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Trial by Fire Awaits Merck CEO

Richard Clark will face plenty of questions after the drugmaker reports earnings Monday.



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these days, Wall Street is focusing more on processes, like cost-cutting, and events, like Vioxx lawsuits, than it is on products.

For the company, whose stock continues to stumble 13 months after it removed the arthritis drug Vioxx from the market, this is a fact of life.

The stock fell to $33 on Sept. 30, 2004, the day Merck announced the drug was being pulled, from the previous day's close of $45.07. In trading Friday, the stock was below $27.

Merck investors will find out Monday if the drugmaker has anything to offer that might jump-start the shares. The company will report its earnings before the opening bell, and for the just-completed quarter, analysts expect a profit of 62 cents a share before items and revenue of $5.45 billion, according to Thomson First Call.

For the same period last year, Merck earned 60 cents a share on revenue of $5.54 billion. Analysts' opinions for the third quarter don't vary much, with the individual earnings predictions in a range of 58 cents to 64 cents.

What Clark Knows

A number of unanswered questions surround Merck, namely if the company will reveal any details about its Vioxx-liability plans, the status of the dividend and whether some sort of restructuring is needed to help the company prepare for the future.

One person who could answer these questions is Richard Clark, Merck's 59-year-old chief executive. Monday's financial report and meeting with analysts will be Clark's first full-scale encounter with Wall Street since he was

named to the job in early May to replace Raymond Gilmartin, who departed 10 months ahead of schedule.

Clark has said little to the financial community, and he skipped the second-quarter financial briefing in July. In a letter to shareholders last month, Clark said Merck must reduce its cost structure "over and above what we have achieved to date."

Merck hasn't issued a comprehensive cost-containment strategy since the Vioxx withdrawal, Catherine Arnold of Credit Suisse First Boston wrote in a recent research report, and she said margin erosion continues to be her key fundamental concern.

Arnold suspects Clark "has had ample time to do a diagnostic on Merck's expense structure," and he may unveil plans for controlling costs. Investors should pay attention to any Merck remarks about inventories, Vioxx legal defense plans and restructuring, she said. Arnold doesn't own shares, and her firm does and seeks to business with companies mentioned in research reports.

Big Caseload

If anyone knows Merck's infrastructure, Clark does. He started with Merck in 1972 as a quality control inspector and later held management jobs in production, new-products planning and strategic planning. He ran the



pharmacy benefits unit for several years before it was spun off as an independent company. Before replacing Gilmartin, Clark ran Merck's manufacturing division.

During the upcoming conference call, Clark will probably face questions about Vioxx, but there's little he can say until Merck tries to quantify its potential losses. The company has set aside $675 million to cover litigation expenses, but it hasn't established a reserve for adverse judgments. Last month, the company said it wouldn't enter in to a global settlement of the Vioxx-related lawsuits.

Clark or other executives might at least update the number of Vioxx-related lawsuits that have been added since Merck's second-quarter report. The company counted 4,100 personal injury lawsuits and 120 class-action personal injury lawsuits as of June 30. That figure excludes personal injury lawsuits filed in other countries and shareholder-related suits in the U.S.

Merck lost its first personal injury case in August before a Texas state court jury, which awarded $24.4 million in actual damages and $229 million in punitive damages to the family of a man who took Vioxx and later died. Merck is appealing the verdict. Even if Merck loses, the total award will be cut by about 90% because the jury ignored the state's legal limit on punitive damages.

Analysts said then that investors shouldn't leap to conclusions, and that's what they're saying now.

At this point, we continue to believe that it's too early to quantify Merck's Vioxx liability exposure," Tim Anderson of Prudential Equity Group wrote in a recent report. Anderson doesn't own shares, and his firm doesn't have an investment banking relationship with Merck.

The second case, in a New Jersey state court, is continuing. An Idaho man who took Vioxx is claiming that it caused his heart attack. "The latest case, in our opinion, is significantly weaker than the one in Texas," Michael Krensavage of Raymond James wrote in a recent research report.

The first federal case, in which procedures are stricter than in state courts, is scheduled to start late next month.

"Appeals of any losses are likely to delay payments for years," says Krensavage. He doesn't own shares, but his firm says it expects to receive or intends to seek investment-banking compensation in the next three months.

Krensavage says the company's best strategy is to oppose the certifying of class-action lawsuits and to litigate individual cases, thus forcing individual plaintiffs' lawyers to run up bills that won't be repaid unless they win.

If Merck wins the New Jersey case, he says, Merck's stock could move toward his 12-month price target of $42.