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Novartis AG (NYSE:NVS)

Q4 2012 Earnings Call

January 23, 2013 8:00 a.m. ET

Executives

Joseph Jimenez - CEO

Samir Shah - Global Head IR

Jon Symonds - CFO

David Epstein – Division Head, Novartis Pharmaceuticals

Kevin Buehler - Division Head, Alcon

Jeff George - Division Head, Sandoz division

Andrin Oswald - Division Head, Vaccines & Diagnostics

Brian McNamara - Division Head, OTC

Analysts

Andrew Baum - Citi

Tim Race - Deutsche Bank

Matthew Weston - Crédit Suisse

Alexandra Hauber - JP Morgan

Michael Leuchten - Barclays Capital

Gbola Amusa - UBS

Seamus Fernandez - Leerink Swann

Odile Rundquist – Helvea

Operator

Good morning, and good afternoon. And welcome to the Novartis Q4 Full Year 2012 Results Conference Call and Live Video Webcast. (Operator Instructions)

With that, I would like to hand over to Mr. Joseph Jimenez, CEO of Novartis. Please go ahead, sir.

Joseph Jimenez

Thank you. Good afternoon. I'd like to welcome everybody to our fourth quarter and full year 2012 earnings webcast. Now joining me on the Novartis end are Jon Symonds, our CFO; David Epstein, Head of the Pharma division; Kevin Buehler, Head of Alcon; Jeff George, Head of the Sandoz division; Andrin Oswald, Head of Vaccines & Diagnostics; and Brian McNamara, Head of OTC. And before we start, I'd like to ask Samir Shah to read the Safe Harbor statement.

Samir Shah

Thank you, Joe. So the information presented in this conference call contains forward-looking statements that involve known and unknown risks, uncertainties and other factors. These may cause actual results to be materially different from any future results, performance or achievements expressed or implied by such statements. Please refer to the company's Form 20-F on file with the Securities and Exchange Commission for a description of some of these factors.

I’ll hand back across to Joe.

Joseph Jimenez

Thanks Samir. So as you saw today we made the announcement that Daniel Vasella, after 17 years of being either Chairman or CEO at Novartis will not stand for re-election at our February Annual General Meeting. And if you know Danny, you know that he shaped this company for many years and also had a significant impact on the overall healthcare industry. So he definitely will be missed.

I’d like to welcome Dr. Jörg Reinhardt as the proposed non-executive chairman of Novartis. Many of you know Jörg, he spent 20 years with Novartis. He knows the company well and I am looking forward to working with him.

Now on to the results. We delivered strong innovation in 2012 and we were able to offset the patent expirations that we saw, so our sales were flat versus year ago in constant currency and this is fully offsetting the almost $2 billion worth of patent expirations.

Our core operating income was down 2% in constant currency. Cash flow was very strong at $11.4 billion. But I think the most important thing about 2012 was the progress that we made on innovation. We had 17 key approvals across the U.S. and Europe.

You can see an overview of the financials on this slide for the full year. We had net income of $9.6 billion, up 4% for the -- versus year ago in U.S. dollars. Core EPS of $5.25 was down 6% in U.S. dollars, and Jon is going to through more of the numbers in greater detail.

If you look by business segment, you can see that we had the strongest year in Alcon and Pharmaceuticals, and this offset some of the supply issues that we had in the other divisions. Now you heard me talk a lot about the other divisions in 2012 and the actions that we are taking in those divisions and all divisions, ex-Pharma are projected to grow in 2013.

Now in terms of the priorities, 2012 was a great year for innovation. I talked about the 17 key approvals. But we also announced nine positive Phase III clinical trials across all divisions. Also Bexsero which did have a positive CHMP opinion, this week received a full EMA approval.

Now in terms of growth, our recently launched products accounted for almost 30% of the group’s total. This is key, because this is really the rejuvenation of the company. And then from a productivity standpoint, we delivered $1.3 billion in procurement savings. We also reduced marketing as a percent of sales in the Pharmaceutical division by almost a point and this is despite funding the -- an unprecedented level of launch activity.

Now, a little bit deeper in innovation, you can see that the Pharma division had 11 product approvals, including Afinitor for advanced breast cancer and we’ve said that we expect this to be a significant indication for Afinitor, as well as Jakavi for myelofibrosis in the EU and that lunch is now underway.

In the Alcon division we had a couple of key approvals, we increased the line of advanced technology intra-ocular lenses in Europe to multifocal lenses, these are critical cataract surgery patients can have a lens implanted in their eye that removes the need to wear glasses basically for the rest of their lives. We also had approval to a new breathable daily disposable contact lens called Dailies Total1 and that launch is underway.

Sandoz paved its way for future growth. Sandoz currently has the most biosimilars of any company either approved or filed there in the clinic and they also achieved a record 12 U.S. First-To-Files in 2012 and this increases the First-To-File pipeline to 45 for Sandoz.

Vaccines and Diagnostics had a good year in terms of innovation. I mentioned Bexsero full approval and we expect to begin shipping in 2013, but also the approval of Flucelvax, which is the first cell-based flu vaccine. This was approved in the U.S. and we expect to begin selling Flucelvax also in 2013.

Now one of the metrics that we watch very closely is the percent of sales that come from our newly launched products and is a measure of how we rejuvenate the portfolio and in 2012 we grew 13% off of a base of $14 billion. So this is a significant number and it's driving a significant amount of growth.

You can see that some of the individual drugs that are driving that key products that are growing double-digit and in fact, Gilenya up triple-digit, I think you saw the announcement today that Gilenya has crossed blockbuster status in its second year since introduction.

In terms of emerging markets, our emerging markets benefited -- businesses is benefiting from a lot of the cross divisional activity that we’re doing across whether its pharma or generics or vaccines and diagnostics. And I want to call out two countries in particular.

Our China business is was up 24% in 2012 and China has now crossed into one of our top 10 markets for Novartis. So it’s becoming an even more important part and in India up 14%.

In terms of productivity, we made great progress in the area of procurement. I’ve said before that we’ve organized our procurement in a virtual central organization across all divisions and geographies. We’re able to pull the total strength of Novartis, reverse section it (ph) and we’re seeing significant savings in the area of procurement. Also in manufacturing we started in 2010, the manufacturing footprint project and since then we have either sold or divested 15 sites out of our manufacturing sites and seven of those occurred in 2012.

Also, you know in the past year we have focused extensively on upgrading our quality systems as well as our talent across the organization in QA. And we’re focused not just on remediation but we’re also focused on increasing the overall level of quality no matter what the division is, whether they’ve had issues in some sites or not. And I think the focus really is paying off. We’ve had over 260 health authority inspections in 2012, over 55 from the FDA, the vast majority of those were either good or they were satisfactory. In fact, our Sandoz site in (inaudible) Colorado, which is one of the sites that was under the FDA warning letter, achieved full compliance. So this is a very important step for us. The work is continuing here. I have said before there may be bumps in the road but we’re definitely headed in the right direction.

So now what I’d like is for Jon to come up and give a little bit more detail on the financials. Jon?

Jon Symonds

Thank you Joe and good afternoon everybody. So before I get into the numbers, let me start with the score sheet for 2012. I think that you can see here that we have done pretty well against all the promises and targets we set at the beginning of the year and especially given what this year is throwing out at us. And I think it gives you also a sense of just how we determined we are to deliver against the promises we make.

On this slide, you can see the summary of the performance for 2012 and let me just pick out four numbers amongst them. You can see under the reporting column, the growth rate in quarter four of 94% is rather dramatic but I am sure you will all appreciate that this is a result of the provisions we made last year in relation to Tekturna and Rasilez as well as on the shutdown of the Lincoln plant.

And I have included at the back of the slides a full reconciliation of the quarter reported results and I won’t go into it in any more detail because there should not be any surprises. What I have – what I do think is striking in the middle column however for the fourth quarter is that all the P&L numbers are positive. Granted we’ve only had half -- about a half of the Diovan generic competition in the U.S. but that generic competition has still added up to $600 million. And you can see that notwithstanding this our profit performance is pretty robust.

Finally in the full year column, you can see that sales were flat with core operating income down slightly as we were unable to fully absorb the impact of generic competition $1.9 billion for the year, the loss of output from Lincoln and the higher quality costs in Sandoz. Although negative compared to last year I believe our free cash flow performance particularly in the final part of the year was actually pretty good and I will come back to some of the factors behind that in a moment.

This slide shows you the normal disaggregation of the topline into its component parts. And this is a particularly important slide to think through as it’s going to become much more relevant to understanding the business in the future particularly as the Diovan impact begins to get into our base. In fact, the Lincoln impact would also be in our base for 2013 and therefore there are really three main components for you to think through.

Firstly, price and as you can see here with the broad portfolio we have, the overall impact is relatively small. Secondly, the impact of generics which as I will come to in a moment will increase significantly over the first two or three quarters of 2013 and that leaves you with the underlying volume growth. And as the impact of generics begins to work through this picture, it will increasingly -- this volume growth will be increasingly visible in our reported top line and this stands at the heart of the longer-term guidance that Joe will come back to shortly.

This slide shows you the performance of the recently launched products for both the group and for pharma. This product portfolio has been at the center of our business transformation and the rejuvenation of our portfolio for the last three years and will continue to be so.

As you can see here, these products comprise 29% of group sales and 35% of pharma sales. And the group growth rates remain strong even in the face of the significant contraction of enoxaparin in the Sandoz numbers.

We’ve been using this definition of recently launched products for sometime as a measure of portfolio rejuvenation. And as we move to the situation where Diovan becomes increasingly in the base, our growth should be more visible from the reported sales figure.

And as a result of this, we’re going to give less emphasis to this measure in 2013 in favor of reported sales less generics, this will show the underlying performance so to say increasingly as part of the reported numbers. And secondly, we’ll focus more on products that are five years old or younger or have protection to 2017 or beyond. And David will show you the products in his portfolio, that references this definition.

So as the slide I’ve just described presents the growth potential of the business over the coming years, this slide lays out the generic competition we expect to face in 2013. Before I look at 2013, it’s clear that 2012 did not go according to expectations.

This time last year, we were assuming a generic exposure to be more or less equally split between 2012 and 2013 with a generic impact of around $2.6 billion in each year or $5.2 billion across two years. As you can see here, things turned out considerably better in 2012 than expected at only $1.9 billion mostly as a result of the failure of Ranbaxy to launch generic version of Diovan mono in the U.S.

All things being equal however, the generic impact is nil sum game and what we benefited from in 2012 simply becomes a higher burden in 2013. This is why you can see that the total impact for 2013 is now something like $3.5 billion, including a small recalibration of the total impact to around $5.4 billion over the two years.

Of course, this estimate still depends to some degree on Ranbaxy’s ability to launch Diovan mono, something that is completely out of our hands. We’ve included a small amount of Diovan mono in our outlook for 2013. We will just have to see how it develops week by week. This is why we say the generic impact could be up to $3.5 billion.

This slide gives you the divisional story on core operating margins for the fourth quarter and for the full year, and is clearly a mix picture although for the reasons that you’re very familiar with. Two division standout for being positive, pharma and Alcon.

Pharma managed to extend its record of core margin increases in the fourth quarter and for the year as a whole by 70 basis points to 31.8%. And in fact, this margin of 31.8% corresponds to the highest annual margin ever reported by the division back in 2009 when the exchange rate environment was much more favorable than it is today, and without the impact of $1.9 billion of generic erosion that we’ve absorbed in this performance.

Alcon had a good fourth quarter recovering well from a week of third quarter with sales growth of 8% and a good performance across all three franchises. Alcon’s core margin now stands at 36.2%, which is approximately three percentage points higher than it was at the time of the merger.

You will note that we have now delivered more than 350 million of synergies that we anticipated than and the year ahead of time. As a result, we’ll start reporting the benefits separately although there will be some further integration costs to be charged in 2013.

You’re aware of the challenges in the other divisions and I won’t label the points here. For Sandoz, it’s been a year dominated by the lowest sales of enoxaparin over $500 million and with high margins as well as lower volumes and significantly higher costs of the plants impacted by the warning letter. All of these factors will be apparent again in 2013. And therefore it's unlikely that we'll see Sandoz margins improve.

Look through these factors, however, you will see that there is a very strong performance across all markets and regions and with excellent momentum heading into 2013. V&D had a good final quarter in what has been a challenging year. The approvals of Bexsero and Flucelvax are important for the future but 2013 will be a tough year until the sales start to come through. As for consumer health the news in the last quarter has been much better with a return of some of the key OTC brands.

So turning now to productivity, and I think by now you know that driving productivity savings is a critical piece of our business performance and I think generally we’ve done a good job yielding productivity benefits to the order of $2.8 billion, and that's well ahead of the 3.5 to 4 percentage points of sales we target.

As you can see here a substantial proportion of savings come from procurement. Our procurement group is really functioning well and approaching buying decisions from the group perspective rather than from a single division. And this is really paying off. There is still however further to go to make procurement really mission critical to the business bottom line that it needs to be.

The other areas are just a selection of [voting] practice amongst hundreds of individual initiatives and it's not just about saving money to the bottom line but it’s also about the reallocation of resources to ensure that we really fund our priorities. Pharma, for example, has yet again reduced M&S as a percentage of sales by 90 basis points to 26.6% of sales and fully invested behind this portfolio.

Turning now to cash flow, and as I said earlier, this was a very good performance, indeed somewhat better than we expected. Overall cash flow for the year of $11.4 billion was 9% below last year taking into account around $500 million of higher capital spending and an increase in inventories of around $700 million. I would not expect the same level of performance for 2013 for three reasons. Firstly, the lower operating profits, CapEx will remain high and could be above 5% of sales and some of the working capital improvements are not repeatable.

As a consequence of the better cash flow, this has translated into expected net debt at a [lower] expected net debt position of the end of the year. Overall we were able to reduce debt by $3.6 billion as free cash flow exceeded the dividends and acquisition.

I’ll give just a word of caution on this. The rating agencies will see a slightly different picture as the pension deficits increased from $2.9 billion to $5.2 billion most of which arose from lower discount rates and adoption of more – lated mortality tables.

So finally to slide 28, which seeks to pictorially present the moving parts in our performance expectations for 2013. This essentially follows the picture presented last year and is the way we think the performance inside the company too. On the top half of the slide you can see that for sales how we get to the flat line for 2012 with the increasing growth products broadly offsetting the impact of generics. This analysis is also the source of our confidence in future years where we expect lower impact of generics while the growth products will continue to grow.

For core operating income, you can see that with the higher impact of generic erosion than was expected last year and with continued investment behind the growth products we’re unable to prevent a decline in earnings even with substantial amounts of productivity. So it’s clear that 2013 is going to be the transition year with a significantly higher impact of generic erosion falling into 2013. Overall we estimate that this will result in a decline in the core operating margin around the mid single-digit mark with the consequential decline in core operating margins. Obviously it’s a pharma business that takes the biggest strain in all of these and if you have seen from the group guidance this morning, we expect the pharma sales to be down in low single digits.

But if you step back for a second and think about what this means. The business is able to absorb $3.5 billion of patent erosion with only a small initial negative impact on the topline. I really think that this is an unprecedented performance.

Finally I have not mentioned currency at this point as with the rates as they are today, it does not seem to be a big deal. Broadly neutral on sales and slightly on negative on earnings but of course we will have opportunities later in the year to update on that. And with that I will now hand you over to David for the review of the pharma business.

David Epstein

Thank you, Jon. I will just start with some numbers. The pharma division delivered 2% sales growth and 5% core operating income growth which was ahead of what most of us would have expected this time one year ago. And as Jon mentioned, productivity improvement allowed us to increase the margin while we continue to invest in our growth portfolio.

More importantly is where that 2% sales growth came from and on this chart you see that 8% growth was driven by our recently launched products and that was offset by 6 point loss or $1.9 billion generic impact for the net of 2% sales growth.

If you look at geographies and where that has come from, what you start to see is that the emerging growth market are becoming ever large portion of our Pharma business, they contributed nicely during 2012. Going forward, as we left Diovan you will see the established markets contributing more to the future growth of the division.

Very importantly, we’ve talked often about being innovation focused company, innovation driven company, it’s very clear that in our hands those innovation investments are paying off, with recently launched products growing 28% in constant currency and that representing 35% of the business.

In addition to this innovation focus we built a very strong global commercial launch capability, which is also contributing and paying off, particularly when one looks at our strong growth platform, products that have protection whether it would be patent or exclusivity until 2017 and beyond, products that all have in our opinion blockbuster potential and these are products that we will continue to talk a lot more about.

In the next couple of slides, I want to give you an update on few of these brands and also share with you some new data that was generated towards the end of 2012.

Starting with Gilenya, very proud to say that the launch of Gilenya is the best launch in the MS space ever, it reached -- Gilenya reached blockbuster status within two years after launch, and the rest of world is now accounting 46% of the business and 67% of the growth driven by very strong launches in markets like Germany and France.

As you know the business has been less dynamic in the U.S. post-label change in part because physicians in the U.S. practice more in a community setting, we’re doing EKGs has been a bit more of a hindrance. We put in place activities and alternatives for these physicians such as remote monitoring, centers that would do the pre-work up on these patients and we’re seeing now encouraging signs in terms of increased volume demand during the fourth quarter and in fact joining in the U.S. is gaining market share.

Turning now to Lucentis, this is the product that did very well for us in 2012, driven in large part by continued expansion in the wet AMD market, which is not yet fully tapped out. And we launched new indications in diabetic macular edema and retinal vein occlusion making up about 20% of our current sales. We also file for new indication Pathologic Myopia towards the end of the year in Europe and in Japan.

I think it’s still not fully understood the potential for the VEGF inhibitor market and although new competitors are launching, we believe there is an opportunity to continue to grow Lucentis given the large unmet need and the large numbers of patients that are not yet either treated or not optimally treated.

Turning now to Afinitor, as you know we have now extended the label to include our hormone responsive breast cancer patients that are HER2-. Herve Hoppenot our Oncology Head presented data at our R&D meeting earlier this year. You see the launches in the U.S., Germany, Australia and beyond have helped really accelerate this brand.

We believe the 85% growth was prior year, which is well on track to achieving our outlook of -- incremental sales of $2 billion alone in breast cancer. In fact, during the second half of this year, we will see the first data in the HER2+ sentiment which can further expand the opportunity for Afinitor.

We also presented data at the American Society of Hematology meeting on a study which compared Tasigna to Glivec and in the study we proved, we believe now conclusively that Tasigna is the better product.

In fact if you look at the data, you look at complete molecular response rates or lack of evidence of active disease in these patients, what you see is about a 24 months 22% of the Tasigna patients had complete molecular response was only about 9% with Glivec. And based on this data that we’ve designed now a comprehensive development program to prove the possibility that patients could actually have a period of treatment free remission. So whether that would be de novo patients in the ENEST Freedom trial or patients who have been on Glivec but not achieved the CMR in the ENEST Top we will be able to show we hope in time that a portion of these patients can go off therapy and we completely then change the paradigm of the treatment of CML. Just as we did several years ago when we introduced Glivec, and we took the disease was fatal and made it a disease possible to live with as chronic therapy, we now have been in a position with this data to offer patients the opportunity to actually be treatment free.

Also in our oncology business we licensed in a product from [inside] a few years ago for the treatment of myelofibrosis, a blood cancer that is associated with really disabling symptoms for these patients, itchiness, lethargy, enlarged spleen and the like, and you can see that the European launch is going very, very well, actually better than we had anticipated. And during the quarter data was also shown that Jakavi has a potential for a survival benefit in addition to those benefits in terms of symptoms. What does it mean? That means more value for patients and health systems but it also means that over time it’s quite possible that our estimates of the number of patients on therapy are underestimated as people live longer and thus the revenue potential for the product can continue to grow over time.

As Joe mentioned, it’s been a very dynamic period for us in terms of major approvals as well as new filings with 11 major approvals in the U.S. and Europe alone rejuvenating our portfolio during 2012. What you don’t see in the chart is we also had a dynamic time in our Japanese market. In fact, Seebri which is a new product for COPD, we were able to achieve approval in Japan about 11 hours earlier than the European Union and the reason that’s important is that when I started in this business quite some time ago, there was a five to seven year gap between European and Japanese approval. By consolidating those approvals in a similar time period is an opportunity to bring revenue forward and bring peak sales up, something that needs to be included as one estimates the potential for products when it needs to look beyond just the U.S. market and the European markets.

Perhaps one of the most interesting products in the portfolio and I would even go as far as saying exciting projects in our portfolio is a drug called RLX030 or Serelaxin which has been developed for the treatment of acute heart failure. As you know there are about 2 million hospitalizations each year in the U.S. and Europe alone, and there’s really not much you can do for acute heart failure patient. You can give him a drug like [LASIKs] and you could reduce some of the water built up, these are dilators, oxygen and beyond that it’s symptomatic therapies such as propping people up in bed with more pillows because they simply can’t even lie flat and they are unable to breathe, so are really uncomfortable for them. We’ve now shown in both phase 2 trial and phase 3 trial that this product reduces all cause mortality as well as cardiovascular mortality. In fact, at six months that’s a 37% reduction. In addition, the trials show improvements in important biomarkers troponin, creatinine, and BNPs.

Based upon very good conversations with the U.S. and the European regulators we’ve put a file together. In fact, we filed early, we filed in Europe in December of last year and will file in the U.S. in the second quarter of 2013. In addition, our development team will do a second phase 3 trial with mortality as a primary endpoint because our expectation is that while mortality could well be in the initial level, it may not be a claim. And the second trial could be required to make that an actual claim. So as opposed to approval commitment we would then be able to update the label.

Last but not the least, the American Society of Hematology meeting data was shown in a whole new approach to cancer treatment, a T-cell therapy, a modified T-cell therapy called CTL019, as you can see from this chart, there is real opportunity to treat patients with end stage or late stage CLL and ALL and give these patients an opportunity to live much better lives, in fact, even the possibility that some of these patients could ultimately be cured.

We have dose optimization trial that has now been initiated and this is something to consider as one model this product as it was not in our forecasts that we showed at R&D day because of data is just so new.

So in terms of newsflow, we will keep you busy yet again this year. We have quite a number of regulatory decisions in the first and the second half although you read them for yourself. But these will then add to the growth opportunity at Novartis. And as we report to you, the percentage of revenue coming from that growth portfolio, some of these products will be entering that growth portfolio over time.

Also as reminded R&D day, we mentioned that over the next 24 months we had 24 pivotal study readouts, so it will be extremely dynamic period. And I know Tim Wright and his development team will be very, very busy. So to summarize, we had strong performance in 2012, above expectations.

I believe our sustained focus on growth, productivity and innovation is the right one. Core operating income grew well ahead of 2011 and as well ahead of sales. We have a very strong growth platform with multiple products on the market today but also multiple additional product launches, products like Seebri, QVA, serelaxin, AIN, LCZ, LDK, Xolair in chronic idiopathic urticaria, all these are new opportunities for our company.

And then finally in terms of an outlook, this year 2013 will be impacted by the loss of Diovan mono we expect in the U.S. although we cannot predict it with any kind of certainty. That would generated a low single-digit sales decline in constant currency and then taking that out and just looking at the underlying growth, it will be high single-digit growth, excluding the impact of generics.

And with that, I’d like to hand it back to Joe.

Joseph Jimenez

Thanks, David. I’d like to close by talking about 2013 and beyond. So you’re going to see us focus on again, innovation. We will strengthen the pipeline in ‘13. In terms of growth, it’s all about executing these launches with excellence because this is going to be key to the ‘14 and ‘15 time period. And then, you will also see us focus on additional productivity, activity in the area, primarily in procurement because we see a big opportunity there.

So our guidance for ‘13 is group net sales, expected to be in line with 2012. So, in terms of the divisions, this results in pharma low single-digit decline but then all the other divisions are up; Alcon, Sandoz and V&D mid-to high single digits increase and consumer health high single-digit increase.

In terms of our core operating income, we expect to decline mid-single digits but that's while covering $3.5 billion of patent expirations. I want to give you a view also of what happens post 2013.

We expect to begin our next growth phase, once the Diovan patent is in our base and this will start in 2013. It’s going to be driven by three factors. The first is growth products, emerging markets, greater exposure and lower exposure to patent expirations going forward.

Our growth products, we showed you how much they were worth in 2012. But we fully expect this number to continue to increase over the next three years up through 2015 and the fact that 80% of the product, this product sales that we expect in ‘15 are already on the market to me underscores the confidence that we have in those projections.

In terms of emerging markets, we expect to have a greater percentage of our total business from emerging markets as countries like China and India and Russia continue to grow at above total rates. And then the third growth driver is the lower patent exposure that we expect. So you see in 2012, we had almost $2 billion of patent expirations.

2013 will be about $3.5 billion we expect. But once we get into ‘14 and ‘15, we expect between 2% and 3% of net sales to be exposed to generic erosion and that includes a conservative assumption like Glivec in the U.S. goes mid-2015. So that's in that guidance for 2015.

Now, historically, we have not given mid-term or long-term guidance, and we don't intend to make this a practice. But as an exception, I wanted to tell you that we do expect to have sales growth in that ‘14 and ‘15 period, at least mid-single digit range, and we expect our core operating income to grow ahead of sales during that period.

I felt it was important that that with the guidance that we give in ‘13, we also show you how the investment that we're making in research and development and launch spending today will result in this expected financial performance in ‘14 and ’15. So that’s it.

With that, I’d now like to open up the call to questions.

Question-and-Answer Session

Operator

(Operator Instructions) We’ll take our first question today from Tim Race of Deutsche Bank.

Tim Race - Deutsche Bank

Quite a lot of market commentary speculated about what Jörg Reinhardt and the change of chairman is going to do to the company going forward. The share price seems to suggest that you’re going to slump strategy into reverse and divest and buyback. Could you just comment on how Novartis is going to be different going forward and in terms of capital allocation et cetera?

Then a couple of other questions, just in terms of emerging market growth, it was very good in China but slightly lower for the overall group. Can you just point to which markets you’ve seen declines in and why?

And just in terms of the long term growth, you -- don’t mention 2016 when you feel the full brunt of Glivec and Exforge. Will that be a [growth or decline year] [ph] in terms of core EBIT margin?

Joseph Jimenez

Okay. Starting first with the change at the chairman level, Dan has publicly said that he believes that the strategy of the company is sound in terms of focused diversification and that we are navigating through the patent expiration period in a way that is as good as I think we could be expected. So we felt now is a good time to have a smooth transition. Jörg Reinhardt knows the company, so he was with the company for 20 years. He and I have worked well together. I don’t think you should speculate that there will be a change in strategy, some of the way that we execute may be different but I think this is a company that has continuity but we also are focused on ensuring that we deliver what we say we’re going to deliver. So I would say you shouldn’t speculate big changes in strategy. We’re going to continue to execute up against those three strategic priorities. We’re going to continue to be driven by research and development and we’re going to invest in research and development. We’re going to focus on translating that into sales and profit that hits the P&L in terms of growth and then we’re going to continue to drive productivity pretty aggressively.

In terms of the EGM growth, we did have a couple of the EGM markets that dragged down the total number but partly because of timing of big tenders. So for example, our business in Russia was not robust in the fourth quarter and even in the full year partly because of the timing of a specific tender that was significant a year ago. But overall our emerging markets business is growing at a significantly faster rate than the business, we still had some of the characteristics of the rest of the business but it is growing at a much faster rate and we would expect that to continue into the future.

In terms of long-term growth not going into ’16, I thought a lot about this but I also agree that when you look at ’13, ’14, ‘15 that's a good period of time and ‘15 does have the U.S. patent expiration of Glivec. So I can tell you that we will move through Glivec in a way that is different than we moved through Diovan. The oncology group has gone on record saying that when you look at their pipeline and their launch brands, they believe that unit itself can move through the Glivec patent expiration in ‘15 and ‘16 with growth and that's because – and so you take the oncology unit then you add on top of that the pharma division in which it sits and then you add on top of that the group. And so I think that's what we're expecting, we’re not going to go out as far as ‘16 but you can see from ‘15 we still expect growth.

Operator

Thank you. We now move on to a question from Andrew Baum of Citi.

Andrew Baum - Citigroup

Good afternoon. It’s Andrew Baum from Citi. With regard to your group structure, when I look across that you have four areas where, I think you’d probably acknowledge your sub scale, so Animal Health, OTC, Vaccines and Diagnostics, a number of your peers in response to shareholder pressure have been considering whether they are the right owners of these assets seeking either scale or to divest?

Is it reasonable to expect that given the change in the Chairman position, these opportunities will be carefully reviewed with an eye to looking at both near-term and long-term shareholder value creation? That’s first question.

Second question with regard to your CHF drug and LCZ696, could you just outline if there is an interim analysis plans for this year related to 75% [events ][ph] or something similar to that, for the primary end point?

And then finally, you have a Phase II compound, a cell cycle inhibitor which LEE011 which is a competitor to a very high profile Pfizer drug. Could you just outline your development strategy in breast and indicate how many years you think you are behind Pfizer in bringing this drug to the market in breast, if indeed you are taking it forward in breast? Many thanks.

Joseph Jimenez

Okay. In terms of the group strategy, we have been consistent in saying that, obviously we have three big engines I think at Novartis today, Pharmaceuticals, Alcon and Sandoz, these are $10 billion businesses. They are -- they have scale. They are driving good results for the company.

And when you think about the other businesses, particularly Vaccines and Diagnostics, I have said before that I think about this as a business that is in start-up phase especially with the approval of Bexsero that can really transform that business.

So we are company that has the ability to look and invest in a business like that with the intent of making it a significant return for shareholders in the long-term and that’s what the objective is.

I don't think the change of Chairmanship would change that. We are constantly reviewing our portfolio, if it look like those businesses as being less scaled than they potentially needed to be successful we would take action on them.

At the same time, you look at a business like Animal Health. It is a small business but ex-Lincoln it has consistently grown year after year after year because the -- when it operates in a market, in a particular category while it may be sub scale on a global basis, it is significant and significant market presence in parasiticides or whatever it competes, and so it's able to have advantage within that category level and that's one of the reasons why it grows.

So we will continue to review the portfolio. The change in Chairmanship will bring what it will bring, just in terms of how the future is going to look. But I don't think that really changes the way that we are looking at our portfolio and the standard by which we are holding each of these businesses to return to shareholders in the long-term. David, on the pipeline questions?

David Epstein

There are two questions, one was on LCZ, so just to remind you there are two indications, ones in hypertension where we are focusing largely on Asia. We’d actually be in a position to submit before the end of this year for hypertension.

And I think Andy -- Andrew your question was mostly about the chronic heart failure indication. We’ll have data in 2014 for that indication. We are particularly excited about it because this will be a chronic therapy which will compliment the use of serelaxin in the acute setting which will really set up a nice franchise in heart failure for our company.

The other question was about our cell cycle inhibitor in breast cancer, I think if you take a step back, we have multiple assets in the breast cancer arena. As you know, we are just launching Afinitor for HER2- patients. Hopefully, we’ll have nice data in HER2+ patients before the end of 2013.

We have a series of PI3 kinase inhibitors that are in clinic. In fact, we are in pivotal clinical trials in breast cancer with our PI3 kinase inhibitors and that should position, that is potentially one of the next launches in the field of breast cancer.

And then we have the cell cycle inhibitor which is much earlier, what’s unique about the Novartis strategy is we are in a position to combine these drugs in a way that other companies can’t because we have each of them in our portfolio.

And we firmly believe that breast cancer patients will rotate through all these therapies, all these lines of therapies, pushing off chemotherapy as long as possible in the company that figures out the ideal combination will be best positioned to win, and we think that’s an advantage that we have.

Joseph Jimenez

Next question?

Andrew Baum - Citi

And just to clarify.

Joseph Jimenez

Oh! Yeah. Go ahead.

Andrew Baum - Citi

Is there an interim analysis for LCZ696 during ’13?

David Epstein

I do not -- all I can tell you, I don’t have in front of me, I don’t recall an interim analysis, if it turns out I’m wrong, we’ll let you know.

Andrew Baum - Citi

Okay. Thank you, David.

Joseph Jimenez

Next question.

Operator

Thank you. We now move on to Matthew Weston with Crédit Suisse.

Matthew Weston - Crédit Suisse

And just two for Jon and one for David. Jon, there was a sharp ramp-up in costs in 4Q as a percent of revenue. It seems to be across the divisions but particularly in pharma and Sandoz. Was it a function of effectively having super normal revenue in both of those divisions and therefore trying to allocate costs accordingly? I thought you were trying to get away from that and smoothing the impact to the cost base going forward, or is the 4Q effect a fairer reflection of what we should consider for those divisions going forward?

And then the second financial question just on indications on tax, you normally help us out at the beginning of the year, 15.2 reported for the full year ’12, is that a fair indication going forward? Does the dive in U.S. loss have any impact on tax and should we consider it going up? And then finally, David, you mentioned the opportunity for Seebri in Japan. I know that your joint venture co-promote deal with SI would cancel only about a year after it was formed, what’s your intention for marketing the respiratory assets in Japan? Why did you decide to end that deal and does that require incremental investment going forward?

Jon Symonds

On your first question, we have tried to smooth costs out but there is an inevitability about the fourth quarter being slightly higher than the rest of year because some of the costs are only determined at the end of the year. If I look at the overall distribution of profit for the group, it’s actually distributed – it was actually, just over 22% in 2011 and 24% in 2012, and for the pharma business it was pretty much the same – same contribution of the annual profit in the fourth quarter it was the same year. So I would assume the cost broadly phases, you’ve seen them this year. I don’t see an opportunity to dramatically rebase beyond what we have done.

And on tax rate, I pretty well assume for 2013 what you saw in 2012 and there won’t be impact on the tax rate because of Diovan.

David Epstein

In terms of Seebri, just as a reminder we’ve now launched in Germany and Denmark. It’s too early to give you sales number qualitatively, we are hearing physicians were happy to have an alternative to Spiriva and as you know this is a key component for QVA which is the big opportunity for the company. In terms of Japan, it was a joint venture decision with our co-marketing partner that both of our strategies had changed and didn’t make sense to continue. Yes, we will put some incremental resources behind the product in Japan and we have a very nice outlook for the brand there.

Operator

We take our next question from Alexandra Hauber of JP Morgan.

Alexandra Hauber - JP Morgan

Firstly on your dividend, given the 2.30 which stands at about 47% payout ratio of core EPS which is basically at the bottom end of the peer group (inaudible) promising 50% plus, you have pretty good idea of where you stand on buybacks, have less good idea of what your outlook on dividend policies, can you just see how – tell us how you see that payout ratio evolving in the coming years? Secondly on Alcon, you emphasized that you have – I see the cost saving targets achieved one year early but if you can make comments on productivity, so is it correct to assume that you think further margin improvement for that division and if so, can you just tell us whether this is mostly coming from the gross margin, or whether the fixed costs are continuing to shrink further as a percentage of sales?

Third question is on Bexsero, I have not watched too closely as a huge number of European vaccine launched. So can you just point that what’s different to the rollout of a new vaccine versus a new drug? And in terms of your approval, can you launch like the way in sort of the private pay markets in the UK and Germany, is it going, can you launch with free pricing and then [Abnox] is doing – go through the [Abnox] procedure? Can you – is anything different in the reimbursement procedures and to which extent does the inclusion into the paediatric vaccine schedule really slow things down?

Joseph Jimenez

Okay. Let me start on the dividend and then Jon can jump in. The dividend of 2 francs 30 that is proposed is payout ratio, you said 47% of core but it is 65% of reported operating income, I think about 65% of payout ratio. Jon, you want to?

Jon Symonds

That’s right. That is the way that we have – we will continue to look at the payout as part of the actual reported numbers.

Yeah, on Alcon, I tried to signal that actually we’ve done a pretty good job or Kevin’s done a very good job on delivering the synergies. We delivered 370 million which attributes about a three point improvement in margin from the time we took it on although we have given a little bit of that margin back because they are now absorbing some of the research costs.

And so I think at 36.2%, we had a pretty high level of margin and we’re not expecting really in 2013 to see much improvement in that. It does have the launch of [ditria] to come through and there are some important great opportunities in the emerging market. So I think the place to focus on Alcon is a topline and less on significantly improving profitability from here.

Joseph Jimenez

And Andrin on Bexsero?

Andrin Oswald

Bexsero, they have, sort of, seen different form of pharmaceutical. I think the first point I would like -- want to highlight is that their production time for Bexsero is quite long. It takes about six months from the moment when we start to fill it until we can finally release it, which has to go with the quite long sophisticated liquid testing release procedure.

This is why we would expect the supply to be available in sufficient quantity for us to start shipping only the second half of 2013. With regards to what happens then in the respective markets, overall, irregardless almost of the country, we can start shipping instead to the private market once we have product.

However, in most countries, the uptake normally of a vaccine is very low unless you have a recommendation from the public health authority. Now, how you get such recommendations that differs for country.

For example, in the U.K., where I think we are quite advanced and there is a committee which is called the JVCI who will review the submission that we make with regards to the public health benefit of the vaccine including, of course, its cost effectiveness at different price points and that will then make a recommendation to the minister of health of the use of the vaccine. If that recommendation is positive then the vaccine is automatically introduced into our public health campaign.

And what we know from that committee is that they will renew the vaccine in June of 2013 of this year and then make a recommendation. And of course, we prepare for a positive one and if it is positive, it will then start to negotiate exactly how to shape the vaccine to be introduced into immunization schedule, most likely I would say in sufficient quantities however on in 2014.

Joseph Jimenez

So Alexandra, I’m not sure we’ve fully answered your dividend policy question. So let me just try again. We’ve said before that the most important thing for us is to make sure that the dividend remains strong and growing. So we increased the dividend or we’re proposing an increase in the dividend to [2.30 francs] this year which is about just over 2% increase.

When you look at this, that takes us to about 65% payout ratio and we also have to take into account the 2013 earnings. So we want to make sure that there is room, given the importance of the dividend to ensure that it remains strong and growing.

We haven’t announced the share buyback in 2013. We have said publicly that we’re balancing the balance sheet, strong balance sheet together with reinvestment in the business and cash return to shareholders that when we think about our capital allocation policy with the priority being on that dividend while we continue to pay down our debt.

Our net debt is now at just over $11 billion. So as you see us start to recover, there may be a change in approach in terms of buyback while we just have not announced anything formally today.

Alexandra Hauber - JP Morgan

Okay. So given that, I mean, earnings may decline, the payout ratio may rise but if next year earnings are growing, is the payout ratio then going to decline as well as in the payout ratio is really not a number you’re focusing on. And it’s more like the dividend is growing that’s the key message?

Joseph Jimenez

Well, the dividend is growing, obviously, within an acceptable payout ratio. So we want to make sure that we removed the range that we said that we’d stay within in terms of a payout ratio. It is important for us to see that dividend remain strong and growing.

Jon Symonds

I think you can look it as a sign, Alexandra. As Joe said, it is a very significant shift in the Swiss franc rate last year and we took the payout ratio out significantly. If you look over the 16-year period, the growth in dividend has been strong. So we’re committed to growing in. It’s just that we take as the base the reported because that’s the real number. Core is a derivative of it but it’s not a real number.

Operator

We move on to Gbola Amusa of UBS.

Gbola Amusa - UBS

Just noticing with the proposed board changes that – you do have one-off 2014 and 2015 guidance. Both are seemed new IR leadership as well, could you comment firstly on changes to culture at the organization especially around communication and what we might see going forward? Second three questions on your Roche stake is worth over $10 billion and I know you are saying that your strategy going forward is the same but could you confirm that, that stake falls under that commentary, or are you looking at how you view it differently today versus a year ago what will you be? And then lastly on Serelaxin and with this new mortality trial coming in a way it’s your third time around. Could you comment on whether recruitment running the trial analysis and filing might go faster given that you have some experience now testing this drug?

Joseph Jimenez

Okay. In terms of the first question around, let’s say, change in culture or change in communication stands, I think a company that is as big as Novartis evolves over time and while we are rooted in the past we also recognize market requirements and things that we need to communicate in full transparency. And I think you’ve seen over the last probably 18 to 24 months more information, more transparency and more guidance. Now I think this – today we also gave mid-term guidance in a way we haven’t historically and I want to make sure that people don’t think that we’re going to continue to do that in the future but it made sense to do today because when you look at ’13, it doesn’t necessarily reflect what is going to happen as we emerge from our patent loss of Diovan and we start to move into our next growth phase.

So because we wanted to give the market transparency and visibility to what we believe will be a period of good growth for the company that’s why we decided to drive that communication in a way that we haven’t in the past. In terms of the Roche stake, yes our standard answer is that this is a strategic investment and that is worth more than the market price today. So for example, you could not recreate that position in Roche today in the open market. And so there is value there. That doesn’t mean that we will never exit that stake. What it means is that there is a value there that we believe exceeds what we could get for in terms of what if we liquidated today. So I guess I would just leave it at that.

And then Serelaxin?

David Epstein

Yeah, I think your comments are correct in that the more use that in a particular therapeutic area you could better at designing trials that are simple, you get to know the sites and things tend to go a little bit more quickly.

Gbola Amusa - UBS

But nothing granular on how quickly it could get down?

David Epstein

We are not in a position yet to talk in detail about the Serelaxin program and in addition to this trial there will be other trials because there are probably multiple opportunities. At some point during the year we will update it.

Operator

We move on to Seamus Fernandez of Leerink Swann.

Seamus Fernandez - Leerink Swann

Just a couple of quick questions. Joe, can you just give us a sense of your statement with regard to animal health and the consumer businesses which we all know are kind of sub-scaled relative to competitors? We know that they are growing or potentially recovering going forward but is there a true benefit to scale that you see where those businesses would – you would prefer to see them larger inside Novartis or even perhaps – even consider strategic partnerships that could benefit those businesses and Novartis shareholders? And then separately, as we think about Serelaxin, David, maybe you can just give us a sense of how the preliminary kind of positioning would be with hospitals off of a single trial with regard to this product and how you would envision in a cost conscious environment Serelaxin really adding pharmaco-economic value?

Joseph Jimenez

Okay. So starting with the first question around animal health and OTC, I do believe there is benefit to having those businesses in the portfolio, even though today they are not generating the -- at least from the size standpoint, they don’t have the scale to make a significant impact on the results.

They -- for example, Animal Health, this is a business where our research and development people in Animal Health can go into the Novartis Institute of Biomedical Research and they can take products off the shelf for their business and they can develop them faster and less expensively than if they were not part of a company like Novartis. So I think there is benefit.

In terms of OTC, one of our biggest brands in OTC is Voltaren which was an Rx switch. So I think there are strategic benefits to having those businesses. And that said that doesn't mean that we have to acquire in those businesses to make them bigger and bigger more material part of Novartis.

We would consider strategic partnerships in a way that would benefit Novartis. If they were right for the business and if they were right for the shareholders as well as right for the patients and the customers that are stakeholders in those business, so I would not exclude that. David on serelaxin.

David Epstein

Yeah. So in terms of serelaxin, first of all just to remind you, we’ve just submitted. I think there is going to be a lot of discussion around what the right label is with the regulators, so until you really have -- until we really have more clarity on that, it’s hard to know exactly what positioning will be.

But just remember these patients are miserable. They don’t have an alternative and they die. There are other categories either like this. We have some experience like in oncology. So it’s not all about health economics because you’re essentially going to keep people alive.

There were some benefits in terms of reduced hospitalization during the study. But I don’t think that should limit our thinking in terms of how the product should be priced. So we have to do some more work and then we’ll discuss it.

Samir Shah

I think we have time for two more questions.

Operator

We take our next question from Michael Leuchten of Barclays Capital. Please go ahead.

Michael Leuchten - Barclays Capital

Thank you. Three question please, one on Glivec, one on corporate expenses and one on Alcon. On Glivec, we now have generics in Brazil. Could you help us understand what other markets are potentially going to see some decline by generic erosion prior to 2015.

On the corporate expenses, that was particularly light in Q4. I understand there is a reduction in the IT and in infrastructure spending. I’m just wondering how sustainable is that, how much of that is phasing?

And then on Alcon, you’ve called out a warning letter in one of the facilities even though you’re saying it doesn’t have an impact on the product coming out of that plant. So I’m just wondering why you need to call that one out? Thank you.

Joseph Jimenez

Okay. Glivec, David.

David Epstein

Yeah. So there are generics on the markets in a number of countries, the Glivec Brazil, Turkey, and a few others. In fact, there were even some, there were generics out there as you know, around the same time that we launched Glivec. Having said that, there will be some additional countries in the not too distant future, there is some small markets in Eastern Europe. There is Canada, there is Russia. These are probably the biggest ones before the U.S. in 2015 and Europe in 2016.

Joseph Jimenez

And Jon, on corporate expenses?

Jon Symonds

On corporate expenses, you are right in spotting that there was a trend breaking quarter for, I mean, it was the total corporate line was $552 million in ‘11 and $337 million in ’12.

Most of that difference arose in quarter four where there was some true-up on, as we said in the press release, there was some captive insurance adjustments and some environmental provisions that were bit more one-off in nature. So I would not assume that would be an annualized effect but a one-off in Q4 ’12 and go back to normal stream for 2013.

And I would also just point out, at this point that the incremental pension costs from the application of the new standard from 1 January, 2013 will be about [$18] [ph] million -- was [$18] [ph] million in – a quarter in 2012 and will be similar sort of amount in 2013 and that will be reported on the corporate core line.

Joseph Jimenez

And then in terms of Alcon, I can just also answer that you’re right in that this was a very small site in Aliso Viejo, California that produces the LenSx laser. They won’t impact the sales but it -- and also LenSx is quite a small amount of total sales today. But, just, I think due to the sensitivity of some of the quality issues we’ve just decided to disclose it even though it wasn’t material. Kevin, anything you want to add.

Kevin Buehler

The only point that I would add is, is that obviously we take the warning letter seriously. Secondly, we work diligently with the FDA, this is an area that’s around devices and the warning letter was specific to some of the changes that happened when you introduce a new device and so we are working through those issues.

Operator

Our last question comes from Odile Rundquist of Helvea.

Odile Rundquist - Helvea

The first one if you could just give us what has been the impact from the price cut in Europe and if you assumed any negative impact in your guidance for the top line let’s say, versus 2013. Then on the vaccines, they all had quite a good performance 18% this last year. Could you just give us the breakdown U.S., Europe especially versus if you take any market share there, and then give us an update on the pentavalent vaccine that is currently in phase 2, are we going to see any data in 2013? Finally on Ilaris, we have seen a positive opinion from CHMP recently, you’re still in discussion with that following your complete response letter a year ago, where do we stand there?

Joseph Jimenez

Okay. In terms of the impact of the price cuts in Europe across all the divisions, we do have assumptions about Europe in 2013, ’14 and ’15 and we don’t anticipate the pricing environment in Europe getting any better. So we do have it built into the guidance that we gave today. As long as it’s in line with where it was in 2012 which was quite significant, I think our pharma in Europe saw about 5 points of negative price. So that’s what would be in the forecast. In terms of vaccines –

Andrin Oswald

First on Menveo, the majority of the sales come from the U.S. and the U.S. growth is double digit. We of course see a bit slowing down as one would expect after certain period of time but we of course also hope that we will get the (inaudible) indication also which was that –give the brand further momentum in 2014 and beyond. With regard to the pentavalent we have completed the phase 2, I think you mean that ABCWY which is the combination of Bexsero with Menveo, that data looked very good as far as immunogenicity is concerned. We have also not seen any interference between the different components which is normally the biggest risk in such a combination program and based on that now we have to evaluate when and how to start the phase 3.

David Epstein

Yes, as you know we just got a positive recommendation from the CHMP for Ilaris and (inaudible) for patients who have multiple attacks a year and can take other more standard medications. We’re in discussions with the FDA on an appropriate study design. As soon as that’s nailed down we would start phase 3 trial in the U.S. market.

Joseph Jimenez

Great, I'd like to thank everybody for attending, and we look forward to updating you at the end of our first quarter. Thanks very much for coming.

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