Executives: Constantin Fest - Head, IR Marcus Kuhnert - CFO and Member of Executive Board Belén López - Member, Executive Board and CEO, Healthcare Luciano Rossetti - Global Head, R&D for Biopharmaceutical Division and EVP of Biopharmaceutical

Division
Analysts: Peter Verdult - Citigroup Matthew Weston - Crédit Suisse AG Sachin Jain - Bank of America Merrill Lynch Simon Baker - Exane BNP Paribas Richard Vosser - JPMorgan Chase & Co. Vincent Meunier - Morgan Stanley Peter Spengler - DZ Bank AG Marcus Wieprecht - MainFirst Bank

AG
Operator: Welcome to the Merck Investor and Analyst Conference Call on First Quarter Results 2017. [Operator Instructions]. May I now hand you over to Constantin Fest, Head of Investor Relations, who will lead you through this conference. Please go ahead, sir.

Constantin Fest: Many thanks, Angela and a very warm welcome from my side here in Darmstadt to this Merck Q1 2017 Conference Call. My name is Constantin Fest. I'm Head of Investor Relations here at Merck. And I'm delighted to have with me here today, Marcus Kuhnert, our group CEO; as well as Belén Garijo, our healthcare CEO. Also, note that we're very happy to welcome to the Q&A portion of this call, Luciano Rossetti, our global Head of Healthcare R&D.

As always, we'd like to run you briefly through the key slides of the presentation and then we'd be happy to take all of your questions. And with this and without any further delay, I'd like directly to hand over to Marcus and Belén to start with this presentation. Marcus?

Marcus Kuhnert: Thank you very much. Constantin, a short disclaimer, I'm only the CFO. So welcome to our Q1 call.

Overall, Q1 was a pretty good quarter, especially, driven by Healthcare and Life Science. Healthcare's underlying business was robust in Q1 and from our pipeline, we have seen very positive signs. First milestones for the approval of Bavencio. For avelumab, as you may know, in Merkel cell carcinoma and the most recent FDA approval for -- of Bavencio for the treatment of bladder cancer in the second line. And Belén will give you more details later.

In Life Science, we continue to grow sales nicely despite challenging prior year base, where we grew as much as 9% organically and also, the margins developed well supported by our ongoing execution on the synergy side. And for PM the quarter was rather sluggish as it declined and liquid crystals could not be offset by the strong performance of our other businesses. As always and as you know from us, we refine our full year guidance with the first quarter result release and expect net sales between €15.5 million and €16 billion and EBITDA pre of €4.4 billion to €4.6 billion, but we'll come to that later more detail. I'm going now to the next slide. And here, we're looking on the key financials and the decomposition of growth.

In Q1 2017, net sales grew organically by 3.1%, again, driven by Healthcare and Life Science which more than offset, however, smaller than before decline in Performance Materials. Currencies were positive for us in Q1, here, especially the U.S. dollar is the obvious driver, but also importantly, some key emerging market currencies were stronger than expected. EBITDA pre rose by 14.5% to €1.24 billion, mainly driven by Healthcare which accounted for roughly 80% of the growth and Life Science. We will discuss Healthcare and the 2 other businesses in more detail later in the presentation.

So just 2 comments at this stage. As mentioned during our results release in March, we benefited in Q1 from the favorable or by not fully leveling development of our royalty income stream in the first quarter. And we also received the first milestone for the approval of Bavencio for Merkel cell carcinoma. On Slide #7, where we see the regional breakdown of sales, there's not much news to tell. Still roughly 1/3 of our sales are accounted for Europe and Asia Pacific, while since the acquisition of Sigma-Aldrich, now roughly a quarter of our sales is coming from North America.

The growth in the first quarter has been delivered by the emerging markets comprising of Asia Pacific with a very nice development still in China and driven very much by Healthcare, Latin America and Middle East, Africa. Now we go a little bit more into the financial details and I jump on Slide #9, where we see the overview of the key financials for the first quarter. EBITDA pre of €1.24 billion exceeds last year's level by €156 million and is also well above the run rate of previous quarters. We discussed most of the drivers already in March, but let me give you some more details here. In February, you know that we have received a lump-sum payment in exchange for future royalty and license income and this led to a benefit of slightly more than €100 million in the first quarter, but please bear in mind that obviously, there will be no more regular license income in the remaining 3 quarters for this specific molecule.

Secondly, we have also talked about our roughly approximately €50 million of quarterly royalty income from AVONEX, so this, as you know, will benefit us over the next couple of years. And we only start since July to have comparables for prior year so the first half here this is still, let's say, an uptake to our results. And thirdly, we also received the first milestone payment of €37 million, $40 million in the first quarter for the approval of Bavencio for Merkel cell carcinoma. So these are drivers of the visible, very visible increase of EBITDA pre and this increase is set through pretty much directly to earnings per share. With a sound operating cash flow, our net financial debt continued to decline and translate into a net-debt-to-EBITDA ratio of approximately 2.4 by the end of the first quarter which is represented further improvement compared to the levels that we have reached by the end of last year.

On Slide #10, when we look on further down into the P&L, reconciliation between EBIT and earnings per share. The EBIT in Q1 2017 is below prior year which is obviously due again for onetime effect, mainly the €324 million disposal gain for the sale of Kuvan at the beginning of 2016. Financial results is about stable versus last year. Here, we have seen obviously, so to say, on the volume side, the benefits from the progress in deleveraging, while on the other hand, the interest rates have gone up slightly and we have also seen a slightly negative effect from LTIP, so all of the effects basically balancing out each other giving us stable financial results. We speak to our guidance of €250 million to €260 million impact from the financial results for the full year -- sorry from the interest result for the full year 2017.

Tax rate is also in line with the expected number between 23% and 25% so nothing special here. And you may have followed the news as well as we have -- we will need to figure out now and the next weeks and months to come what are the net impacts of any future changes in the U.S. tax system. So this is an ongoing task we're dealing with and it is too early to communicate something about that because simply it is at that point of time, the moving target. So with that, I would now like to hand over to Belén, who will give us a deep dive into Healthcare.

Belén López: Thank you, Marcus. And also, a very warm welcome from my side. As you have seen from the previous figure -- figures that Marcus has already shown, Healthcare is off to a good start and we delivered a very solid Q1 in 2017. We contributed to 80% of the quarterly growth of the group and this is illustrated by a business which is well on track and deliver 4.4% organically versus the same quarter of last year which even if you adjust for Glucophage in China, will stay positive at around 1.5%. Rebif came probably not better than most of you have expected, with an organic sales decline of minus 4% on a year versus prior year.

But given the prebuying that we have seen at the end of 2016 in North America that was ahead of the price increase in January 2017. We think that this is fairly solid. Erbitux showed moderate organic growth, mainly coming from demand in growth market, although, the competitive pressure remains as you see on the slide. Gonal, on the other hand, was on declining sales versus same quarter of last year, largely due to very high base -- comparable base, mainly in the U.S. during early 2016 that, if you remember, was on the back of a very favorable competitive situation.

Let me say a word on the R&D cost in the quarter which basically has stayed in line with prior year. And this is simply because of the phasing, so we see some seasonality and some backloading of the spending towards the remaining quarters. Our trials, all of our programs are very well on track and we will keep you updated as the year goes on. For 2017, overall, before you ask me the question, we're expecting R&D cost to rise by €150 million to €200 million versus 2016. Let me now provide some additional focus on relevant business and our milestones during the quarter, both in terms of business performance as well as on our pipeline.

By now, we have developed 23rd consecutive quarters of growth and our business -- our core business is very solidly performing and we intend to focus in making this performance sustainable. So there you have references to the January price increase in the U.S. Erbitux was also favorably endorsed by NICE for first line metastatic colorectal cancer. And we have a new presentation for Pergoveris. A new pen for Pergoveris which is going to be convenient for the patient.

For Bavencio, we have now our second FDA approval which is really a major success for our organization and is confirmatory of how diligently we're executing our R&D strategy. In addition to that, we have 9 Phase III trials of that registrational trials and to date, more than 5200 patients have been treated already with Bavencio in all those trials. Together with those registrational studies, we obviously, have ramp up our efforts on investigator-initiated trials both in monotherapy and combination in multiple indications. In addition to Bavencio, you heard in January that we licensed 4 oncology programs in the field of DNA damage repair from Vertex and this is going to give us an undisputable leadership in this space versus existing competitors. We also announced a development agreement for our IL-17 nanobody to be developed to Phase II trials in psoriasis, speaking once again of how much we want to focus our internal resources on our high-priority program and how innovative we became into funding external sources and external resources to fund those who do not qualify as such.

In Q1, we also announced a divestment of our biosimilar activities to Fresenius. We're still in transition and we will be providing several services to Fresenius in the coming months. You're familiar with the agreements since this is already public. And this once again speaks of our stringent focus on our biopharma pipeline high priority programs. On Slide #17 -- 13, you have data on our ASCO abstract focusing on the pipeline.

I obviously will not go through each and every line of the slide, but we have a very extensive presence this year, ASCO which is reflected in almost 50 publication of both our pipeline assets and Erbitux. We also have, for the first time, an abstract of our BTK study in oncology which you can find also in the book. And well, we will discuss these during the question-and-answer as deeply as you want. Last, I wanted to take you through the news flows that you can expect from our pipeline in the next 12 months. Avelumab, MCC, European decision is expected in the second half 2017.

TGF-beta trap is tracking as expected, is totally on track. We can give you more details on the enrollment of the cohorts later. And we're aiming to present selected cohorts by the year-end either at SIC or ESMO, iOnc. Although we will have obviously, the data internally as expected by mid-2017. Cladribine, you're familiar with.

We're expecting an EMA decision by Q3. Sprifermin, this Phase II data readout by Q3. The next for avelumab will be the Phase III data readouts for both gastric third line and nonsmall cell lung cancer second line and last, but not the least, atacicept on the Phase III decision. I would like to talk a bit more on BTK since this is not subject of further detail on the presentation because this program is progressing very well. We're encouraged by the early findings and indeed, by the interest that is generating from significant prospective partners.

Our focus on this program is ensuring that we can maximize the potential of BTK even if -- it's anticipated potential in immune-mediated diseases and in oncology. With the prospect that the molecule have the potential that it has to supplant other oral immune modulators. We're focusing on 3 major disease areas, SLE, MS and RA and obviously, we're expecting to address in this context, a significant market opportunity. We're rapidly progressing Phase IIbs in 3 indications with the aim to maintain the pace with competition, mainly in RA and ensure leadership in SLE and MS while considering potentially additional applications. Our ambition, as you have been told before, is to find the right partner with the same vision and with the right competence to ensure that we can jointly deliver on the leadership and transformative potential of our BTK.

As I mentioned, we're now receiving real interest, but we, of course, are expecting to be selective in our approach and our commitment to the Phase II, means that we can be selective without compromising the future potential. So we keep this program moving, while we identify the right partner. With this, I'm going to hand it over to Marcus for him to continue with the rest of the businesses.

Marcus Kuhnert: Thank you, Belén. So we go to the deep dive into Life Science.

Life Science saw a continuously robust demand in the first quarter. However, as elsewhere in the industry, we're running against very tough comparables. So last year shown some 9% organic sales growth and this kept the Q1 growth somewhat in check with an overall 3.3%. While we look a little bit on our businesses, the major growth drivers in the first quarter has been Process Solutions and Applied Solutions. Process Solutions, however, a little bit slower than we were used to in the past because we had a slower start with some key accounts in the first quarter.

Applied had a very good quarter. And in research, we're, at the moment, struggling a little bit with, I would say, reluctant investment behavior and climate, especially in the U.S. But overall, demand remains quite solid and we have seen no signs of weakening so far. Maybe one word to be orders that we have mentioned in the Q4 2016. We have seen roughly 2/3 of the orders flowing through into our numbers in the first quarter, however, as I said, mitigated by the initial slight weakness of some key accounts in the area of Process Solutions.

We're confident that our Life Science sector will grow slightly above the market growth rate of some 4% in 2017 and this is also reflected in our guidance and was -- is basically unchanged to the expectations we have already articulated with the March results release. And the synergies continue to ramp up and together with the underlying growth of the business, led to a 13% growth in EBITDA pre and a very healthy margin, so we had collected 30% in the first quarter which is surely a very good thing. Going to Performance Materials, for PM, Q1 was showing, let's say, a little bit -- a not so negative organic sales growth than what we have seen in Q3 and Q4 last year. And of course, here, our 4-pillar business model and the resulting ability to better mitigate sales and earnings fluctuations than in the past has helped. On the positive side, Integrated Circuit Materials and Pigments especially performed strongly in Q1 and also OLED made again a good contribution, but this was obviously sufficient to compensate for the year-on-year sales decline in liquid crystals.

Let me add a couple of words to liquid crystals. We have outlined that the major reason for the ongoing sales decline here is -- or by the market environment is basically back to normal since Q3 last year and ongoing normalization of market share. To share with you some information on that. We're coming actually from a very favorable situation 2, 3 years ago, where capacity has been built up in China, not only by Chinese manufacturers, but by all of them, by all of our customers. And due to the fact that at this point of time, they were basically not yet any meaningful Chinese competitors in the market and Merck is and still the quality leader.

There was a natural tendency when these manufacturing lines were ramped up and went live to use actually Merck product because this was a low risk way and safe way to get the production lines running. And that actually resulted in artificially high market shares that we were enjoying now for some 2 to 3 years significantly in excess of 60%. What we have observed meanwhile, is the market correction last year and some of the sourcing behaviors, consulting strategies were somewhat revisited, more going back to double or even multiple sourcing strategy which actually leads to some normalization of market shares. So that means we're going back from a number in excess -- significantly, in excess of 60%, now more towards again the historical averages which are between 50% and 60%. And last, but not least, also some of the Chinese competitors who have grown a little bit meanwhile.

They have catched up in quality. So that is some information on the development on market shares. Moreover, we have seen still a healthy EBITDA pre margin of close to 41%. It is, however, a little bit lower than 1 year ago. The reasons for the reduced margins is actually portfolio mix because Display Materials is still the, by far, most profitable part of PM and here, we have seen a decline, while the other segments are growing.

And we also, we invest at the moment in further top line generating activities, predominantly, in the area of Integrated Circuits and of liquid crystal applications which are not related to displays. So the most prominent one for sure is the liquid crystal windows initiatives. And that -- these 2 effects, mix and higher R&D has somewhat reduced our margins, but we're still well above 40% what we committed to. Last, but not least, I mean, we have seen the effect of the earthquake in Taiwan in the first quarter and then, of course, also, as Belén mentioned, was not really helpful in this context. On maybe a positive note, UB-FFS has reached record sales in the first quarter, so the decline is pretty much happening in the established liquid crystals technologies.

And, yes, so this is the deep dive into Performance Materials. And we will provide, by the way, a little bit more details after the second quarter end. Walter Galinat will be in the call and then we will give you an even more comprehensive update on where we stand. Slide #17, a short glance on the balance sheet. So this is not very spectacular here.

Most important topics are further reduction in intangible assets, driven by scheduled amortization and FX. On the liability side, equity ratio is now close to 38%, driven by profit after tax. And in financial debt, financial debt reflects the leveraging that I've referred to at the beginning of the presentation. Strong operating cash flow on the next slide with €777 million, if you deduct CapEx of around about €200 million and the cash out for the Vertex deal that Belén mentioned, then you come approximately to the €400 million net debt reduction that you see in our balance sheet. Financing cash flow reflects the payback of the first tranche of our U.S.

dollar bond. Closing the presentation with the guidance. Jumping to Slide #20. Net sales expected between €15.5 billion and €16 billion, EBITDA pre between €4.4 billion and €4.6 billion and earnings per share pre between €6.15 and €6.50. And we drove this usually down to the business sector level and the key statements you find on Slide 21.

We believe we will see a further slight organic growth, at least, slight organic growth in Healthcare with an ongoing organic Rebif decline, however, well under control. And all other franchises growing, driven by the emerging markets and here also, the business model shift, Glucophage in China will help. And EBITDA pre expected in the range between €1.9 billion and €2 billion which reflects pretty much the increase in R&D costs that Belén referred to. So if you would add back the €150 million to €200 million, we would be basically on prior year level. Life Science, we continue to believe to grow above the market which we assume to grow at 4% round about in 2017.

And we expect first contributions from top line synergies. EBITDA pre shall be in the range between €1.78 billion and €1.85 billion. And last, but not least, a little bit more cautious for cost on Performance Materials. The reasons I've just elaborated on, slight organic decline in 2017. Still increasing volume in all of our businesses, further ongoing normalization of market shares in liquid crystals and EBITDA pre more or less on prior year level in the range between €1.05 billion and €1.13 billion.

With that, thank you for your attention so far following our presentation. And Belén and myself, we would now be happy to take your questions.

Operator: [Operator Instructions]. The first question comes from Peter Verdult of Citi.

Peter Verdult: Peter Verdult, Citi.

Just a few questions for Belén and or Luciano. Just firstly, on the TGF-beta trap the ASCO abstract seems to be the same data in 16 patients that was presented in a poster last year at the NTA. So just wondering why there's no further update to give at ASCO, given we're 6 months down the line? And whether ESMO is the most likely setting to see the interim data from your ongoing 700-patient study? Question number two, for Belén, just on the BTK. I know you've already made some comments in your prepared remarks. But can you just -- do you actually have the Phase II RA data in-house here? Primarily asking wondering whether we should interpret your decision not to press release that data but wait until later in the year some sort of signal regarding your conference in the asset and where that's changed.

And then lastly, again, Belén or Luciano on avelumab. I realized its early days, but wondering if you could share with us some -- any patient start numbers. And secondly, address the issues in infusion site reactions is noticeable, so looking at the label there. These are significantly higher than you're competing PD-1 and PD-L1 agents. Realize that based on Grade III and IV events is still very low, but just want to see you to address that issue and give us your perspective?

Belén López: Yes.

Thank you, Peter. Let me start by addressing BTK and then I will hand it over to Luciano to give you a bit more details on TGF-beta trap. So our BTK Phase IIa data will be in-house in June. This is exactly as we have communicated before and we're on track to deliver on that. I guess, to position this trial, this is still in the dose-ranging study in NIH and this is a signal-finding study, right.

In the meantime, we have, as I mentioned before, initiated 2 other trials. We're progressing in 3 indications in parallel with the aim to maintain the pace with competition and as I mentioned before. And surely, they're severe SLE and MS, while considering additional applications. We're very satisfied with the progress of this program. And as I mentioned, before, our intention is to find the right partner to continue to develop this molecule that is quite unique in terms of the specificity to the transformative potential that we have identified in it.

Then for TGF-beta trap I'm going to hand it over to Luciano to give you more information. But as we have announced before, the data that we're disclosing at ASCO comes from the dose escalation study. And we will progressively, as the data matures, present the different cohorts which are now almost enrolled by the different next stages of follow-up. And we need to have additional data. Then your question on the profile for avelumab, I will ask Luciano to take at the same time that he give you information on TGF, Peter.

Luciano Rossetti: Peter, very nice being here with you. So let me start with TGF-beta trap, basically what we have clearly discussed in the past is that we're now having a much better understanding of the safety profile of this molecule. And we have a very full understanding of how the molecule in humans engages the 2 targets. So in order to really present to you a clear dose response about how TGF-beta I, TGF-beta II, TGF-beta III are inhibited to PBMC. And we're with time trying to develop data also in the tumor.

And now the interaction between PD-1 and PD-L1 is blocked. So we have confidence now that with the dose we have selected to move forward in the latest cohorts, we're truly testing original hypothesis. If we block TGF-beta as well as PD-L1, where are the tumor types, in which these makes the big difference. So the reason we went into 14 cohorts in parallel is that what we want to do very rapidly this year is to select the cohorts on which we want to focus and really invest in the future. And the one that we think we will decided to stop.

So where we're internally is that we're just starting to have 1 or 2 of the initial cohorts, providing the interim data. Interim data means that we're going to have data on the short duration of treatment for about 40 patients or so for each cohort. So as soon as we start to accumulate and ask for this initial cohort, by the middle of the year until the end of the year, we're going to communicate perhaps which cohort we decide to move forward into later stage of development. In terms of data, in order for the data to be mature enough, we plan to submit abstracts on some of the cohorts like Belén already mentioned, toward the end of this year, rather than ESMO that is in September. It's much more likely that you're going to see the data at the end of the year.

So, so far, so good. More than 600 patients are already enrolled out of 660. So everything is proceeding very, very rapidly. We can -- you can see probably some more information on the dose escalation that is going to be only on those 16 patients because the dose escalation went very rapidly with 3 patients roughly for each one. Now let me address briefly the question on avelumab and infusion-related reaction.

So the great majority of this reaction we have seen, as you know, are very mild, Grade I and II. If we look at the more severe reaction or the reaction leading to discontinuation, we're well below 1% and this is actually been observed with almost all the competitors. So that -- and I think is that they're very simple premedication seems to have really made this reaction even milder and less rich. So far even on the marketing experience, we don't see this as an issue so far that the patients or the physicians have had any concerns whatsoever.

Peter Verdult: And on patient numbers, if I may squeeze that one in, in terms of so far?

Belén López: Patient numbers for avelumab?

Luciano Rossetti: It's more than 5,000.

Peter Verdult: Yes. The avelumab. For avelumab?

Belén López: I mentioned this already in the presentation, Peter, around...

Luciano Rossetti: 5200 plus.

Belén López: 5200.

Operator: The next question is from Matthew Weston.

Matthew Weston: A number of questions, if I can. A quick follow-up to Pete's question on Trap. Luciano, can you confirm whether or not cervical and pancreatic are 2 of the patient expansion cohorts that you have chosen. And if you can share any other further details on the expansion cohorts that you picked that would be very interesting.

Secondly, Belén, on Gonal-f, we were obviously expecting a slowdown in the U.S. given the market dynamics. But the press release particularly called out ex U.S. pressures as well. It's not one of the products that you disclosed the revenue split on.

So can you just walk us through what you're experiencing ex U.S.? And how the generic penetration is affecting revenue in those markets? And then Marcus, by a process slowdown, can you just give us some more details. Are we trying to understand that this is some of your key accounts that have delayed orders that you expect to come into second quarter? Is this a market share issue that some of your competitors are becoming more aggressive and you are now required to fight back? I think it would be very interesting to understand how we can go from double-digit growth rates guidance that was predicated, I think, previously on high single to low double-digit growth rates in bioprocess. And then we see an organic growth rate in Q1 which is only half that. What gives you the confidence that it bounces back towards the end of the year?

Belén López: Let me start by the fertility franchise Gonal-f in the rest of the world. Today, our expectations are of the performance in a different world -- in a different way, the performance that we have seen in Europe is quite aligned with our expectations.

So obviously, we see increasing pricing pressure coming from biosimilars in Europe, while we see growth coming from emerging markets, in particular, China and other Asian countries. The U.S. is fully explained by the comparable of last year. We're not losing market share. When you look at this from the in-market perspective on IMS, Gonal-f is actually very well on track in terms of market share.

So we're confident that, up-to-date, the main factor is on comparable that we have last year in the back of this favorable competitive situation. You see, when I look forward to the rest of the year, we're rather confident that we will continue to see good dynamics in growth markets. However, it's very difficult to predict the situation in the U.S. and even less predictable the situation in Europe with biosimilars. So we're really following our strategy very strictly which is focusing on emerging markets to partially offset what we may lose in Europe and at the end, the franchise is performing nicely in other new markets, mainly emerging markets.

The U.S., difficult to predict, Matthew. We have not seen anything that we were not expecting and as I said, the in-market data are solid. Now the second question was on the cohorts of TGF-beta. And then I'm going to hand this question to Luciano for him to comment.

Luciano Rossetti: Yes.

So Matthew, first, thanks for the question. Obviously, as I mentioned early on, we're selecting those 14 cohorts, try to address the 4 fundamental questions in terms of going into tumors, in which PD-L1 and PD-1 therapies were already established. Going to tumors in which there was only an initial signal of efficacy of PD-1, PD-L1, where we can be competitive on the time line. Third group is what you're referring to, that is tumor that appears to be nonimmunogenic and therefore, very weak signals or no signals from PD-1, PD-L1. And finally, we're also very interested in [indiscernible] also disclose to you guys that is to look at PD-L1 refractory and resistent tumors.

Unfortunately, our decision was not -- for competitive reasons, not to disclose the specific tumors. But I would guess that if you're looking the third category, for instance, there will be potential that pancreatic cancer would have been included as well. So we're going to find out, I think, more rapid understanding of where to go, particularly, in Category III and Category IV that I described. Might take longer and bigger duration and more number of patients to really understand the first 2 categories because we have to show the superiority to PD-1, PD-L1.

Belén López: Marcus?

Marcus Kuhnert: Yes.

So I'm addressing the Life Science question. So first of all, Matthew, I would like to make the point that we see the overall growth trend in the biopharma area still intact. The growth is driven by single use which we see ongoing. Also, services and upstream have performed very well in the first quarter, bringing out at least close to 5% organic sales growth. We currently do not see that we have any market share issues.

Obviously, as you can imagine, we're performing every quarter a more in-depth analysis on our own performance versus also of our competitors. And if we compare really on an apples-to-apples basis, we see us growing roughly at the same pace as our major competitors in the different segments which lead us to the pretty same conclusion that we do not lose market shares or have not lost market shares. The order shift actually is an effect which, I would say, is minor. It is not even 1% of the growth when it accounts for. So I think, this is actually not really playing a major role when we look on the performance for the full year of 2017.

Thirdly, I would just like to remind you that we have had indeed a slower start at some of our larger accounts this year. And at that point of time, we clearly believe that this is temporary and that we will catch up in the quarters 2 through 4. And last but not least, I would like to remind you that we have easing comparable -- [indiscernible] easing comparables in the second half of the year. So the first half of 2016, Process Solutions was growing some 16%. In the second half of the year, the growth slowed down, that will also just technically help us to get where we want to be.

And that is above market and above 4% for 2017.

Operator: The next question comes from Sachin Jain of Bank of America.

Sachin Jain: Two important questions and one on Performance Materials. And first, just going back to BTK, in your introductory comments, Belén, you mentioned you're retracting interest and you want to maximize the value. I just want to understand the timing of any potential deal from your perspective.

My understanding of prior comments was that you wanted to wait for full suite of Phase II data. Has that shifted at all? And can potentially the RA data, if strong enough, drive an earlier deal than perhaps you previously thought? Secondly, again, back to TGF-beta trap. I don't know whether you can comment on this, Luciano, but the initial data you have in the 1 or 2 cohorts you mentioned, is that in the Category III and IV i.e. previously where PD-1, L1 has not worked in PD-L1 refractory. The reason for question is, I wonder when you think you'll have sufficient data in those potential faster route markets to progress to Phase III and whether indeed that could happen before you presenting the data to us later in the year.

And then the final question on Performance Materials. I guess, for Marcus, I wonder if you could just outline what share assumptions you assume within guidance i.e. from the much higher than 60. Where are you roughly now or where do you assume you get to within guidance? And then, how can you be sure that, that normalization doesn't proceed to share loss below the prior range, as you referenced the Chinese competitors are catching up from a quality perspective?

Belén López: Sachin, let me start by BTK. Again, I wish I could tell you the timing, obviously, when we find the right partner, a partner that share our vision, a partner with the right competence and a partner that is ready to recognize the value that we see in this molecule.

So at this time, I couldn't comment on when do we will be able to announce a deal. And -- but I can tell you we have already initiated conversation with some of the potential interested parties. And we will do this as diligently -- we will try to do this as diligently as our experience with avelumab. There is a second question. There was a second question on BTK? So as I mentioned before, this is a highly selective BTK and we see potential for this molecule to replace other oral immunomodulators and other antibodies addressing B cell biology in different disease areas, right? So far, rheumatoid arthritis is the most advanced.

We have a Phase IIa study in a small number of patients which is actually focused on finding signals of BTK inhibition and -- basically CRP. And the data will be in house in June, exactly as we said before. Then the other 2 studies have already been initiated and those are SLE and MS. And in those 2 indications, this has been -- we believe that we have today and we want to keep a leadership position. The estimated primary completion for MS is December 2018 and for SLE December 2019.

On TGF-beta trap, I don't know, in a way, I think the question to your answer was already captured on what Luciano mentioned before. We're definitely focusing on these 4 clusters of tumors. And the study is enrolling very, very quickly. And regardless of the cluster in which we have the cohorts, you will see the data as well as soon as those data are mature enough. And we will communicate our decision on what cohorts are going to move in -- moving forward.

Luciano Rossetti: Maybe I can add just a little bit of color on the BTK. Just that you asked what are the signals that we really have already now. So compared to few months ago, what we have now is, #1, you saw the abstract on BTK oncology that demonstrate even at the very low dose, that there is a signal on -- very strong signal of BTK in B-cell tumor. So that gave us an idea that a very, very selective BTK inhibitor can affect B cell in oncology. That's 1 component.

Then we have the safety study, the Phase 1b in SLE that confirmed that our BTK inhibitor not only in normal subjects, but also in patients with systemic lupus is very, very well tolerated and therefore, we advanced rapidly to the Phase II proof-of-concept in SLE. And then the other thing I can say that the RA Phase IIa study that Belén has clearly described that signal-finding small study will lead in almost a similar transition in the Phase IIb component. We're organizing this in a way that whenever in June when we get the final signal, we can move very, very rapidly in the Phase IIb phase of the trial. So we don't expect major delays in the case we move forward. And on TGF-beta, the only thing I can say is that my prediction that the Category III and IV will give us more data earlier, is mostly based on the fact that in those, we don't have so much signal to noise.

Because when you have to compare directly to PD-1, PD-L1, we're seeing obviously responses. But the responses will have to be categorized whether they are superior to the standard of care, so the PD-1 and PD-L1. And that might take longer time. That's only a prediction.

Belén López: Sachin, apparently I missed part of your question on what kind of partnership are we looking for.

I mean, we're very flexible. On the ongoing conversations, obviously, we have already identified what could be the potential win-win for the potential -- for the partners. But this will highly depend on expectations. And it is very premature to speculate what kind of partners we will land.

Marcus Kuhnert: Okay, I'm going to take the PM question.

So of course, I understand very well, Sachin, from where you are coming from. Let me give you a few, maybe additional facts and my -- yes, how shall I say my assessment on that. So to reiterate on the market share. So at that point of time, we're still above 60% in our market shares which are ever as I've outlined in the presentation is well below the elevated levels of the past as I think, I have alluded to the reasons for that. The prognosis where we will be at year-end is not so easy, simply because of the fact that obviously market share on the one hand and pricing/profitability on the other hand are, let's say, interdependent.

So that means if we would go significantly down with our pricing, we would obviously deburden the pressure on market shares, but on the other hand, of course, then we would see and feel this in our EBITDA and EBITDA margin. So when we want to achieve our guidance which I believe is absolutely realistic, then we need to play with these 2 things. That means it could be that we give in a little bit on price, meaning that would actually be beneficial for market shares, but obviously not so much that we would endanger the 40% EBITDA pre margin. So therefore, it is difficult to say -- to make a concrete forecast on the market share level at the end of the year. What I can say is I'm very convinced we will see an EBITDA pre margin above 40%.

And at the same time, we will not drop off the cliff when it comes to market share. That means, at the moment, we definitely do not believe that we would undercut historical averages which is what I said between 50% and 60%, somewhere in between. What prevents us from going even deeper, that was the second part of your question. And I think, although we're currently operating in a tougher -- somewhat tougher competitive environment, there are still a lot of topics which play to our benefit and to our favor. It is innovation.

I just want to remind you that over now a period of 20 years, all existing liquid crystal technologies in the market have come from us, started with IPS, then VA, PS-VA, UB-FFS and in the second half of this year, we plan to launch SA-VA, so also this will help. We're still, by far, the quality leader in the market. We have unprecedented supply reliability. And last but not least, also a very close relationship to most -- or almost all of our customers. So these are, of course, efforts that we're playing and playing even more aggressively in these more difficult times.

And so that is why we're very confident that we will not drop off the cliff and deliver against our guidance.

Operator: The next question comes from Simon Baker of Exane.

Simon Baker: Three, if I may. Firstly, on Life Sciences. The gross margin in Q1 was very impressive.

So I wonder if you could give us a little more color on the factors that are behind that and also, the Q1 gross margin as a predictor for the rest of the year. Then on to a value -- one for Luciano. On the issue of ADCC, I wonder if you could give us your latest thoughts on its implication or not in the infusion reactions and also the potential it offers you for enhanced efficacy in certain tumor types, something that was alluded to on the Pfizer call. And then finally, on -- going back to the BTK. You said, Belén, that you are very flexible on the types of deals.

I was wondering if that meant carving out different indications for different partners because I can imagine there are lots of people interested in RA or SLE or MS, but perhaps if you are interested in all 3. So if you could give us a little more color on what the degree of flexibility is, that would be very helpful.

Belén López: Okay, Simon, let me start by this one. Yes, this may happen and again, we will take into consideration what the priorities are for the potential partners. Our precedence, if you ask me to give you our target partner is the one that will help us maximize the potential of this molecule.

And we see -- I mean, if you look at the ASCO abstract for oncology, there is clear signals of activity. And we're very confident that because of the selectivity of this molecule, the potential in immune-related diseases is very, very high. So our preference today is to go with a partner that would have the same understanding. But if we have to consider alternatives which are not the one that I'm mentioning, we will take that into consideration. We -- remember, we have quite a long experience in partnering and the more you complexify the whole thing by slicing the molecule in different diseases, the less you may want to get at the end.

So our preference is clear. However, these I think close the door to other potential options.

Marcus Kuhnert: Should I address the ADCC or...

Belén López: Yes, go for it, please.

Marcus Kuhnert: So obviously, Simon, we have been talking about the natural ADCC activity of avelumab for many, many, many meetings now.

It's clear to us that if you look at the safety profile of avelumab now across thousands of patients in capturing 2 different BLA -- independent BLA application to the FDA, really we see no trend whatsoever to have any difference in the safety profile even in detail. Regarding infusion-related reaction, I mentioned already that if we look at the more severe grade, really we're well below 1%, similar to most of the others, there seems to be -- at least the way we capture that is different probably, than some of the other competitors, some of the very mild reaction. We have no evidence that, that has any relationship to ADCC activity to relate to any other factor. Frankly, we don't have any hypothesis for that. I wanted to just mention to you a little bit considering the ASCO abstract on the non-small cell lung cancer, second line and first-line information about the dose intensity.

That obviously, the marked difference we have seen in exposure response curves in non-small cell lung cancer second line, we also mentioned also in the first line in the modeling in the abstract. It led us to add an arm to our non-small cell lung cancer first-line trial that will capture patients that will have about fourfold increase in their [indiscernible] avelumab levels to really have, sort of, a upside whether we can really push the efficacy beyond what we see with the current treatment. And I mentioned that in the abstract for the second line, you have actually some numbers, how this also seems to restore very robust responsiveness related to PD-L1. So I'm not saying the ADCC might be the reason for this potential upside, that we need to still demonstrate with experiment. But we think that if there is an upside compared to other, PD-1, PD-L1 in efficacy, that would be driven most likely from the ADCC activity, but still a hypothesis to be tested, but now in some way we're testing it, at least partially.

Marcus Kuhnert: Okay. Simon, I take the question on Life Science gross margin. So please note that -- so you're absolutely right in your observation, but please note that the first quarter of 2016 was artificially low because it contained a special effect from the purchase price allocation Sigma-Aldrich, namely the effect from an inventory step up which actually was burdening the gross profit by more than €90 million in the first quarter of 2016. And that has left us with an artificially low gross profit margin in Q1 2016. Moreover, 2017 first quarter was good in gross margin because also we were enjoying positive pricing effects.

So this together with the special effect explains the difference to the prior year. If we look forward for the remainder of the year, please note that normally we see quite some fluctuations during or over the quarters. However, I would like to urge you be a little bit cautious, 58% is a pretty elevated level. So it could be that the full year is a little bit below. But you should actually assume gross profit margin in that ballpark, at least.

So it will not be significantly lower.

Operator: We have a next question from Richard Vosser of JP Morgan.

Richard Vosser: A few questions, please. Firstly, perhaps you could give us an update of your ongoing discussions with the European regulators on cladribine where you are timing and what sort of discussions and questions you are having. Second question on R&D spend.

You called out an increase of €150 million to €200 million which sounds aggressive, especially given the lack of spend on biosimilars when the transaction closes. So just if you could give us some color where this additional spend is going. It sounds like TGF-beta is running substantially ahead and perhaps the BTK trial has a relatively limited increase spend. So just some idea there would be good. And then finally, just -- you of course called out the milestones on avelumab.

Perhaps you could give us a flavor of the future size of milestones when other indications are forthcoming. Are they related to the size of the indication or do they get smaller as new indications come? So is the first milestone the largest? Just some color there to help us out because they're going to become over the next quarters, that would be useful.

Belén López: So let me start by the status of the European filing of cladribine. So right now, almost as we speak, we're going to submit the answers to the 130 [indiscernible] questions. So we're today on track with the process and we're expecting a decision, as I mentioned, during the [indiscernible] in Q3 this year, that is for cladribine.

Then on the incremental spending, Richard, I mean, this is going to cover some of the additional high priority programs that we have. BTK is one of the important programs that is now ramping up the Phase II studies for BTK. Depending on what we see with the cohorts of TGF-beta, certainly some of the new studies that we may initiate and some of the newly announced trials, such as avelumab Phase III in [indiscernible] indication. And a little bit on the Vertex portfolio as we fully transition that portfolio into our house.

Luciano Rossetti: If I may add 1 point, please keep in mind that while we have signed the biosimilar deal on the 24th of April, the closing is expected only towards rather end of the year.

So that simply means we would not have a significant cost release, at least not in 2017.

Belén López: Richard, do you have the question on the milestones of avelumab and those are going to be in the ballpark of what we have announced at this time.

Luciano Rossetti: Yes, they are independent from the size of indication.

Belén López: Exactly, not related to that.

Operator: The next question comes from Vincent Meunier of Morgan Stanley.

Vincent Meunier: The first one is a followup on the liquid crystals division. So in the current context and the market share evolution you are talking about, I'm thinking about the midterm. Would you consider investing more in liquid crystals for display in order to maintain your leadership and target the high end of the portfolio or would you at some point reduce investments in the display, reduce the cost base in the display in order to put and allocate more resources on other applications like the windows, for instance. I have as well a question on the DNA damage repair. So you talked about undisputed leadership versus competitors.

Can you tell us more how you want to differentiate the 4 programs you have and how you believe that you can do better than competitors. And the last question is on Rebif. What are your U.S. pricing expectations in the context of the volume decline and also the launch of Ocrevus.

Luciano Rossetti: Vincent, I'm starting with the liquid crystals question and the midterm outlook here.

So if I would answer your question very generally, I would say we're currently in the mode of rather investing than cutting down. Reason is because we're already in a pretty lean mode when it comes to operating and managing our PM business. That means we have actually very lean cost structures in that business sector and we see only a very limited leverage to react on temporary, let's say, a temporary tougher market environment by now cutting cost. So we believe there is not much room actually to maneuver and that this could eventually hamper our midterm growth expectations. When it comes to further investment, I think I've outlined already in my presentation that at the moment, indeed, the major part of incremental R&D investments go in areas which are not directly related to the traditional liquid crystal display applications.

So we're investing a little bit more at the moment in integrated circuits because this business, first of all, is enjoying a very nice industry dynamic and we have seen also an excellent track record here over the last couple of quarters. And secondly, as you pointed out rightly, we're also now continuing to invest in applications which are not display related. So liquid crystal windows is, I think, one very good example. Smart antenna is another one. And we've also some other initiatives running where we believe or we'll hope that with some moderate investments today, we would be actually able to not only support future growth, but also to confirm our role and to defend our role as the innovation leader in the industry.

Belén López: So Vincent, let me address the DNA damage repair question. How are we going to differentiate our portfolio is a fair question, but we're still in a very early phase of development. Many of these compounds are [indiscernible]. And what we were intending to do with this acquisition is actually increase our optionality in oncology, right? So we have significant expertise in the DNA damage repair space in-house and you may have heard that we have published some data on our own DNA-PK and now we have an extensive portfolio comprising 4 programs which is definitely allowing us to be ahead of any other competitor that is actually present in the DNA damage repair. We will further inform you of our studies.

We will start for registrational purposes and progressively enhance the target profile in order to keep this leadership that we have today.

Luciano Rossetti: Maybe I can add a few...

Belén López: Luciano, please.

Luciano Rossetti: I think if you take our portfolio today -- DNA-PK clearly, now we have the sole leadership in that very important mechanism, where as you know, we feel that the preclinical data and the initial clinical data would be [indiscernible] really suggest that these, in particular in combination with radiotherapy and perhaps with immunotherapies could be a really very important asset. Having now the first 2 clinical asset and DNA-PK was really very important to us because Vertex was the only competitor that was really close in the time line in the clinic on DNA-PK.

And the second is ATRi. ATRi I think is a fantastic asset. We're at similar level of development than the only major competitor that is AstraZeneca. And we have an IV compound as well as an oral compound. So I think, ATRi is clearly an asset in which we're putting some of our resources in the clinic to really move it forward.

The third one is the combination ability. So these compounds, in my opinion, could be a very important combination partners, potentially for immunotherapies due to the immunogenic cell death, another component of mutational activity that might be generated by [indiscernible] mechanisms. And the second is combination among the various DNA repair mechanisms. And so we think that with our own pipeline in DNA repair now, some partnership with a PARP inhibitor that we're working on, as well as the immuno-oncology pipeline, we're in a great place to really leverage this acquisition and this -- for DNA damage and repair.

Belén López: I understand there is a question on Rebif.

Can you please repeat that Rebif question?

Vincent Meunier: Yes, of course. The question is, what are your U.S. pricing expectations in the context of volume decline and also, the launch of Ocrevus in the U.S.?

Belén López: So far we have not factored additional price increases in the U.S. in our outlook. And as we have mentioned before, we're going to be following the market in terms of price decisions and price strategy.

So far, what we understand from the early launch of Ocrevus is absolutely aligned with our expectations. So it seems from the market research and the customer insights that we have available that many of the eligible PPMS patients appear to be the patients going on Ocrevus. And from the still relatively limited information that we have, it appears that Ocrevus is currently targeted for later lines and as an alternative to Tysabri in RMS. All in all, it's premature to conclude and we're, as you can imagine, following this as a very important competitor for us in the U.S., but so far so good for Rebif, aligned with our expectations. In terms of pricing, [indiscernible] appreciate that one kind of simplify the pricing comparison in the U.S.

and focus only on the one. This is very misleading. And the early communication on this was very misleading. And obviously to be very transparent, we don't believe at this time that this is going to be a competitive advantage for us because when you look at the way Rebif competes in the channel in which we go through, our price is that -- our net price is very favorably comparing with the one of Ocrevus.

Operator: Peter Spengler of DZ Bank.

Peter Spengler: I have three remaining questions. One is on your ad hoc announcement you disclosed on Tuesday that you are planning to switch to a management holding. So is the holding structure paying tribute to the higher complexity of the management process with Life Sciences and Healthcare and Performance Materials are other advantages. And where are the future headquarters of the segments. And I have a follow-up on biosimilars.

Can you give us some more details on the transaction? Is it part of the other segment than in the end of the year? Can we expect a profit of €170 million or is it lower? Is it a special item and what are the annual development cost savings from 2018 on -- what's your best guess? And then finally, on -- follow up on liquid crystals market situation or competitive situation. In the past, you mentioned [indiscernible] Nippon Inc. as your main competitors and now there are new Chinese players, so is it more like 2 or 5 new players, can you tell us the names? And are there more, let's say, have they higher market shares than the other 2 in Japan. So just to get an idea what's going on there in the market?

Luciano Rossetti: Okay. Peter, I'll start with your first question, the ad hoc message.

Let me please reiterate, we're not entering into a management holding structure or type of [indiscernible] or whatever. So we're just building 3 operational legal entities below the Merck KGaA in order actually to react on the historical grown structures here at the headquarters in Darmstadt which actually from our current point of view do not support any longer the different business models, the globe steering models of our 3 businesses and what also in light of the implementation of our divisionalized ERP strategies, create risks and complexity when implement -- or when, let's say, implementing divisionalized ERP strategies, but having only 1 legal entity, it's KGaA, so this is actually not what we believe is a future setup we should go with when going ahead. Your second question, followup on the biosims deal. So we would have in the time or in the point of time of closing, we would have the upfront payment realized as cash flow and also excluded from EBITDA pre. And we would, let's say, at a later point of time, then publish the details of the agreement.

So when we're coming closer to the closing, we will give you a more comprehensive update on the accounting treatment of the biosimilars, because I can tell you it is quite complex and maybe not the right time today to go into the details. The third question, liquid crystals market situation. I think I've referred to that in a pretty detailed way in addressing prior questions, maybe just 1 word to the competitive situation. We have 2 to 3 Chinese competitors which have actually emerged and who have been growing over the last 2 to 3 years. They are growing market shares at the moment, but only with Chinese customers of us.

So there's not -- they're not playing a big role outside of China, but in China they are growing market shares and -- they're gaining market shares and they're gaining from us and from the Japanese as well. So this is just by and large the picture.

Operator: The next question comes from Marcus Wieprecht of MainFirst Bank.

Marcus Wieprecht: I've actually 1 question which is related to the Life Science division. Have you changed your longer term growth expectations for that market? You talk now about 4% average growth rates going forward.

And I recall earlier presentations like 2 years ago, you implied somewhat higher longer term growth rate, in particular, for the Process Solutions. You talked about high -- mid- to high single digit, same for Applied Solutions and just for Research Solutions you were talking about low to mid-single digit growth. So if I consolidate those weighted growth assumptions, I come up with something north of 5% actually. Has there been any changes during the last 2 years?

Luciano Rossetti: No, actually, not really. So the message as follows very briefly.

So we have 3 customer segments in the market which are mirrored more or less by our 3 business segments within Life Science. We believe and also believe on the past that the Process Solution segment will grow somewhat in the high single digit, let's say 8%, applied is growing in the mid-single digits, so 4% to 5%, Research is growing rather in the low single digits, so let's say 1% to 2%. If you do the math and all of the 3 are roughly of equal size, when you come indeed to a growth rate between 4% and 5% for the total market and we say we want to grow slightly above that. And this is actually reflected and mirrored in our guidance for 2017. So actually, we have not really see change in the midterm growth assumptions for our markets.

Marcus Wieprecht: Okay. So your market growth assumption would be rather 4% to 5% [indiscernible]?

Luciano Rossetti: Yes. We said 4% because as I said, precedes a little bit slow environment at the moment in the U.S. Coming of -- as I said, they're a little bit reluctant at the moment in terms of investment due to maybe the overall political situation, but nothing we worry about and nothing would really change the midterm growth expectation for the total market.

Constantin Fest: And with this, we conclude this call and I'm happy to hand over to Marcus for the final words.

Marcus Kuhnert: Yes. Thank you very much Constantin and also, thanks to all of you for dialing in for your interest in Merck and your questions, of course. We look very much forward to meet you at our upcoming roadshows and of course, also for the upcoming event in due course, the R&D call and later in the year the Capital Markets Day. Thank you very much and goodbye.

Operator: Dear ladies and gentlemen, thank you for your attendance.

This call has been concluded. You may disconnect.