with the People’s Republic of China (focused initially in Sichuan Province) to help strengthen China’s response to the HIV epidemic.

 

To further catalyze access to HIV medicines in developing countries, under price reduction guidelines that the Company announced in 2001, Merck makes no profit on the sale of its current HIV/AIDS medicines in the world’s poorest countries and those hardest hit by the pandemic, and offers its HIV/AIDS medicines at significantly reduced prices to medium-income countries. In February 2007, Merck announced that it had again reduced the price of Stocrin in the least developed countries of the world and those hardest hit by the pandemic. By the end of 2006, more than 475,000 patients in more than 75 developing countries were being treated with antiretroviral regimens containing either Crixivan or Stocrin. Through these and other actions, Merck is working independently and with partners in the public and private sectors alike to focus on the most critical barriers to access to medicines in the developing world: the need for sustainable financing, increased international assistance and additional investments in education, training and health infrastructure and capacity in developing countries.

 

The Company is subject to a number of privacy and data protection laws and regulations globally. The legislative and regulatory landscape for privacy and data protection continues to evolve, and there has been an increasing amount of focus on privacy and data protection issues with the potential to affect directly the Company’s business.

 

Although no one can predict the outcome of these and other legislative, regulatory and advocacy initiatives, the Company is well positioned to respond to the evolving health care environment and market forces.

 

As patents on certain of the Company’s products expire, Merck has entered into, and may continue to enter into, authorized generic agreements which allow the Company to benefit when these medicines become available in generic form.

 

The Company anticipates that the worldwide trend toward cost-containment will continue, resulting in ongoing pressures on health care budgets. As the Company continues to successfully launch new products, contribute to health care debates and monitor reforms, its new products, policies and strategies should enable it to maintain a strong position in the changing economic environment.

 

Acquisitions

 

In December 2006, Merck completed the acquisition of Sirna for approximately $1.1 billion. Sirna is a biotechnology company that is a leader in developing a new class of medicines based on RNA interference (“RNAi”) technology, which could significantly alter the treatment of disease. The transaction was accounted for as a business combination in which the excess of the purchase price over the fair value of the acquired net assets has been recorded as goodwill of $345.9 million. The goodwill was not deductible for tax purposes. The Company recorded a charge of $466.2 million for acquired research associated with Sirna’s compounds currently under development, which related to the development of treatments for both the hepatitis B and hepatitis C viruses, which are in preclinical development, as well as licensing agreements held by Sirna. The charge was not deductible for tax purposes. The ongoing activity with respect to each of these compounds under development is not expected to be material to the Company’s research and development expenses. The allocation of the purchase price also resulted in the recognition of an intangible asset of $357.8 million, and a related deferred tax liability of $146.3 million, related to Sirna’s developed technology. The acquisition of Sirna is expected to increase Merck’s ability to use RNAi technology to turn off a targeted gene in a human cell, potentially rendering inoperative a gene responsible for triggering a specific disease. (See Note 5 to the consolidated financial statements.)

 

In June 2006, Merck acquired GlycoFi, a privately-held biotechnology company that is a leader in the field of yeast glycoengineering, which is the addition of specific carbohydrate modifications to the proteins in yeast, and optimization of biologic drug molecules, for $373 million in cash ($400 million purchase price net of $25 million of shares already owned and net transaction costs). The Company recorded a $296.3 million charge for acquired research in connection with the acquisition which is not deductible for tax purposes. The Company also recorded a $99.4 million intangible asset ($57.6 million net of deferred taxes) related to GlycoFi’s developed technology. In May 2006, Merck acquired Abmaxis, a privately-held biopharmaceutical company dedicated to the discovery and optimization of monoclonal antibody products for human therapeutics and diagnostics, for $80 million in cash. Substantially all of the purchase price was allocated to an intangible asset relating to Abmaxis’ technology platform. While each of the acquisitions has independent scientific merits, the combination of the GlycoFi and Abmaxis platforms is potentially synergistic, giving Merck the ability to operate across the entire spectrum of therapeutic antibody discovery, development and commercialization. (See Note 5 to the consolidated financial statements.)

 

Operating Results

 

Sales

Worldwide sales for 2006 increased 3% in total over 2005 primarily driven by higher volumes. Foreign exchange and price changes had virtually no impact on sales growth in 2006. Sales performance over 2005 reflects strong growth of Singulair, a once-a-day oral medicine indicated for the chronic treatment of asthma and the relief of symptoms of allergic rhinitis, and the Company’s vaccines, which include Gardasil to help protect against cervical cancer and genital warts caused by certain types of HPV, ProQuad, the combination vaccine for simultaneous vaccination against measles, mumps, rubella and varicella, and RotaTeq to help protect against rotavirus gastroenteritis in infants and children. Also contributing to the sales growth were higher revenues from the Company’s relationship with AstraZeneca LP (“AZLP”) primarily driven by Nexium, and increased sales of Cozaar/Hyzaar for high blood pressure. In addition, sales in 2006 reflect certain supply sales associated with activities not expected to continue beyond 2006, including the Company’s arrangement with Dr. Reddy’s Laboratories (“DRL”) for the sale of generic simvastatin. Sales growth was partially offset by lower sales of Zocor, the Company’s statin for modifying cholesterol and Proscar, a urology product for the treatment of symptomatic benign

prostate enlargement. Merck’s U.S. marketing exclusivity for Zocor expired on June 23, 2006, while Proscar lost U.S. marketing exclusivity on June 19, 2006.

 

Domestic sales increased 8% over 2005, while foreign sales declined 4%. Foreign sales represented 39% of total sales in 2006. Domestic sales benefited from the launch of three new vaccines, while foreign sales were negatively affected by the loss of marketing exclusivity and continued generic erosion related to Zocor and Fosamax products.

 

Worldwide sales for 2005 decreased 4% in total over 2004, reflecting a decrease of 7% related to the voluntary worldwide withdrawal of Vioxx, offset by revenue growth in all other products of 3%. This growth reflects a 1% favorable effect from foreign exchange, a 1% favorable effect from price changes and a volume increase of 1%. Foreign sales represented 42% of total sales for 2005.

 

Sales⁽¹⁾ of the Company’s products were as follows:

 

 

 

The Company’s pharmaceutical products include therapeutic and preventive agents, generally sold by prescription, for the treatment of human disorders. Among these are Singulair, a leukotriene receptor antagonist respiratory product for the chronic treatment of asthma and for the relief of symptoms of allergic rhinitis; Cozaar/Hyzaar and Vasotec, the Company’s most significant hypertension and/or heart failure products; Fosamax and Fosamax Plus D (marketed as Fosavance throughout the European Union (“EU”)), for the treatment and, in the case of Fosamax, prevention of osteoporosis; Zocor, Merck’s atherosclerosis product; Primaxin and Cancidas, anti-bacterial/anti-fungal products; Cosopt and Trusopt, the largest-selling ophthalmological products; Proscar, a urology product for the treatment of symptomatic benign prostate enlargement; Maxalt, an acute migraine product and Propecia, a product for the treatment of male pattern hair loss.

 

Among the products included within vaccines/biologicals are Varivax, a vaccine to help prevent chickenpox, M-M-R II, a vaccine against measles, mumps and rubella, ProQuad, the pediatric combination vaccine against measles, mumps, rubella and varicella, Gardasil, a vaccine for the prevention of cervical cancer and genital warts caused by certain types of HPV, Pneumovax, a vaccine for the prevention of pneumococcal disease, RotaTeq, a vaccine to help protect against rotavirus gastroenteritis in infants and children, and Zostavax, a vaccine to help prevent shingles (herpes zoster) in individuals 60 years of age or older.

 

Other primarily includes sales of other human pharmaceuticals, pharmaceutical and animal health supply sales to the Company’s joint ventures and revenue from the Company’s relationship with AZLP, primarily relating to sales of Nexium and Prilosec. Revenue from AZLP was $1.8 billion, $1.7 billion, and $1.5 billion in 2006, 2005 and 2004, respectively. In 2006, other also includes certain supply sales associated with activities not expected to continue beyond 2006, including the Company’s arrangement with DRL for the sale of generic simvastatin.

 

Segment Revenues

 

 

 

Pharmaceutical Segment Revenues

Sales of the Pharmaceutical segment decreased 1% in 2006 primarily due to declines in Zocor and Proscar post-patent expiration, partially offset by increases in Singulair and Cozaar/Hyzaar.

 

Singulair, Merck’s once-a-day oral respiratory medicine indicated for the treatment of chronic asthma and the relief of symptoms of allergic rhinitis, continued its strong performance in 2006, reflecting the continued demand for asthma and seasonal and perennial allergic rhinitis medications. Singulair continues to be the number one prescribed product in the U.S. respiratory market. Total 2006 sales of Singulair were $3.6 billion, an increase of 20% over 2005.

 

Global sales for Cozaar, and its companion agent Hyzaar (a combination of Cozaar and hydrochlorothiazide), for the treatment of hypertension were $3.2 billion in 2006, a 4% increase over 2005. Cozaar and Hyzaar compete in the fastest-growing class in the antihypertensive market, angiotensin II antagonists (“AIIA”). Cozaar/Hyzaar remained the number two branded AIIA in the United States and Europe in 2006.

 

In December 2006, the Company’s Japanese subsidiary launched Preminent, known as Hyzaar in most worldwide markets, the first-ever-fixed-dose combination in Japan of an angiotensin receptor blocker and hydrochlorothiazide for the treatment of hypertension. Japan is the second largest pharmaceutical market in the world.

 

Global sales for Fosamax and Fosamax Plus D, for the treatment of postmenopausal, male and/or glucocorticoid-induced osteoporosis, were $3.1 billion in 2006, a decrease of 2% over 2005. Sales outside of the United States were affected by the availability of other generic alendronate sodium products in some key markets, including the United Kingdom, Canada and Germany. The Company has ongoing litigation in certain of those European countries based on the Company’s alendronate patents. Fosamax and Fosamax Plus D together remain the most prescribed medicine worldwide for the treatment of osteoporosis. Fosamax and Fosamax Plus D will lose market exclusivity in the United States in February 2008 and April 2008, respectively, and the Company expects significant declines in U.S. Fosamax and Fosamax Plus D sales after each product’s respective loss of market exclusivity.

 

In August 2006, Fosamax (marketed as Fosamac) became the first once-weekly, oral medicine for osteoporosis to be launched in Japan.

 

Worldwide sales of Zocor, Merck’s statin for modifying cholesterol, were $2.8 billion in 2006, a decrease of 36% from 2005. Sales of Zocor were negatively affected by the loss of U.S. marketing exclusivity in June 2006. Global sales of Zocor are expected to be $0.6 billion to $0.9 billion in 2007.

 

In February 2006, the Company entered into an agreement with DRL that authorized the sale of generic simvastatin. Under the terms of the agreement, the Company is reimbursed on a cost-plus basis by DRL for supplying finished goods and receives a share of the net profits recorded by DRL. Merck continues to offer branded Zocor and to manufacture simvastatin for branded Zocor, Vytorin and the Company’s investigational compound MK-0524B. In 2006, Merck recorded $208.9 million associated with the DRL arrangement for simvastatin. This revenue is not expected to continue beyond 2006.

 

In October 2006, Januvia was approved by the FDA, and is now the first and only dipeptidyl peptidase-4 (“DPP-4”) inhibitor available in the United States for the treatment of type 2 diabetes. DPP-4 inhibitors represent a new class of prescription medications that improve blood sugar control in patients with type 2 diabetes by enhancing a natural body system called the incretin system. Januvia has been approved as monotherapy and as add-on therapy to either of two other oral diabetes medications, metformin or thiazolidinediones (“TZDs”), to improve blood sugar (glucose) control in patients with type 2 diabetes when diet and exercise are not enough.

 

On January 25, 2007, the Company received a positive opinion about Januvia from the Committee for Medicinal Products for Human Use (“CHMP”) of the European Medicines Agency (“EMEA”) in Europe. The CHMP opinion recommended that Januvia be approved in the EU for the treatment of type 2 diabetes. Following the conclusion of the CHMP review, the opinion for Januvia will be transmitted to the EC. If the EC adopts the opinion, Januvia will be the first and only prescription medication in a new class of drugs known as DPP-4 inhibitors, which enhance the body’s own ability to lower blood sugar (glucose) when it is elevated. The decision will be applicable to the 27 countries that are members of the EU. Marketing authorization from the EC is expected in early April 2007 after the adoption of the opinion. Including the EU, Merck anticipates approval for Januvia in at least another 55 countries in 2007.

 

Clinical studies show that Januvia provides significant A1C (a measure of average blood glucose level over a two- to three-month period) reductions in both monotherapy and when added to two commonly used types of diabetes drugs, metformin and TZDs. Treatment with Januvia was not associated with weight gain or an increased risk of hypoglycemia. Januvia is now available in 11 countries including the United States, Mexico, and Brazil, and other regulatory filings around the world are moving forward. Global sales of Januvia were $42.9 million in 2006.

 

In October 2006, the FDA approved Zolinza for the treatment of cutaneous manifestations in patients with CTCL who have progressive, persistent or recurrent disease on or following two systemic therapies. The approval of Zolinza represents the first anticancer treatment approved for CTCL since 1999.

 

Other products experiencing growth in 2006 include Cosopt to treat glaucoma, Propecia for male pattern hair loss, Maxalt to treat migraine pain, Arcoxia for the treatment of arthritis and pain, Invanz for the treatment of selected moderate to severe infection in adults, Emend for prevention of acute and delayed nausea and vomiting associated with moderately and highly emetogenic cancer chemotherapy as well as for the treatment of post-operative nausea and vomiting. Also contributing to Merck’s total sales in 2006 was revenue resulting from the Company’s relationship with AZLP, primarily relating to sales of Nexium.

 

Proscar, Merck’s urology product for the treatment of symptomatic benign prostate enlargement, lost marketing exclusivity in the United States in June 2006. Merck’s U.S. sales of Proscar for 2006 were $243.7 million, a decrease of 34% compared with 2005. The Company expects the decline in U.S. Proscar sales to continue. The basic patent for Proscar also covers Propecia, however, Propecia is protected by additional patents which expire in October 2013.

 

Vaccines Segment Revenues

Sales of the Vaccines segment increased 73% in 2006 as a result of new product launches and the continued success of in-line vaccines. The following discussion of vaccines includes total vaccines sales, the vast majority of which are included in the Vaccines segment and the remainder, representing certain sales of vaccines by non-U.S. subsidiaries, are managed by and included in the Pharmaceutical segment. These amounts do not reflect

sales of vaccines sold in most major European markets through Sanofi Pasteur MSD (“SPMSD”) the Company’s joint venture with Sanofi Pasteur, the results of which are reflected in equity income from affiliates.

 

In 2006, the Company announced FDA approval of three new breakthrough vaccines: Gardasil, RotaTeq and Zostavax.

 

On June 8, 2006, the FDA approved Gardasil, the only vaccine available in the United States to prevent cervical cancer and vulvar and vaginal pre-cancers caused by HPV types 16 and 18 and to prevent low-grade and pre-cancerous lesions and genital warts caused by HPV types 6, 11, 16 and 18. Gardasil is approved for 9- to 26-year-old girls and women. Gardasil is a three dose, intra muscular vaccine given over six months. In the United States, it is estimated that approximately 9,700 women will be diagnosed with cervical cancer this year, and approximately 3,700 women will die.

 

In June 2006, the U.S. Centers for Disease Control’s (“CDC”) Advisory Committee on Immunization Practices (“ACIP”) voted unanimously to recommend that girls and women 11 to 26 years old be vaccinated with Gardasil.  The ACIP recommended that Gardasil be administered to 11- and 12-year-old females and to females aged 13 to 26 who have not previously been vaccinated, and that 9- and 10-year-old females be vaccinated with Gardasil at the discretion of their physicians.

 

On November 1, 2006, the Company announced that the CDC added Gardasil to the CDC’s Vaccines for Children program for eligible girls and women aged 9 to 18. As of February 2, 2007, managed care plans representing at least 96% of privately-insured lives in the United States (currently more than 120 insurance plans) had decided to reimburse for Gardasil when covered under the member’s benefit design. These insurers are reimbursing the vaccine at or above the lowest price paid to Merck by private non-HMO customers.

 

In September 2006, Gardasil was approved as the first and only vaccine in the EU for use in children and adolescents aged 9 to 15 years and in adult females aged 16 to 26 years for the prevention of cervical cancer, high-grade cervical dysplasias/precancers [cervical intraepithelial neoplasia (CIN 2/3)], high-grade/precancerous vulvar dysplastic lesions (VIN 2/3) and genital warts caused by HPV types 6, 11, 16 and 18. Gardasil is marketed by SPMSD in 19 European countries, including 15 in the EU. In the remaining Central and Eastern European countries, Gardasil is marketed by Merck Sharp & Dohme as either Gardasil or Silgard.

 

In 2006, total sales of Gardasil recorded by Merck were $234.8 million. Gardasil has been approved in 54 countries, all under accelerated reviews, with regulatory applications pending in approximately 50 countries.

 

In February 2005, the Company announced that it and GlaxoSmithKline (“GSK”) entered into a cross-license and settlement agreement for certain patent rights related to HPV vaccines. Pursuant to the agreement, GSK received an upfront payment and is receiving royalties from the Company based upon sales of Gardasil, upon development and launch. The agreement resolves competing intellectual property claims related to the Company’s and GSK’s vaccine candidates. In addition, in 1995, Merck entered into a license agreement and collaboration with CSL Limited relating to technology used in Gardasil. Gardasil is also the subject of other third-party licensing agreements. As a consequence of these agreements, the Company will pay royalties on the worldwide sales of Gardasil of approximately 24% to 26% in the aggregate.

 

Clinical studies to evaluate the efficacy of Gardasil in females 27 to 45 years of age and males 16 to 26 years of age continue in more than 30 countries around the world. The Company expects to submit to the FDA an indication for females 27 to 45 years of age in the fourth quarter of 2007, and an indication for males 16 to 26 years of age in 2008. The Company is also conducting ongoing clinical studies to assess the potential for cross-protection against HPV types related to HPV 16 and 18, including HPV 31 and 45. Cross-protection, if proven, could potentially expand the vaccine’s prevention coverage against cervical cancer.

 

In February 2006, the FDA approved RotaTeq, the Company’s vaccine to help protect against rotavirus gastroenteritis in infants and children. The FDA approval of RotaTeq was based on data from the Company’s Phase III clinical trials of nearly 70,000 infants, including data from the Rotavirus Efficacy and Safety Trial (“REST”), one of the largest pre-licensure vaccine clinical trials ever conducted. In these clinical trials, RotaTeq prevented 98% of severe cases of rotavirus gastroenteritis and prevented 74% of rotavirus gastroenteritis cases of any severity caused by serotypes targeted by the vaccine (G1, G2, G3, G4) compared to placebo through the first full

rotavirus season after vaccination. RotaTeq also reduced hospitalizations by 96% and emergency room visits by 94% for rotavirus gastroenteritis caused by serotypes targeted by the vaccine through the first two years after the third dose.

 

In February 2006, the CDC’s ACIP unanimously voted to recommend that all infants, starting at 6 to 12 weeks of age be vaccinated with RotaTeq, now the only rotavirus vaccine available in the United States. The ACIP recommended that the oral, ready-to use vaccine be given during the current routine well-baby visits at 2, 4, and 6 months of age. In April, RotaTeq was made available in the CDC Vaccines for Children program.

 

Within the United States, as of February 6, 2007, health insurance plans representing approximately 90% of covered lives in the eligible age group of infants and young children between six and 32 weeks of age have added RotaTeq to their formularies. RotaTeq has been approved in 34 countries and applications for licensure have been filed in more than 100 countries. In Nicaragua, where RotaTeq was approved in 2006, the Company will provide the vaccine free of charge for all infants born in the country over a three-year period commencing in October 2006, through a joint demonstration project with the Nicaraguan Ministry of Health. In 2006, RotaTeq sales recorded by Merck were $163.4 million.

 

In February 2007, Merck updated the labeling information for RotaTeq to include post-marketing reports of intussusception and hematochezia to the Vaccine Adverse Events Reporting System (“VAERS”), a national vaccine safety surveillance program. In February 2007, the FDA reported that since the licensure of RotaTeq on February 3, 2006 until January 31, 2007, 28 cases of intussusception in infants who received RotaTeq have been reported in the United States to VAERS and that this number does not exceed the number of cases expected based on the background rate. REST was specifically designed to evaluate vaccine safety with respect to intussusception. In REST, there was no increased risk of intussuception with RotaTeq, compared to placebo.

 

In May 2006, the FDA approved Zostavax, the Company’s vaccine for prevention of herpes zoster (shingles) in individuals 60 years of age and older. It was also approved by regulatory authorities in the EU and Australia in May. Zostavax is the first and only medical option approved for the prevention of shingles.

 

In October 2006, the CDC ACIP voted unanimously to recommend that adults 60 years of age and older be vaccinated with Zostavax to help prevent shingles. Following the ACIP recommendation, in the United States, as of February 6, 2007, managed care plans representing approximately 85% of covered lives are reimbursing for Zostavax. Sales of Zostavax recorded by Merck in 2006 were $38.6 million.

 

In June 2006, the ACIP unanimously voted to recommend that children 4 to 6 years of age routinely receive a second dose of varicella (chickenpox)-containing vaccine. Merck’s Varivax and its combination vaccine ProQuad are the only vaccines to help protect against chickenpox available in the United States. The ACIP also voted to recommend that children, adolescents and adults who previously received one dose of varicella-containing vaccine should receive a catch-up second dose. The ACIP voted to include the second dose of chickenpox vaccine in the Vaccines for Children program.

 

Merck has recently determined that the bulk manufacturing process for the Company’s varicella zoster virus (“VZV”)-containing vaccines was producing lower amounts of bulk VZV intermediate than expected. The VZV bulk in question was designated for use in fulfilling future quantities of the three VZV-containing vaccines — Varivax, ProQuad and Zostavax. As a result, production of the VZV bulk has been temporarily suspended while the Company identifies the cause of this issue.

 

This situation does not affect the quality of any of Merck’s VZV-containing vaccines currently on the market, any lots of vaccine in inventory that are ready for release to the market or any vaccines which will be filled and finished from existing VZV bulk.

 

As the Company works to resolve this issue, it is decreasing the availability of ProQuad, while increasing the availability of the component vaccines Varivax and M-M-R II. Additionally, the Company will postpone the introductions outside the United States of ProQuad and Zostavax until the VZV bulk issue is resolved.

 

Based on this approach and in view of current projections, the Company currently expects to meet anticipated market demand for VZV-containing vaccines.

Costs, Expenses and Other

 

Share-Based Compensation

On January 1, 2006, the Company adopted Financial Accounting Standards Board (“FASB”) Statement No. 123R, Share-Based Payment (“FAS 123R”) (see Note 14 to the consolidated financial statements). FAS 123R requires all share-based payments to employees be expensed over the requisite service period based on the grant-date fair value of the awards. Prior to adopting FAS 123R, the Company accounted for employee stock options using the intrinsic value method which measures share-based compensation expense as the amount by which the market price of the stock at the date of grant exceeds the exercise price. The Company elected the modified prospective transition method for adopting FAS 123R, and therefore, prior periods were not restated. Under this method, the provisions of FAS 123R apply to all awards granted or modified after January 1, 2006. Total pre-tax share-based compensation expense was $312.5 million in 2006, $48.0 million in 2005 and $25.7 million in 2004. Incremental pre-tax expense related to the adoption of FAS 123R was $227.8 million in 2006. In addition, the unrecognized expense of awards that have not yet vested at the date of adoption shall be recognized in Net income in the periods after the date of adoption. At December 31, 2006, there was $273.8 million of total pre-tax unrecognized compensation expense related to nonvested stock option, restricted stock unit and performance share unit awards which will be recognized over a weighted average period of 2.0 years. For segment reporting, share-based compensation expense is recorded in unallocated expense.

 

 

Materials and Production

In 2006, materials and production costs increased 17%, compared to a 3% increase in sales. The increase is primarily attributable to $736.4 million recorded in 2006 related to the global restructuring program compared with $177.1 million recorded in 2005. Of the amount recorded in 2006, $707.3 million represents accelerated depreciation associated with the planned sale or closure of five of the Company’s manufacturing facilities (see Note 4 to the consolidated financial statements). The remaining $29.1 million represents impairment charges associated with the abandonment of certain fixed assets that will no longer be used in the business as a result of these restructuring actions. Materials and production costs in 2006 also include stock option expense of $23.8 million. Additionally, materials and production costs included a 1% unfavorable impact from inflation in 2006.

 

In 2005, materials and production costs increased 4%, compared to a 4% decline in sales. The increase is primarily attributable to $177.1 million recorded in 2005 related to the global restructuring program. Of this, $111.2 million represents impairment charges associated with the abandonment of certain fixed assets that will no longer be used in the business as a result of these restructuring actions. The remaining $65.9 million represents accelerated depreciation associated with Merck’s plan to sell or close five of its owned manufacturing facilities. Additionally, 1% of the increase in materials and production costs in 2005 is attributable to the unfavorable effect from inflation. The variance in these costs relative to the sales decline reflects the impact of the items noted above, as well as the unfavorable effect on sales associated with the voluntary worldwide withdrawal of Vioxx in 2004.

 

Gross margin was 73.5% in 2006 compared to 76.6% in 2005 and 78.4% in 2004. The restructuring charges noted above had an unfavorable impact of 3.3 percentage points in 2006 and 0.8 percentage points in 2005. In addition, in 2006, Zocor lost U.S. marketing exclusivity which negatively affected the gross margin. The impact of the voluntary worldwide withdrawal of Vioxx had an unfavorable effect on the gross margin in 2004.

 

Marketing and Administrative

In 2006, marketing and administrative expenses increased 14%, primarily reflecting $673 million of additional reserves solely for legal defense costs for Vioxx litigation (see Note 11 to the consolidated financial statements) as well as costs associated with the launches of three new vaccines and other new products, mainly Januvia in the United States. In 2006, marketing and administrative expenses also included a $48 million charge to establish a legal defense reserve for Fosamax litigation (see Note 11 to the consolidated financial statements), as well as stock option expense of $143.7 million. Additionally, marketing and administrative expenses included a 3% unfavorable effect from inflation in 2006.

 

In 2005, marketing and administrative expenses decreased 1% primarily due to costs recorded in 2004 of $141.4 million for the voluntary worldwide withdrawal of Vioxx and $604 million for the establishment of a reserve solely for legal defense costs for Vioxx litigation. Partially offsetting the decrease was an additional reserve of $295 million for Vioxx legal defense costs recorded in 2005, as well as costs required to prepare for the launch of three new vaccines. Additionally, a 4% unfavorable effect from inflation and a 1% unfavorable effect from exchange also partially offset the declines.

 

Research and Development

Research and development expenses increased 24% in 2006. Included in the increase is a $466.2 million acquired research charge related to acquisition of Sirna, as well as a $296.3 million acquired research charge resulting from the GlycoFi acquisition. In addition, the increase reflects accelerated depreciation costs of $56.5 million in 2006 related to the closure of research facilities in connection with the global restructuring program, as well as stock option expense of $55.5 million. Additionally, a 2% unfavorable effect from inflation also contributed to the increase in 2006.

 

The Company has three drug candidates currently under FDA review:

 

In June 2006, the FDA accepted for standard review an NDA for MK-0517, the intravenous prodrug of Emend, for the treatment of CINV. The Company anticipates a decision on the NDA in the second quarter of 2007.

 

In July 2006, the FDA accepted for standard review the NDA for Janumet, the Company’s investigational oral medicine combining Januvia with metformin, which is designed to provide an additional treatment for patients needing more than one oral agent to help control blood sugar for treatment of type 2 diabetes. The Company expects FDA action on the NDA by the end of March 2007. The Company is also moving forward as planned with regulatory filings in countries outside the United States.

 

Arcoxia, the Company’s investigational selective COX-2 inhibitor, remains under standard review by the FDA in the United States. In response to the FDA’s approvable letter, Merck included results of the MEDAL (Multinational Etoricoxib and Diclofenac Arthritis Long-Term) Program that showed the rate of confirmed thrombotic cardiovascular events was similar between Arcoxia and diclofenac, the most widely used nonsteroidal anti-inflammatory drug in the world. The Company anticipates FDA action in April 2007. The Company expects that an FDA Advisory Committee meeting will be held prior to FDA action. Arcoxia is currently available in more than 60 countries in Europe, Latin America, the Asia-Pacific region and Middle East/Northern Africa.

 

The Company anticipates filing three NDAs with the FDA in 2007:

 

The Company plans to file an NDA for MK-0518 with the FDA in the second quarter of 2007 and has received fast track designation for an indication in treatment-experienced patients.

 

Interim 16-week data from the dose-ranging Phase II trial of MK-0518, the Company’s investigational HIV integrase inhibitor, in patients with advanced HIV infection were presented at the 13^th Annual Conference on Retroviruses and Opportunistic Infections in February 2006. The results showed that the oral investigational medication at all three doses studied in combination with optimized background therapy (“OBT”) had greater antiretroviral activity than OBT alone. Study results also showed that MK-0518 in combination with OBT was generally well tolerated in these patients who were failing antiretroviral therapy (“ART”), who were resistant to at least one drug of each of the three available classes of oral ARTs, and who had limited active ARTs as options for treatment. At the American Society for Microbiology’s 46^th Annual International Conference on Antimicrobial

Agents and Chemotherapy in September 2006, the Company presented interim 24-week data from this ongoing study in treatment-experienced patients, which demonstrated MK-0518 maintaining viral load regression.

 

In August 2006 at the 16^th International AIDS conference, the Company presented interim 24-week data from the Phase II dose-ranging trial of MK-0518 conducted in treatment-naïve, HIV-infected patients. The data showed that MK-0518 twice daily, when used in combination with tenofovir and lamivudine, achieved a comparable viral load reduction to efavirenz combined with the same agents in previously untreated patients. In September 2006 at the American Society for Microbiology’s 46th Annual International Conference on Antimicrobial Agents and Chemotherapy, the Company presented additional interim 24-week data from this Phase II dose-ranging study in treatment-naïve patients that demonstrated no increase in lipid levels in patients taking MK-0518 with tenofovir and lamivudine.

 

The Company has entered into Phase III clinical trials with MK-0524A and to support MK-0524B, investigational therapies for lipid management. MK-0524A represents a novel approach to lowering LDL-C, raising HDL-C and lowering triglycerides. MK-0524B combines MK-0524A with the proven benefits of simvastatin to potentially reduce the risk of coronary heart disease beyond what statins provide alone. The Company plans to file MK-0524A with the FDA in 2007 and to file MK-0524B in 2008.

 

In November 2006, the Company presented data from a Phase II study at the American Heart Association’s Scientific Sessions 2006 in Chicago that showed co-administration of MK-0524 with ER niacin significantly reduced flushing in patients with dyslipidemia compared to those patients who took ER niacin alone. Flushing, characterized by redness of the skin with warming or burning on the face and neck caused by the dilation of blood vessels near the skin, is a common niacin-induced side effect that can cause discomfort to patients and is a significant factor leading to discontinuation of niacin therapy.

 

In October 2006, the Company and H. Lundbeck A/S of Denmark announced that the submission of an NDA for gaboxadol, a novel investigational drug in Phase III development for the treatment of insomnia, will occur in mid-2007. Phase II clinical studies of gaboxadol showed improved sleep quality as well as increased slow-wave sleep without suppressing REM sleep. In December 2006, Merck announced that gaboxadol will likely be a scheduled compound.

 

Also, by mid-year 2007, Merck expects to have four products in Phase III development (including MK-0524B discussed above):

 

The Company has initiated a targeted Phase III program with its investigational compound for the treatment of obesity, MK-0364, which is an investigational cannabinoid-1 receptor inverse agonist. Results of early clinical studies indicate that MK-0364 demonstrated significant weight-loss efficacy versus placebo and was generally safe and well-tolerated, however, as reported with another cannabinoid-1 receptor inverse agonist, some psychiatric adverse experiences have been observed.

 

As announced in December 2006, the Company plans to start Phase III testing of MK-0974, the calcitonin gene related peptide receptor antagonist for the treatment of migraine headaches. The Phase III program is expected to commence in first quarter 2007.

 

Also announced in December 2006, the Company anticipates that MK-0822, a Cathepsin K inhibitor for the treatment of osteoporosis, will enter Phase III testing in mid-2007.

 

In August 2006, Merck and Gilead Sciences, Inc. (“Gilead”) established an agreement for the distribution of Atripla, a once-daily, single tablet regimen for the treatment of HIV-1 infection in adults, in developing countries around the world. Atripla contains 600 mg of efavirenz, a non-nucleoside reverse transcriptase inhibitor, 200 mg of emtricitabine and 300 mg of tenofovir disoproxil fumarate, both nucleoside reverse transcriptase inhibitors. Efavirenz is marketed by Merck under the tradename Stocrin in all territories outside of the United States, Canada and certain European countries (where it is commercialized by Bristol-Myers Squibb (“BMS”) under the tradename Sustiva). Emtricitabine and tenofovir disoproxil fumarate are commercialized by Gilead under the tradenames Emtriva and Viread, respectively. The compounds are commonly prescribed together as a once-daily, fixed-dose tablet, marketed under the tradename Truvada for use as part of combination therapy.

 

In October 2006, the Company along with BMS and Gilead announced the submission of a Marketing Authorisation Application (“MAA”) for Atripla in the EU to the EMEA. The MAA will be reviewed by the CHMP, subject to validation by the EMEA. The MAA for Atripla in the EU was filed jointly by the three companies through a newly established three-way collaboration based in Ireland. Review of the MAA will be conducted by the EMEA under the centralized licensing procedure, which, when finalized, provides one marketing authorization in all member states of the EU. Discussions among the three companies regarding agreements for manufacturing, commercialization and distribution of Atripla in the EU are ongoing.

 

Merck continues to remain focused on augmenting its internal efforts by capitalizing on growth opportunities, ranging from targeted acquisitions to research collaborations, preclinical and clinical compounds and technology transactions that will drive both near- and long-term growth. The Company completed 53 transactions in 2006 across a broad range of therapeutic categories, as well as early–stage technology transactions. Merck is currently evaluating other opportunities, and is actively monitoring the landscape for a range of targeted acquisitions that meet the Company’s strategic criteria. Highlights from these activities for the year include:

 

In March 2006, Neuromed Pharmaceuticals Ltd. (“Neuromed”) and Merck signed a research collaboration and license agreement to research, develop and commercialize novel compounds for the treatment of pain and other neurological disorders, including Neuromed’s lead compound, NMED-160 (MK-6721), which is currently in Phase II development for the treatment of pain. Under the terms of the agreement, Neuromed received an upfront payment of $25 million. The successful development and launch of NMED-160 for an initial single indication on a worldwide basis would trigger milestone payments totaling $202 million. Milestones could increase to approximately $450 million if a further indication for NMED-160 is developed and approved and an additional compound is developed and approved for two indications. Neuromed would also receive royalties on worldwide sales of NMED-160 and any additional compounds developed under this agreement.

 

Also in March 2006, Merck and NicOx S.A. (“NicOx”) entered into a new agreement to collaborate on the development of new antihypertensive drugs using NicOx’s proprietary nitric oxide-donating technology. The agreement covers nitric oxide-donating derivatives of several major classes of antihypertensive agents for the treatment of high blood pressure, complications of hypertension, and other cardiovascular and related disorders. Merck has the exclusive right to develop and commercialize antihypertensives that use NicOx’s nitric oxide-donating technology for the treatment of systemic hypertension.

 

In May 2006, the Company acquired Abmaxis, a privately-held biopharmaceutical company dedicated to the discovery and optimization of monoclonal antibody products for human therapeutics and diagnostics. In June 2006, the Company acquired GlycoFi, a privately-held biotechnology company, a leader in the field of yeast glycoengineering and optimization of biologic drug molecules. In connection with the acquisition, the Company recorded a charge of $296.3 million for acquired research associated with GlycoFi’s technology platform to be used in the research and development process, for which, at the acquisition date, technological feasibility had not been established and no alternative future use existed (see “Acquisitions” above).

 

In October 2006, Merck and Ambrilia Biopharma Inc. (“Ambrilia”), a biopharmaceutical company developing innovative therapeutics in the fields of cancer and infectious diseases, announced they entered into an exclusive licensing agreement granting Merck the worldwide rights to Ambrilia’s HIV/AIDS protease inhibitor program. Under the terms of this agreement, Ambrilia granted Merck the exclusive worldwide rights to its lead compound, PPL-100, which has completed a Phase I single-dose pharmacokinetic study and is currently in a Phase I repeat dose pharmacokinetic study. In return, Ambrilia received an upfront licensing fee of $17 million on signing and is eligible for cash payments totaling up to $215 million upon successful completion of development, clinical, regulatory and sales milestones. Ambrilia will receive royalties on all future product sales.

 

In November 2006, the Company expanded the scope of its existing strategic collaboration with FoxHollow Technologies, Inc. (“FoxHollow”) for atherosclerotic plaque analysis. Additionally, Merck acquired a stake in FoxHollow with the purchase of $95 million of newly-issued shares of FoxHollow common stock for $29.629 per share, representing approximately an 11% stake. The existing strategic collaboration, entered into in 2005, provided for FoxHollow to receive an upfront payment with the opportunity for additional payments if the collaboration continued. Under the terms of the expanded collaboration agreement, Merck will pay $40 million to

FoxHollow over four years in exchange for FoxHollow’s agreement to collaborate exclusively with Merck in specified disease areas. Merck will also provide a minimum of $60 million in funding to FoxHollow over the first three years of the four year collaboration program term, for research activities to be conducted by FoxHollow under Merck’s direction. FoxHollow will receive milestone payments on successful development of drug products or diagnostic tests utilizing results from the collaboration, as well as royalties.

 

In November 2006, Merck and The J. David Gladstone Institutes announced a major collaboration and license agreement for research and development of drugs to treat neurodegenerative diseases, including Alzheimer’s disease, that are linked to apoE-regulated mechanisms in the body. The agreement provides Merck, through an affiliate, with a worldwide, exclusive license to research, develop and commercialize compounds that are directed to apoE-regulated pathways and result from collaborative research or discoveries that have been made in the field of neurodegeneration by the Gladstone Institutes.

 

Also in November 2006, Merck and Advinus Therapeutics (P) Ltd. (“Advinus”) announced they have formed a drug discovery and clinical development collaboration in the area of metabolic disorders. Advinus and Merck will work together to develop clinically validated drug candidates for metabolic disorders, with Merck retaining the right to advance the most promising of these candidates into late-stage clinical trials. Advinis will receive an upfront payment and could potentially receive milestone payments of $74.5 million for each target included in the collaboration. The collaboration will begin with two target programs, and could expand to include others over time.

 

In December 2006, Merck completed the acquisition of Sirna, a publicly-held biotechnology company that is a leader in developing a new class of medicines based on RNAi technology, which could significantly alter the treatment of disease. In connection with the acquisition, the Company recorded a charge of $466.2 million for acquired research associated with Sirna’s compounds currently under development, for which, at the acquisition date, technological feasibility had not been established and no alternative future use existed (see “Acquisitions” above).

 

Additionally in December 2006, Merck and Idera Pharmaceuticals (“Idera”) announced that they had formed a broad collaboration to research, develop and commercialize Idera’s Toll-like Receptor (“TLR”) agonists. Under the terms of the agreement, Merck will receive worldwide exclusive rights to a number of Idera’s agonist compounds targeting TLR 7, 8 and 9 for use in combination with Merck’s therapeutic and prophylactic vaccines under development for oncology, infectious diseases and Alzheimer’s disease. Merck and Idera will engage in a two-year research and development collaboration to generate novel agonists targeting TLR 7 and TLR 8 and incorporating both Merck and Idera chemistry for use in the licensed fields. Merck paid an upfront license fee of $20 million to Idera and purchased $10 million of its common stock at $5.50 per share. In addition, Merck will fund the research and development collaboration. Idera is eligible to receive milestone payments of up to $165 million if vaccines are successfully developed in each of the three fields. Additional milestones of up to $260 million would be payable for follow-on indications in the oncology field and the successful development of additional vaccines containing Idera’s TLR agonists. There is no limit to the number of vaccines to which Merck can apply Idera’s agonists within the licensed fields. In addition, Idera will receive royalties on products commercialized under the collaboration.

 

The Company maintains a number of long-term exploratory and fundamental research programs in biology and chemistry as well as research programs directed toward product development. The Company’s research and development programs are generally designed to focus on the development of novel medicines to address large, unmet medical needs. Merck’s new efforts to improve drug discovery involve focusing on nine priority disease areas, as well as utilizing new research technologies, building alliances with external partners and making targeted acquisitions which will complement the Company’s strong internal research capabilities. The previous announced nine priority disease areas are: Alzheimer’s disease; atherosclerosis; cardiovascular disease; diabetes; novel vaccines; obesity; oncology (targeted therapies); pain; and sleep disorders. These therapeutic areas were carefully chosen based on a set of criteria including unmet medical needs, scientific opportunity and commercial opportunity. A chart reflecting the Company’s current research pipeline as of February 15, 2007 is set forth in Item 1. “Business” above.

 

Research and development expenses decreased 4% in 2005. Included in 2005 are accelerated depreciation costs of $121.8 million related to the closure of research facilities. In addition, the decrease reflects the 2004 impact of $225.0 million of licensing expense for the initial payments for certain disclosed research collaborations and $125.5 million of acquired research expense from the acquisition of Aton Pharma, Inc. in 2004. Partially offsetting the decrease is an 8% increase in other research and development activities supporting Merck’s pipeline, as well as a 2% unfavorable effect from inflation.

 

Restructuring Costs

Restructuring costs were $142.3 million and $322.2 million for 2006 and 2005, respectively. Included in restructuring costs are separation costs associated with Merck’s plan to eliminate approximately 7,000 positions by the end of 2008. In 2006 and 2005, Merck incurred $113.7 million and $182.4 million, respectively, in separation costs associated with actual headcount reductions, as well as headcount reductions that were probable and could be reasonably estimated related to the global restructuring program. The Company eliminated 3,700 positions in 2006 and 1,100 positions in 2005 (which are comprised of actual headcount reductions, and the elimination of contractors and vacant positions). Also, in 2005, the Company recorded $116.8 million for separation costs associated with other restructuring programs. Restructuring costs are included in unallocated expense for segment reporting purposes.

 

Equity Income from Affiliates

Equity income from affiliates reflects the performance of the Company’s joint ventures and partnerships. In 2006 and 2005, the increase in equity income from affiliates reflects the successful performance of Vytorin and Zetia through the Merck/Schering-Plough partnership. The growth in 2005 is also attributable to higher partnership returns from AZLP. See “Selected Joint Venture and Affiliate Information” below.

 

Other (Income) Expense, Net

The increase in other (income) expense, net, in 2006 reflects an increase in interest income generated from the Company’s investment portfolio derived from higher interest rates and higher average investment portfolio balances. The decrease in other (income) expense, net, in 2005 primarily reflects a $176.8 million gain in 2004 from the sale of the Company’s 50% equity stake in its European joint venture with Johnson & Johnson, as well as realized gains on the Company’s investment portfolio recorded in 2004.

 

Segment Profits