Executives: Constantin Fest - Head of Investor Relations Stefan Oschmann - Chairman and Chief Executive Officer Marcus Kuhnert - Chief Financial

Officer
Analysts: Peter Verdult - Citigroup Jo Walton - Credit Suisse Simon Baker - Exane BNP Paribas Sachin Jain - Bank of America Merrill Lynch Wimal Kapadia - Bernstein Research Gunnar Romer - Deutsche Bank Vincent Meunier - Morgan

Stanley
Operator: Good day and welcome to the Merck Q4 2017 earnings release call. At this time, I would like to hand the call over to Constantin Fest, Head of Investor Relations. Please go ahead, sir.

Constantin Fest: Many thanks, Holly. Warm welcome from my side here in Darmstadt to this full year 2017 Merck conference call.

My name is Constantin Fest, Head of Investor Relations at Merck. And I'm delighted to have with me here Stefan Oschmann, our group CEO, as well as Marcus Kuhnert, our CFO. In the next half hour or so, we'd like to run you through the key slides of this presentation and then we'd be happy to take all of your questions as always. Yeah. Please keep in mind that we have roughly about one hour for this call.

Some of us will have to catch a plane for the afternoon roadshows. And with this and without any further delay, I'd like to directly hand over to Stefan to kick off this presentation. Stefan?

Stefan Oschmann: Thank you very much, Constantin, and welcome, everyone, to our full year earnings call. As you know, 2017 turned out to be a quite challenging year for us with headwinds in Performance Materials, headwinds from currency and a highly dynamic R&D pipeline, which kept us pretty busy. So, in the second half of the year, we worked very hard to reach our guidance, which was our promise to you.

And I'm proud today to be able to say we achieved it and we managed the headwinds. Healthcare – and I'm on slide five, healthcare had a good year operationally. The base business was very solid and our pipeline led to the first approvals and subsequent launches of Bavencio and Mavenclad. In Life Science, we finished the year with a visible pickup in momentum and in 2017 as a whole. And the business diligently executed the integration of Sigma-Aldrich.

And I can confirm that we reached the €185 million target in 2017. In Performance Materials, the fourth quarter turned out okay given the circumstances. In terms of the adjustment process in Liquid Crystals, we can reassure you that at least so far the situation has not worsened compared to what we had anticipated. However, it is also clear that the development will continue in the coming quarter. In August 2017, we had given you a range for the expected decline in our Liquid Crystal sales for 2017 and 2018 of €200 million to €300 million.

This range is valid. But we will most likely be at the higher end of this. We anticipate that the expected volume growth will not be able to offset price declines we're facing. For the group overall, we expect a moderate increase in net sales in full year 2018 and a slight organic decline in EBITDA pre compared to last year, with a minus 4% to 6% headwind from currencies. But we will discuss guidance in more detail later in the presentation.

On slide six, we give you a brief look at our headline financials. Net sales, EBITDA pre and EPS pre came in within our guidance ranges, albeit at the lower end. On the next slide, we give you a couple of examples that helped us to achieve this. as I just said, the organization worked very hard to deliver on our promises. And, in fact, our efforts to manage the well-known headwinds gained traction over the months.

Example include a tight management of our groupwide travel expenses or very conscious new headcount decisions. On top of this, businesses went the extra mile to deliver on their business plans. Chart eight now. The regional distribution of our €15 billion net sale is pretty much unchanged compared to the prior-year. North America accounts for 25% of our sales and Europe and Asia-Pacific account for roughly one-third each.

And Asia-Pacific remains our largest region. Slide nine. To the AGM on April 27, we will propose a dividend of €1.25 per share. This is an increase of 4% year-over-year and it translates into a payout ratio of around 20% of EPS pre. The increase is evidence of our policy to ensure a sustainable and resilient dividend to shareholders.

That being said, in the future, our dividends will continue to develop in line with our sustainable earnings and our strong commitment to deleverage as quickly as possible remains unchanged too. On slide 11, before Marcus will guide through the financials, let's take a minute to share our thoughts on Merck's strategic positioning. The Merck group as it is today has a strong basis for future profitable growth. We hold leading positions in all business activities. We have a unique portfolio with high future growth and innovation potential.

And our financial situation is solid as a rock. We aim to deliver profitable growth which should translate into attractive shareholder return. The next couple of slides provide you with a short overview of what we have achieved so far. Slide 12. Healthcare today presents itself with the best product pipeline ever.

The launches of Mavenclad and Bavencio in 2017 were already first evidence of this. And as you will see in the months to come, there's going to be a lot more to come in 2018 which will underpin the confidence in our R&D pipeline. Our announcement yesterday that we reached a primary endpoint in our Phase IIb BTK trial in multiple cirrhosis is a good example. And one additional word on Consumer Health. The business has seen a very good performance in 2017 and achieved compound organic net sales growth between 2013 and 2017 of more than 6%.

As you know, we're analyzing strategic options for the business. As soon as we have more details to reported, we will inform you. And I can reassure you, however, that our process is well underway. Moving to slide 13. Life Science is our proven success story.

And 2017 was another year with impressive financial performance. Our Life Science business has a well-established track record as an innovation powerhouse and is a highly profitable business with sustainable above-average growth. For 2018, we expect similarly positive organic sales growth, slightly above market rate of 4%. And important for you, we see currently no more signs of any weakness at our key accounts. Moving to chart 14, and now to Performance Materials, we're all aware that the Liquid Crystal business has been facing difficulties and I referred to this in my opening remarks.

We know it is time to act and we have implemented organizational changes. We have introduced new management and the new organization is now focusing on turning around the business as soon as possible and we will communicate the outcome to you by mid-2018. And with this, I hand over to Marcus to lead you through the key financials.

Marcus Kuhnert: Thank you, Stefan. And I am now on slide number 16.

We have certainly analyzed our full year financials already in great detail this morning, so I will only highlight a couple of additional points here. We've talked a lot about the currency headwinds in the last few months. And in total, they reduced our net sales by €228 million compared to 2016 and by even €337 million in the second half alone. Because of Merck's special regional setup, you can assume that, typically, some 35% to 45% of this falls through to EBITDA pre, depending on which and by how much certain currencies actually fluctuate. The earnings per share pre of €6.16 may have come in at the low end of expectations for some of you.

We had a slightly more negative financial result in Q4 due to higher interest rates applicable to our long-term provisions and a €30 million impairment related to the Vertex agreement that is recorded in our regular D&A line. However, with 2017 EBITDA pre only slightly below the prior year, the solid operating cash flow and a further reduction on net financial debt, you would most probably agree with me that headwinds in Liquid Crystal and currencies were pretty well managed. Slide number 17, in 2017, our net sales grew organically by almost 4%, driven by Healthcare and Life Science. When you look at the first quarter only, the organic sales growth in Healthcare as well as in Life Science was very sound. We will come to that in a minute.

Whilst Performance Materials sales declined by 1.7% organically, which is in line with the trend we've seen in the previous quarters, EBITDA pre in 2017 declined slightly by 1.7% year-on-year, mainly driven by the higher investments in Healthcare, by the ongoing correction in our Liquid Crystals business and the adverse FX environment which could not be offset by a better result in Life Science and in our Corporate & Other segment. I go over to slide number 18. While our EBITDA pre for the full year is approximately €70 million lower, EBIT is slightly better compared to last year's level. This difference of about €110 million is very much driven by considerably lower depreciation and amortization charges, partially offset by higher exceptional items. The swing in our D&A charges is primarily related to the write-ups of our Vevey plant and our Mavenclad effort, which we discussed in Q2 and Q3 already.

In a year-over-year comparison, the gain from the disposal of our biosimilars activities of €321 million is largely neutral because we also had a €330 million disposal gain from Kuvan in 2016. It's not much to say under financial result, apart from my earlier comments about Q4 and the reasons why Q4 financial results have been lagged behind expectations, driven by increasing interests, especially in the US. As many of you had expected, our income tax line is actually a profit, both for the fourth quarter as well as for the full year. As a result of the US tax reform, we revalued our deferred tax liabilities by €906 million, which led to a corresponding profit in our P&L. Adjusted for this effect, our tax rate would've been 23.4% and in line with our guidance range of between 23% and 25%.

Given our set up in the US, our past acquisitions, and some specific provisions under the new tax regime, our average tax rate from 2018 onwards with, in fact, be slightly higher at a level between 24% and 26%. On slide 19, Healthcare had operationally another good quarter in Q4 2017. The base business was on track and delivered organic net sales growth of 5.9% or plus €104 million. Similar to the previous quarters, around 40% of this growth is attributable to the change in our Glucophage business model in China. As a side note, for 2018, the effect will now be fully included in the base.

Further, our Consumer Health business contributed another 25% to Healthcare's overall organic growth in Q4. And as Stefan just outlined, we are very happy with the development of this business, especially in the second half of 2017. Even without these two drivers, Healthcare grew by more than 2% and thus posted its 26th consecutive quarter of organic sales growth. Our newly launched products, Bavencio and Mavenclad, performed nicely in their first few months after respective launches and delivered according to expectations. Bavencio contributed €21 million in sales in 2017 and we expect it to generate a mid-double-digit million euro sales amount in 2018.

Mavenclad generated €5 million net sales in 2017 and we have seen a very good ramp up in the last couple of weeks both in the number of patients on drug as well as on the number of patients waiting to start their treatment. So, we see it well on track to reach double-digit million euro sales in 2018. When you look at our large established products, Rebif and Erbitux, we've seen actually no material changes in the trends compared to previous quarters. GONAL-f's growth trajectory has improved. On slide number 20, we turn to Life Science, which had a very solid quarter when you look at margins as well as sales growth momentum.

Research and Applied Solutions achieved yet again good organic growth in the mid-single digits in Q4, driven by good demand across the board. Process Solutions saw a visible acceleration of organic growth to 14.4% in Q4. We observed especially strongly demand for single-use systems and services and we are encouraged by the take-up of growth momentum over the year. You will remember that the start in 2017 was a little bit moderate, but we have been able to increase the topline growth momentum significantly over the last quarters. I would like to reiterate Stefan's earlier comment.

We currently see no more signs of key account weaknesses. Profitability-wise, our EBITDA pre margin again exceeded the 30% level in the fourth quarter, even if the recent FX developments do not leave Life Science unaffected. We reached in full our €185 million synergy target in 2017 and confirmed the achievement of the full €280 million for 2018. On slide 21, in Performance Materials, net sales declined organically in the fourth quarter by minus 1.2% and EBITDA pre is 18% below last year's level. On the other hand, integrated circuit materials, pigments and advanced technologies – our three pillars alongside display – were again the sales growth drivers in Q4 and mitigated the decline in display materials.

In Liquid Crystals, the market share declines have continued as we had expected. Like in the previous quarters, the ongoing sales decline in the Liquid Crystals business and the unfavorable FX environment impact Performance Materials' EBITDA pre and EBITDA pre margin. For 2018, we envisage no change in trend in net sales and EBITDA pre. The balance sheet on slide 22 does not show many spectacular effects, so to say. Our equity ratio stands at 39%, improved once more versus September 2017 and also compared to the end of 2016, albeit it has not increased in absolute terms.

Net earnings were basically eaten up by the dividend payments and by FX effects. On the liability side, the net financial debt decreased to a level of €10.1 billion until end of December and our net debt to EBITDA ratio now stands at a factor of 2.3. On slide number 23, we have shown the cash flow statement for the fourth quarter. our operating cash flow in Q4 was solid with €642 million and we continue to deleverage the balance sheet as we had promised. You will notice some of the very high fluctuations compared to Q4 2016.

Here, again, you see very prominently the impact of the US tax reform. On the one hand, it raises pretax profit significantly, while – our after-tax profit significantly, while on the other hand this effect is offset in others assets and liabilities as we reduced our deferred tax liability. None of these effects is cash relevant. And now, I hand back to Stefan for the guidance.

Stefan Oschmann: Thank you, Marcus.

I'm on page 25. For 2018, we expect moderate organic net sales growth, mitigated by a moderately negative currency effect, which we believe will be particularly visible in the first half of the year. This should not be entirely new. When you look at our second half in 2017, you will see that we lost already 4.5% of sales year-over-year due to exchange. Given the expected magnitude of this effect and because of our focused regional setup, a considerable share of the expected sales reduction will typically feed through to EBITDA pre and we decided to provide you with more clarity around the topic.

So, for full year 2018, we forecast a slight percentage decline in EBITDA pre on a currency-adjusted basis compared to 2017. The drivers for this are well-known and discussed at length in the previous months. In addition to this, currencies will most likely reduce EBITDA pre versus 2017 to the tune of minus 4% to minus 6%. And let me in that context give you a couple of additional details. First, we see the average euro to US dollar rate for 2018 at €1.18 to €1.22.

Secondly, the exchange headwinds do burden of businesses' EBITDA pre, albeit the magnitude differs between them. Thirdly, exchange hedging gains are expected to help, but our hedge rates are fairly close to spot rates and to the above range, so the magnitude will be rather small. Hence, Corporate & Other costs should be at minus €320 million to minus €360 million. And fourthly, our guidance is based on a constant portfolio assumption, i.e. it includes consumer health.

Before we come to the Q&A session, let me add a couple of additional thoughts on the next slides. We understand that there are considerable uncertainties in the market and this is important feedback for us. And under these specific circumstances, we, therefore, decided to provide transparency at this point and give you first indications for 2019. Let me reiterate first indications. Please don't expect more granularity when it comes to the information we provide on 2019 at this stage.

For the Merck group, in 2019, we are highly confident to deliver growth in net sales, in absolute EBITDA pre and in our EBITDA pre margin. The expected profitable growth in Healthcare and in Life Science will more than compensate the trough year we expect to see in Performance Materials' profitability in 2019. So, on page 27, we're summarizing. Merck has a unique and promising portfolio with leading market positions and high innovation potential. Merck is highly profitable and invests strongly in its future.

And Merck will show sustainable profitable growth from 2019 onwards. Merck is financially rock solid and, therefore, able to finance its future organic growth and we will continue to deliver on our promises. And now, on to your questions.

Operator: Thank you. [Operator Instructions] Our first question on the telephone today comes from Peter Verdult of Citi.

Please go ahead. Your line is open.

Peter Verdult: Good morning. Peter Verdult. Three questions please.

Stefan, on evobrutinib, how should we interpret the press release you issued yesterday. Obviously, [indiscernible] trial versus placebo, but no mention of how the relapse or the lesion reduction fared versus the Tecfidera arm of the trial? So, are you willing to discuss the data a little more this afternoon or at least tell us how quickly or not you want to push evobrutinib into Phase III with – in MS. Secondly, on Bavencio, numerous interactions with KOLs over the last couple of weeks continues to raise the dosing concerns across the JAVELIN clinical program. Could you speak to that? And is that why the dose intensification arm was added to the first-line lung trial last year? And then, lastly, ending on a positive, on Life Sciences, very impressive organic growth coming out of Q4. Given the momentum that you are seeing and comments about actions at your major clients, could you just discuss a little more about the top line growth aspirations at Millipore and Sigma-Aldrich versus market expectations of 4% to 5%? Thank you.

Stefan Oschmann: Thank you, Peter. So, first, on evobrutinib, obviously, this is a positive news for us. We have communicated because we had said in the past that we would be interested in partnering this asset, which we have in Phase II in three indications, one of them being MS and that we would first one to maximize the potential of the asset by having proof of concept and before that the fact that we believe now that we have proof of concept in this important indication is worthwhile communicating separately. We intend to present these results at a global scientific congress this fall. We cannot comment on any insights into the data yet with more granularity.

This was a Phase IIb study which showed clinically meaningful reduction in lesions compared to placebo, i.e. we cannot speak to differentiation versus other assets yet. And then, the full 48-week data will then guide our next steps. The Tecfidera is a control – in an open label setting, therefore, the study design does not allow us to make any judgment at this stage in this respect. That, to evobrutinib.

Marcus will respond to your question on Life Science top line assumptions.

Marcus Kuhnert: Yeah, Peter. Your question on Life Science, so, first of all, let recap what I had just briefly outlined during the presentation. So, we have seen a moderate start in 2017. Afterwards, a strong pickup in momentum over the quarters of the year, with a very nice growth in process solutions of 14% in Q4.

That leads us actually to the conclusion – to the optimistic conclusion as well – that the key account weaknesses that we had pointed to during the year 2017, we believe, is over now. We continue to believe and to assume that our business is so strong that we should be enabled to grow above the market over the next year or for this year. We think that the market growth potential will be around 4%. And so, you should be prepared to see an organic sales growth rate which is above 4% for 2018. I do not want to comment on the very bullish comments that some of our competitors have been doing.

What I can say, however, is that also you see that our order books look pretty nicely, so that there is, let's say, no doubt that we are, at the moment, in a quite friendly market environment. And I would like to give now back to –

Stefan Oschmann: Your other question, Peter, on the range. So, we do not share dosing concerns. When we look at the results of the third line lung trial – sorry, the second line lung trial, the issues are related to the crossover topic. I think you had ample opportunity to discuss that with our head of R&D, with Luciano.

The other question was the PD-L1 expression. You know that the test that different competitors are using use different labels. We've seen pretty encouraging result actually in this trial. In the high expressers yet, in a mechanistic sense, the primary endpoint was not met. When we test the high-dose, in the first line, as one of the arms in the first line trial, this is testing for the hypothesis that a higher exposure could result in enhanced efficacy versus what we know.

Marcus Kuhnert: Peter, I have just seen that I have not answered a part of your question, which was your question around the split between legacy Millipore and Sigma. You know that we do not give, I would say, detailed split data anymore. However, I can provide, for sure, a little bit color. So, Sigma, as you know, consists mainly of the research piece. Here we have seen actually a good Q4, a very satisfactory Q4, while the start of the year 2017 was a bit slower.

And here, we have seen the recovery, especially in North America. The BioReliance services for Process Solutions piece is going double-digit, but it is a relatively small piece of the former Sigma business. On the Millipore side, we have the applied section, so to say, which is growing nicely. We have had a good year in applied all over. And also, again, the Process Solutions part of Millipore is as dynamic as the whole division.

Peter Verdult: Thank you.

Operator: Thank you. Our next question today comes from Jo Walton of Credit Suisse. Please go ahead. Your line is open.

Jo Walton: Thank you. A few please. I wonder if you could also talk a little bit more in more detail about Mavenclad. It doesn't seem to have had a significant sales in 4Q after some sales in 3Q and now you're expecting strong growth as we go into 2018. I wonder if you could perhaps discuss with us where you are getting traction, the rollout that you're expecting through Europe and also update us on your discussions with the FDA now that we know that you are going to file in the second quarter of this year.

Looking at the Performance Materials business, I wonder if you could help us a little bit more on the decline of the Liquid Crystals sales. Is there a general price decline such that the market is shrinking perhaps at the high end of your expectations or is the market perhaps okay and you're actually losing more market share within a stronger market? And if you could also just help us, as we move into 2019, you're, obviously, expecting profitability to fall again in 2019. Do I assume that your expectation is that sales will also fall in 2019 or could we start to see that be an acceleration in sales, but just at a lower level of ongoing profitability? And my final question would be, to get a sense not just of this year's capital expenditure, but next year's because your CapEx is now running quite a bit higher than your depreciation rate. Thank you.

Stefan Oschmann: Thank you very much.

So, starting on Mavenclad, you know that we achieved approval in the EU in a couple of other legislations. The market introduction depends on local pricing and reimbursement discussions. Most typically, the first countries where such a product would hit the market is in the US, Germany and in the UK. And we will continue to launch in major European countries going forward. Scandinavia, Spain and others.

So, when I comment on Mavenclad, it's mostly about data from Germany, which was the earliest launch in Germany. We're tracking the launch performance of a leading competitor in the high disease activity segment that has led to sales of €5 million. What you must bear in mind is that this product has a very special treatment regime. That means that patients take the product for – during the course of two months and then that is sufficient for a very long period. So, when you have first – when you have patients that have been sort of warehoused by physicians in anticipation of the launch, you would see a fast pickup and then a more steady growth over time.

We are targeting high double-digit sales in 2018 and we've also recently received a positive recommendation by NICE. So, we are very confident on Mavenclad. When it comes to the US, you've heard us say that we're planning to submit in the US, which implies that we are in negotiations with the agency. Filing in the US doesn't mean that we simply take our European package and send it to the FDA. It requires significant work on specific formatting of the data.

We will typically communicate once the agency has accepted the file. We wouldn't file if we didn't we had a serious chance for getting the final acceptance. So, when it comes to the Performance Materials business, this is a business where panel makers and display makers and so on have their own dynamics. I think you are familiar with that. Please do understand that, for competitive reasons, we don't disclose price and volume details.

But, as you know, there are always price negotiations. We must very carefully assess on a case by case basis or we must take the decision very carefully how much we discount and how much we're willing to give on the respective LC mixture. Some of our competitors compete on price, but given that our value position is not just on the quality and supply chain security, but also accounts for the superior customer support that we provide and the ability to supply our customer with the latest innovation, we can still justify a price premium, and that's an assumption that we carry forward. You can also assume, however, that more competition doesn't help the overall price there is either, but please don't forget that there has always been price reductions and please also don't forget that exchange also plays a significant role in that area. For 2018, we have given you guidance last year that it will be very challenging to keep the 40%.

And if you look at our guidance, you will see that, in 2018, again, we expect a significantly a higher reduction EBITDA than in sales, which will lead to a lower margin than in 2016. Sorry, not in 2016. 2017\, obviously. And in the interest of transparency, we gave you some feeling for 2019 where we say that this will be the trough year for profitability and that, right now, the name of the game is to focus on strategic execution and turnaround of that business.

Marcus Kuhnert: I will take on the CapEx question.

We have seen, especially since the Sigma acquisition, a quiet significant uptake of our CapEx spend. On the one hand, of course, acquisition related. On the other hand, also due to the fact that we had to catch up in some areas at the Sigma space and also due of following the favorable volume situation that the overall group is in. So, that means we have seen an uptake of capacity investments, especially over the last 2 to 3 years. This development, however, has come – a little bit of the increase has come a little bit to a halt, which means that we expect the 2018 CapEx levels basically in line or in the same range as in 2017.

For 2019 and 2020, we would see, let's say, if any, only moderate further increases in CapEx. So, the big jump is behind us and that was from 2015 to 2016.

Jo Walton: Thank you.

Operator: Thank you. Our next questions come from Simon Baker of Exane.

Please go ahead. Your line is open.

Simon Baker: Thank you for taking my questions. First, a couple on the 2018 outlook and guidance. If I particularly at Healthcare, on the commentary around the expected revenue growth, the expected EBITDA pre evolution and your commentary on cost lines, it's difficult to square one with the other.

So, I'm just wondering if there's anything else we should be thinking about in terms of cost lines and items beyond SG&A and specifically marketing and selling and R&D within that. And as a broader point on the 2018 outlook, you're now helpfully providing us with organic constant currency EBITDA pre growth rates. But we've not seen those historically. So, I wonder if you could tell us what the respective rates on that basis were for 2017. Also, related to guidance on tax, Marcus, I wonder if you could just give us a little bit more explanation as to why the tax rate is going up rather than down in light of US tax reform.

And then, finally, on multiple sclerosis, I wonder if you could give your thoughts on where you see the volume of Rebif and indeed the interferon market as a whole settling out. I think most of us assume – the market assumes that decline is almost inexorable. But, presumably, at some point, notwithstanding some price reductions, we'll start to see volume flatten out for Rebif and interferons. I wonder if you could give us your thoughts on whether you believe that and secondly where you think we are relative to that plateau. Thank you.

Stefan Oschmann: So, thank you for your questions. I will start with addressing the Healthcare financials – financial question. The Healthcare financials are driven by the need to invest in marketing and selling for the launches, including a ramp up of the commercial organization in the US for MS. And there are no other factors. If you have specific questions, I would suggest that they be clarified with Constantin and investor relations in more detail.

I will hand over to Marcus when it comes exchange rates 2017.

Marcus Kuhnert: Yeah. Simon, so, actually, we're not prepared to give organic EBITDA growth rates for the past. We have decided deliberately to start more transparency on the split of the organic and also FX-driven development of EBITDA pre going forward in order to increase our transparency in that range. But we would not actually provide a comparable basis of a couple of years back.

On the tax rate question, I think it's a very valid one. It's a bit – a technical effect. So, we would expect actually, from the US tax reform, the positive effect on cash flows because all of our cash flows and gains generated in the US would be taxed at a lower rate, which is I think quite straightforward. We believe that we are not significantly affected by the interest capping rule on the one hand and also not by the new BEIT [ph] regime. So, this would basically have no material impact on us.

What drives or what will drive our tax rate in the future, in the midterm future, a little bit up, is the technical revaluation effect that I have mentioned to you. So, think about what happens. When we acquire, let's say, for example, Sigma-Aldrich, we identify intangible assets that we have acquired. We value them and then recapitalize them in the balance sheet and build a respective position of the deferred tax liability, which is basically reflecting a temporary deference. So, in the future, it's a time when we are amortizing the intangible assets.

We are releasing correspondingly the deferred tax liability. So, that means that as an expense in the P&L via the amortization, but we also have a gain in our tax result from the release of the DTL. What we have done basically now first with the US tax reform is that we have brought forward this P&L relief on the tax rate, this future P&L relief all in this one time revaluation gain that you see. And simply, the negative data for the lower DTL releases in the future, they overcompensate from our current viewpoint the future benefits from lower cash taxes in the US. And this, ultimately, leads to the slight increase in the tax rate.

So, I hand back to Stefan for the interferon question.

Stefan Oschmann: Yes, Marcus. And, Simon, if we look at the multiple sclerosis market globally, and the interferon market more specifically, the dynamics are, obviously, an amalgamate of different regional trends. If you went back a couple of years, many observers would have expected that the interferon market collapse or implode once the orals have been introduced. We have disputed that.

And we have always said that interferons and Rebif will stay an integral part of the of the armamentarium of the physicians. And I think we were right in this. We've seen the different factors influencing results are that, in the US, we've had price increases plus a certain degree of market share loss for the interferons. But we were defending our market share within the interferons quite well. We've seen in markets like in Europe, we've seen some price increases given the austerity measures and equally slights market share decrease and we've seen volume growth in some emerging markets.

What is new was, let's say, the impact of Ocrevus as well as generic Copaxone. We haven't seen any major effects of that on our market share and we don't expect major trend shifts going forward.

Simon Baker: Right. Thank you very much.

Operator: Thank you.

Our next question is coming from Sachin Jain of Bank of America. Please go ahead. Your line is open.

Simon Baker: Hi. Thanks for taking my questions.

A few please. Firstly, on Performance Materials, just to try and clarify the commentary around 2019, do you expect continued declined in the top line beyond the €200 million to €300 million that you had previously guided for by the end of 2018? If that's so, is that a change and do you still believe in the prior communication of 50% share sort of trough or has that changed? Secondly, on consumer. Thanks for the update, Stefan. But just wonder if you could clarify when we should expect a final decision here and just any color on what's taking so long post receipt of bids in December? And then, two pipeline questions. On the BTK, just to clarify why you need longer follow-up designed to study that, waiting for great evidence of efficacy to emerge? And then, on the TGF-beta, on the Bavencio call that Luciano recently hosted, I think he alluded to starting first-line lung studies there and that they could be complementary to Bavencio.

Are you able to provide more color on that? Thank you.

Stefan Oschmann: So, in your question on PM going forward, as I said, we're not in a position to give a lot more granularity in addition to what we said. Let me reiterate. We sent the positive message that we expect what we said for the group, i.e. sales growth, more EBITDA pre and the margin increase.

And that's what we want to say. We expect – within PM, we expect further growth of our semiconductor and our pigments business. Our display activities will, on the one hand, benefit from the rising demand for larger displays and we don't see any major change. We expect a certain stabilization of the known dynamics that we see now. We continue to be the innovation leader in this field.

There are no liquid crystal modes out there that have not been developed by us. As I said before, we expect a decline in our Liquid Crystal sales in this range that we had communicated of €200 million to €300 million. And it will clearly be now at the higher end of this range. We have rebuilt the – reshuffling the business. As of April, there will be three units.

It will be a display unit, which is the combined – and the combined liquid crystals and OLED business. There will be a integrated circuits solutions unit, which consists largely of the business we acquired through AZ Electronic Materials. And there will be the surface solutions business where the majority will be the business that we had in pigments before. I would like to ask you for a bit more patience when it comes to details. As you know, we will provide you with more quantitative guidance in early May.

The CH process. The CH process is progressing well. The kind of process is in line with industry practice. The business has seen – what we should note is the business has seen very good performance in 2017. We have very strong – we have very strong organic growth for the year and we see a particularly strong fourth quarter.

So, I think that's a good sign for the process. We have approached – potential candidates have been approached in November and they've received the book, the package. We had requested nonbinding offers in the course of December of 2017 and now it's standard practice that these offers are being. There's a lot of diligence happening. There are thousands of questions in any such process that are being asked and are being answered.

It keeps the organization extremely busy. The executive board is analyzing this. And once we see what the situation is, we will take a decision on to which option we will follow, but we are happy with the process and we see no delays. We had discussed the possibility of Pfizer also maybe selling their asset when we put our strategy together. We believe that our asset is very, very different from the Pfizer asset.

That was about the CH progress. So, on BTK, evobrutinib, this is very early. We must just say this. We thought it would be in your best interest to share this information with you as soon as possible. It also indicates that the availability of this data now trigger more activity in the partnering field where we entertained discussions, but we've been waiting to see this data.

You should expect us to take the next steps in this area. Your other question was about TGF-beta trap. And we have no more color to add today before what Luciano said. The decision will be taken after ASCO and when the second line, the PDX naïve cohort will be presented.

Simon Baker: Thank you.

Operator: Thank you. Our next questions now come from Wimal Kapadia of Bernstein. Please go ahead. Your line is open.

Wimal Kapadia: Hi.

Thanks very for taking my questions. Wimal Kapadia from Bernstein. So, just thinking about your 2018 guidance for PM, it seems to suggest that EBITDA margins for the division are moving towards 34%. So, if I assume that the other subdivisions within PM remain flat margin, does that imply that EBITDA margins for display in particular actually declined by double-digit? So, on my math, it seems like EBITDA margins declined by about 10% for display. Is that a fair assumption? And then, following on from that, if that isn't a fair assumption, is it possible that the other subdivisions within the PM are actually growing in margin terms such that the display EBITDA margin is declining more than 10% in 2018? My second question is on display again.

In 2Q 2017, you've highlighted a slide which suggested that display would be a growth business post the near-term decline. And if we used a very high-tech method of a ruler, it suggests that PM in totality could have revenues of €2.83 billion in 2022 based on the slide you've highlighted in 2Q. Do you stand by that exhibit that you presented in 2Q? And then, finally, I have one question on tepotinib, the METex14 mutation study for me is relatively interesting. Can you just give us a little bit of update on how the recruitment of the study has progressed? Is it possible for us to see an interim this year? And if we do see an interim that is positive, will that be enough for filing? Thanks very much.

Marcus Kuhnert: Wimal, I'm not sure that I fully captured your question.

So, I start to answer to the best of my knowledge. Eventually, we have to go on a second round term. So, first of all, on the guidance. if we make the math, and we show a slight to moderate organic decline in net sales in Performance Materials and we mirror against these projections on the EBITDA pre. Your calculation of the mid 30s percentage margin for PM is appropriate, I think.

We do not believe or we do not think that we would face any margin declines in our other businesses except for PM – sorry, except for Display Materials. So, that means that we are convinced that pigments, integrated circuits – especially pigments and integrated circuits will continue their very good growth trends. There's no reason for us to believe that we would face any kind of margin declines in 2018 over 2017. And then, you can make the math what it means for the margins of Liquid Crystals when having in mind, let's say, roughly 50-50 percent portfolio split between Display Materials on the one hand and the rest of the businesses on the other hand. So, sorry, I did not get your question what went beyond 2019.

Q - Wimal Kapadia No, I think that's really helpful for the first question. My second question was on 2Q 2017. You highlighted a slide which suggested that Display would be a re-growth business post the near-term pressure. And, actually, if you look at the PM in totality, it suggested that potential revenues for the division in 2022 could be above €2.8 billion, just using a very simple ruler math. Do you still stand by that exhibit that you highlighted at 2Q 2017?

Marcus Kuhnert: So, actually, when we look on this longer time period until 2022, we still stand to this.

So, there's no reason for us to make a significant correction today. What we see – however what we said we will see, a declining trajectory until 2019; and if 2019 is the trough year, then it implies that from 2020 onwards, we would see top line growth again, which would then, actually, over a time period from 2017 to 2022, could result in a basically flat development there. So, this is a statement where I see no need today to meet it or to cancel it, so this remains valid. And as Stefan said, the new organization that we have now brought in place is focusing on turning around the business and we are working on a new strategy that we would present by mid of this year, where eventually we would also then be prepared to provide a little bit more color to financial development, but not sure yet what we definitely will do if presenting new strategy until mid of 2018.

Stefan Oschmann: I'm answering your question on tepotinib.

Tepotinib for me is a good example of the choices we're making in pharma R&D these days. I think it's a good example on focusing on a powerful niche with a relatively high probability of success and where we have liquid biopsy as potential difference here versus competitor. And that is in lung MET Exon 14. The estimated primary completion is June 2019 and recruitment – there are no issues with recruitment. We could potentially see interim data in mid-2018, but we cannot promise that.

And when it comes to filing, that is obviously – that will be a function of how good the data look. You know that very well. So, let's see the Phase II data and then we decide on filing strategies.

Wimal Kapadia: That's great. Really helpful.

Thank you very much.

Operator: Thank you. Our next questions now come from Gunnar Romer of Deutsche Bank. Please go ahead. Your line is open.

Gunnar Romer: Gunnar Romer, Deutsche Bank. Thanks for taking my questions. The first one would be on the healthcare guidance for 2018. So, you're talking about higher underlying R&D, higher selling and marketing negative mix effects and then you will lose basically €200 million of special gains that you've seen in 2017 against which your guidance for only a slight EBITDA pre decline looks actually quite strong. So, in this context, if you could provide a bit more color on the underlying drivers here, i.e.

is it that you assume only very minor increases in R&D and selling and marketing? Also, are you assuming higher gross margins in 2018 compared to 2017? And what have you assumed in terms of potential milestone or partnering income, if at all? And then, secondly, on Performance Materials, firstly, a bigger picture question here. So, you seem to become increasingly cautious here also relative to what you said mid last year. So, what are the main reasons? And how can you be confident that 2019 will be the trough? And in this context, if you can also talk around micro LEDs as a potential threat to your existing liquid crystals and OLED franchises? And then, more specifically, on the recent developments here in Liquid Crystals, if you look at the market share declines, can you comment on to whom you're losing these shares? Would it be your long-standing competitors or are you losing also to new players in the market? And then, last question, on your guidance for corporate and other, quite a significant increase, I believe, 6% to 20% that you're guiding, probably there's even some small hedging gains as you commented. So, what is driving that fairly significant underlying increase please? Does that relate to your 350-year anniversary? Should we expect that to come down again next year? So, any additional color around this Corporate & Other line would be helpful?

Stefan Oschmann: Thank you, Gunnar. I will start with answering the questions on 2018 Healthcare guidance.

This guidance is based on some favorable trends that we're seeing for different products. We now see that the comparables for the fertility franchise are easier and we see that the good organic or longitudinal growth translates very nice into a growth patterns. We see – we have expectations for Bavencio in the mid-double-digit area. As I said, we've seen Mavenclad developing very well and tracking the oral competitor that we have identified as the standard. That is also in the high disease area.

I think you know what I mean. We expect for Mavenclad high double digits sales in 2018. So, all of these are positive – a highly positive factors. We're fairly confident on our guidance. Marcus is going to add some more color to this.

Marcus Kuhnert: I would like to add one more point, Gunnar. And that is also something which Stefan had outlined in his presentation. It required us really some effort to reach our financial targets 2017 despite the headwinds from PM and from FX. So, that means we have also, I would say, implemented a new level of cost discipline within the organization, which was reaching across all of the three business sectors. And you should expect that some of the benefits will be sustainable, so will not swing back entirely in the future.

So, we would also have a slightly more favorable cost basis to start with and that also helped us to compensate for the planned investments in R&D and in marketing and selling to prepare for a potential Mavenclad launch in the US. And, of course, it goes without saying that also here, like in the past, we would exercise a high level of scrutiny. So, that means we would invest in these categories on R&D and marketing and selling against robust clinical data, on the one hand, and/or sound business plans, on the other hand.

Stefan Oschmann: Gunnar, your question on how certain are you that 2019 indeed will be the trough year for PM, I cannot give you a simple answer. So, let me try to shed some light on what our assumptions are.

First of all, remember that Liquid Crystals is about 50% of our PM business now and that the other non-Liquid Crystals business are growing nicely in the mid to high-single-digit range. So, as the proportion of these businesses will become bigger, that is one element. If we look at the Liquid Crystal business as such, dynamics vary from geography to geography. We don't give any specific guidance there, but let me try to explain these in a bit more detail. The main countries in which our panel manufacturer customers reside are Korea, Taiwan, China and Japan and these markets have very, very different dynamics.

We see – in the more traditional market, we see a market share battle with our, what can I say, traditional competitors. That is something that is no news in itself and we feel rather confident in being able to forecast developments with a certain degree of accuracy in this area. We have very different market shares in different geographies. In China, we have seen that for the lower and mid quality range displays that are mostly used for the domestic market that we have seen the erosion of market shares. We have also seen that fabs that have been qualified would then switch from a single supplier to a dual supplies type of regime.

On the other hand, we see that new fabs are being set up in China. And we see that there is a trend toward more – toward higher quality and sort of applying more modern technologies to display technology within China and also for exports. And then, lastly, we also see some degree of impact in projects such as liquid crystal windows or antennas going forward. When we add all of these trends up, we are confident with this statement that 2019 will be the trough year for PM. And then, Gunnar, we'll put in new management.

We have Kai Beckmann and his – basically his entire team is new. The fact that that is new management means that we were unhappy with where things were going. So, we acted, and this team is working very, very hard on putting a new strategy together and we will communicate this by mid-2018. Your question on micro LED, that is something that we are tracking very carefully. First of all, we also are into micro LED.

The materials that we make that are being used in micro LED currently – this is very early technology. We've seen prototypes for very large displays, very extreme complexity in manufacturing. Would require major investments in manufacturing. So, for now, we do not perceive this as a threat to us.

Marcus Kuhnert: Gunnar, I want to take over your questions on segment corporate.

So, actually, the 350 years' costs do not play a significant role. They are by and large adjusted. There's little bit coming this year, but the major piece actually is already adjusted in the P&L. The drivers for the increase our actually two-fold. First of all, since we have finalized or completed our new innovation center, we have started some corporate R&D initiatives, which have actually the aim to increase the synergies in the business sectors, and which by nature or by design dealing with activities which go beyond one single business sector of Merck, so cross business sector R&D initiatives.

They will account for a piece of the increase. The other piece is actually coming from hedging because the hedging space, we are at average hedge ratios, let's say, between $1.19, $1.20. So, the majority of the hedging gains were actually coming in 2017 when we were still hedged at rates, let's say, between $1.10, $1.12, $1.13, but when we had the big movement in currencies. When the currency, in the second half of the year, were depreciating against the euro, that was a time when we had the big hedging gains that have driven our corporate results downwards as it relates to the minus in 2017. Now, we are at an unfavorable level of currencies, but we don't see much movement at this point in time, which means also when we hedge on a – when we roll over our hedges, there's no big difference anymore between the forward rate and the actual development of the FX rate, which means their hedging gains are significantly reduced.

And that is also something that is mirrored, as you know, in segment corporate.

Gunnar Romer: Thank you very much. Just a quick follow-up on Healthcare. Are you assuming anything in terms of milestones or partnering income or would this be excluded from your current guidance in 2018?

Marcus Kuhnert: What we see so far or what we could anticipate, it's basically included. That is, we have, of course, let's say things like – last year was a royalty swap and this kind of, let's say, more significant performance changes is not in.

But what we could reasonably eventually assume, you should be considered as included. And it is, by the way, also not so material normally that it should completely kill our guidance. And if it is, then most probably we don't have it on the radar screen yet.

Gunnar Romer: Okay, thank you.

Operator: Thank you.

We have time now for one final caller. And so, the last questions for the call today come from Vincent Meunier of Morgan Stanley. Please go ahead. Your line is open.

Vincent Meunier: Thank you very much for taking my questions.

The first one is on Bavencio. Can you make comments on how is evolving the partnership with Pfizer and any comments on potential adjustments following the setbacks in lung, in gastric and 4-1BB trial? Second question is on atacicept, any details regarding the trial design and the strategy behind in terms of differentiation? And a quick question on corporate strategy. Any update on the trade-off between deleveraging the company versus doing business development? Thank you.

Stefan Oschmann: Thank you, Vincent. So, on Bavencio and the Pfizer partnership, we see that the partnership is very, very solid.

Just like you, we heard Pfizer repeatedly express the strategic importance avelumab business for their success in oncology. We've also said that if there was ever any alternative scenario, which we currently don't have on the radar screen, that the contract would stipulate such a scenario and that we were not naïve about that. When we look at what you mentioned as setbacks, we feel that this is very much comparable to what our competitors are facing too. Some trials work. Some trials don't work.

And if you look at the globe – the third line gastric trial, it was the global trial in a third line setting to evaluate a checkpoint inhibitor compared to active chemotherapy control that was very high risk from the beginning. I was talking about the second line lung where the most likely explanation is the proportion of patients in chemotherapy arm, crossing over to immune checkpoint inhibitor outside the study, but we see encouraging results in moderate to high and high PD-L1 expression patient populations. It's very difficult to extrapolate that on other trials, but we don't see this as a negative for other trials. And when we look to atacicept, we have a path forward to begin the Phase III trial later this year, but that will be subject to external financing. We had said that before.

We are preparing for that. But our interest – all of this is subject to the decision whether we get external financing interested in sharing the risk. When it comes to corporate strategy, we maintain what we said, i.e. that until the end of this year, there will be no major acquisitions beyond €500 million unless financed by divestitures. You have Marcus and me saying that we do focus on deleveraging that we want to deliver on our commitments in this field.

On the other hand, I think we have – we should have some degree of credibility in being an active portfolio manager, both when it comes to divestitures as well as when it comes to acquisitions. So, long-term, you should expect us to continue to be active in this field and to plan accordingly.

Vincent Meunier: Thank you very much.

Operator: Thank you. That will now conclude the Q&A session.

I'd like to hand now back to our speaker for any additional or closing remarks.
Constantin Fest : Thank you. And I'd like to hand over to Stefan for short closing words.

Stefan Oschmann: So, we have to end the call. Several of us are trying to catch a plane to go into in-depth discussion.

Thank you very much for your questions. I'm looking forward to see many of you during the upcoming roadshow. Marcus Kuhnert : Thank you. Bye-bye.

Operator: Thank you.

That will now conclude today's conference call. Thank you for your participation, ladies and gentlemen. You may now disconnect.