Merck's Management Discusses Q1 2013 Results - Earnings Call Transcript

May.14.13 | About: Merck KGaA (MKGAF)

Merck KGaA (OTCPK:MKGAF) Q1 2013 Results Earnings Call May 14, 2013 8:00 AM ET

Executives

Constantin Fest - Head, Investor Relations

Matthias Zachert - Chief Financial Officer

Analysts

Vincent Meunier - Exane BNP Paribas

Holger Blum - Deutsche Bank

Matthew Weston - Credit Suisse

Richard Vosser - J.P. Morgan

Michael Leuchten - Barclays

Graham Parry - Bank of America Merrill Lynch

Daniel Wendorff - Commerzbank

Operator

Dear ladies and gentlemen, welcome to the Merck Analyst Call on the First Quarter Results 2013. As a reminder, all participants will be in listen-only mode. (Operator Instructions)

May I now hand you over to Mr. Constantin Fest, Head of Investor Relations who will lead you through this conference. Please go ahead, sir.

Constantin Fest

Gloria, thanks a lot. Welcome on the call for Q1 2013 results. I'm very happy to have our CFO, Matthias Zachert with me here today. As always, we'd like to briefly go through a few slides in the presentation and then we'll be happy to take your questions.

With this, I'd like to immediately hand over to Matthias.

Matthias Zachert

Warm welcome from my side as well. I move to page four of the presentation directly and address the highlights Q1 2013. First of all, let me comment on the sales development, which posted 4% growth rates reported wise reflecting however a nice 5% organic increase.

Of course, over the last few months we have seen that currencies developed more unfavorably compared to 2012 and this is a theme we are going to see throughout 2013 most likely.

As far as our transformation program is concerned, we can report that we are running well on track and it’s become visible when you look at the EBITDA performance, which for the first time in Merck’s history reached €800 million.

Based on the first quarter results and the outlook that we had for our business in 2013, as a management team we today announce that the original target for 2014, which was conveyed to you on the 15th of May last year will be brought forward to 2013 already, and here at the higher ends of the range that we have communicated. I think this is also a confirmation that we consider ourselves well on track driving organic growth but also delivering bottom line results which for Merck was not always the case in the past.

With this I’ll turn my attention to page number five and here I would like to highlight that all divisions contributed to the sales developments in the first quarter 2013, while of course, on the currency side we saw that all divisions respectively had a shortfall driven by the Japanese yen and the U.S. dollar.

On the lower part of the slide five you see that the base in Q1 2012 is the lowest one, Q1 ’12 was a clearly as far as the underlying profitability was concerned, the lowest in the last 12 months we had than rather quarters in the area of 740 to 760, and therefore you see a growth momentum versus previous year that in Q1 versus last year’s quarter is surely quite pronounced. This will level off in the quarter’s to come.

Two bigger contributors to the profitability are notably Merck Serono and Performance Materials, and different to last year, where we faced hedging losses, we now see credits from our risk management protection basically stemming from the Japanese yen, but also slightly from the U.S. dollar.

Let me turn the attention to page number six and here we’ve given overview on where our sales are stemming from, on the left hand side of this slide you can see the good portion that our group is reporting in the emerging markets and this is most likely going to increase cost of the entire year due to the growth rates that you can see on the right hand side of this very slide.

So here the two points I would like to stress, Europe continues to be sluggish, even though we are able to report in Q1 a growth rate of around about 1%, we are more conservative here for the next few quarters, whilst the emerging markets, we are quite strong with organic growth being in the range of 11 percentage points.

So this is a theme we’ve already seen in course of 2012 and its most likely seen that its going to continue over the next few years, whilst Europe will definitely still face a competitive pressure on the pricing side, whilst the emerging markets will see upward momentum on the volume side.

Let me now be more explicit on the financials and with this I move to page number eight. Here I would like to make four statements, one on the absolute EBITDA, but also on the structural improvement that you can see with 30% EBITDA margin. Also this is something that’s for Merck is an achievement which can be reported for the first time on an operational basis.

It was predominantly being stemming from organic growth, higher production yields in the gross margin, but also through the nicely implemented changed cost structure. This was running through on EPS pre and it was also leading to a very favorable operating cash flow of €516 million, which is further improvement versus last year. And I make special note of that because in the first quarter we had one-time costs in terms of cash outs, which we are in the neighborhood of €100 million.

And for that very reason I would like to stress that the first quarter cash flow momentum has been sounds and helped us to delivery on the net debt reduction which is also reported on the slide leading to a roughly 20% increase of financial net indebtedness.

Let me now turn to the [linked] reported numbers on page number nine. Beside having one-time charges of around about €75 million we could report an EBITDA increase of roughly 30% and on top of that we were able to reduce financial charges due to the bonds repayments that we did last year and also things through some tax optimization in cost of 2012.

We had some further one-time positive tax credits in the first quarter ’13 we could come out with a relatively benign tax ratio of 21%. So operational improvements, financial results and tax optimization, of course, then nicely increased EPS reported by slightly more than 50%.

Let me now comment on the divisional performance and here I start with our Merck Serono business, first of all. The organic nice growth of 4% is the theme that you have seen already in course of the last few quarters. And here basically driven by the pricing that we introduced over the last few months on Rebif also in light of the Rebidose launch.

Whilst Erbitux had a relatively moderate performance in 2012 first quarter and therefore has posted a nice growth. But I would like to reflect also here that launch of our head and neck in Japan contributed nicely to the volumes performance. And overall, not only for Erbitux, but overall the emerging markets has concluded earlier, performed very nicely and all in all, this was leading to the nice organic sales development.

On the marketing and selling side, you very clearly see the implementation of our initiatives coming through in the P&L. So despite organic growth you see a further reduction in absolute numbers and of course, very visibly also in the relative numbers to sales and this is running down to bottom line improvement.

On the R&D side, I would like to reflect the following, of course, we have started further early stage projects leading to costs, we had some one-time charges on top of that and there is one element that we would see in the fourth coming quarters as well that we start to, in line with our financial targets invest in further lifecycle managements and in some, of course, emerging markets as well in order to take care of future growth rates.

Let me now turn your attention to page 11 and here the Consumer Health business. The one element that we see here in Q1 is one that should be familiar through yourself, this is the relatively long cold season unfortunately not with sunshine but with rain and for that very reason we saw quite a uptick in the cough and cold product range.

Our lovely Nasivin which by the way react extremely fast and last long, so who ever has faced flu or congested nose, most likely has experienced the strong efficacy that Nasivin is bring to your nose.

And also Bion 3 in terms of vitamin was nicely demanded by our end customers and because of that sales momentum was quite upbeat with some moderate base than Q1 2012.

So this was driving organic growth and of course, please do not expect that the same kind of seasonality will be one that is visible in the second quarter. So be pleased more realistic with your assumptions going forward.

On the bottom line side you see the improvement to €40 million EBITDA in absolute terms. This is a nice structured improvement and shows that when momentum is going right -- into right direction on sales meeting a good cost structure than profitability structurally of course moves up.

I would now like to turn your attention to Performance Materials. This was definitely a division that performed better according to our internal expectations and we saw here a quarter where we had strong January and modest February, and when we went out the streets in March and reported full year numbers to you. We were still assuming that March would be softer and that turn out to be another very good months again.

So here we clearly can convey a strong results, set of results, not only on the organic side in terms of sales growth, but also bottom line profitability and the two reasons behind that is definitely the contribution coming from PS-VA and IPS. Both products has been further refined over the last several quarters.

So here the products are very much likes by our end customers and for that very reason we saw strong momentum in PS-VA, which predominantly used in the television display application. Also IPS saw strong momentum not only in the television display but also in the tablet and for that very reason this lovely two products contributed nicely to topline performance.

For the first time, I would like to draw your attention however also to Pigments and Cosmetics. My words in the past has been more humble on this business units, but we’ve seen that the sales momentum kept delivering good results, but now for the first time meeting a healthier cost structure and for that very reason we came with relatively strong results in Q1 2013.

I would like to address, however, two watch outs that Pigments normally has the strongest Q1 seasonality-wise and a very good Q2 as well, softening out in the third and fourth quarter, which predominantly has to do also with the seasonality of the biggest end customer for the coatings segment here the automotive industry, which are more moderately asking for volume in August and then again in December, so for that very reason the first half stronger than the second. And as this division will contribute more profitability in course of 2013, you might see the slightly seasonality coming through for the very first time.

So that’s the one watch out. The other watch out is liquid crystals which we have graphically provided to show to you on page number 13. And I am now guiding for one to two quarters on a potential destocking and the reason behind that is visible on this slide.

We’ve seen over the last two quarters basically that stocks are moving upwards and we are now not in a situation where we have completely overstocked end customers situation but we’ve reached a situation where basically there are three to four weeks of incremental stocks versus the normal range, and for that very reason our expectation is that this is going to unfold or unwind in course of the third and fourth quarter respectively.

We still see reasonable momentum now in Q2, but therefore we clearly would like to highlight, give you the rational behind that, the fundamentals in liquid crystals are not changing but of course in the chemicals industry sometimes you see more stocks less stocks which we have to track, and for transparency reasons we are tracking this for the last one to two years in order to prepare the market with facts so that you can make your cost accordingly.

With this, I would like to move on to page 14 and here comment on the nice organic performance. If you look into the life tools industry, especially the companies that (inaudible) now reported in the U.S. You see that the growth in this industry has been moderate to say the best reporting numbers on the organic side between 2% and 3%. So with 3%, 4% we are not doing badly, which was predominantly driven by our Process Solution business which we in detail explained in the fourth quarter last year. So here we had high single-digit organic growth.

However, in the business unit that is exposed to the academia. In the U.S. we clearly saw softness coming from the sequestration and here we were flattish. So for that very reason we have to look at this division with exactly this perspective. Process Solution is our big flagship should continue driving the organic sales whilst in Bioscience most likely we will continue to report modest numbers in course of 2013 for the reason I have mentioned.

We continue also to invest here in the R&D area and this is basically in the Process Solution camp and of course, strengthens our sales force and that has led to the overall profitability performance, which was slightly below last year.

Here, however, my feedback is different to Performance Materials that the momentum should be more positive in the next three quarters, so whilst I’ve been a little bit more moderate on Performance Materials. Here my guidance to you should be that in the next three quarters profitability is expected to be above previous year.

I now move on to page number 15 and address the balance sheet, but only here two comments on the gross financial debt, of course the figures by and large on the level of previous year and here the reduction should only occur in the second half when another bond is going to mature. Fortunately, it’s -- we can now address a bond that has relatively high interest rate.

On the net financial debt, I already provided you with the feedback that the good organic cash flow generation was enabling us to further reduce our net financial indebtedness. This becomes visible on page 16 when you look at the operational cash flow before working capital and then also after working capital implications.

Like indicated to you with our fourth quarter conference call we were building up working capital in Q1 because we had a relatively low rate of 22% to sales. We are still at a very good rate of around about 23.5% or 23.6% on the last 12 months sales, so we keep at the lower end of our guidance of round about 25% to sales and therefore, you see that with the reasonable level of working capital, good operational performance the operation -- operating cash flow was healthy.

Let me now turn to page number 18 and here’s our guidance. As communicated this morning, we are able in light of good organic growth momentum and good execution on our transformation program which is implemented faster than we originally expected. We are able to advance our targets for 2014. So we move them upwards on sales. This is net sales and not total revenue.

And on EBITDA pre, we had originally the €3 billion to €3.2 billion and now we can bring this forward by one year, however, at the upper end. The same holds true for EPS pre, and with this, I think it gives you more clarity on where we are driving for in course of this year.

A little bit more color on the segments I would like to provide on page number 19. So here Merck Serono moderate organic sales growth, whilst EBITDA pre should be in the range of €1.9 billion to €2 billion EBITDA pre.

Please take note of the fact that normally sales-wise Q1 is more moderate quarter. We’ve seen also last year that Q2 to Q4 are pretty say stable topline-wise and we should see more, of course, benefits coming from the efficiency as we go into the next two quarters, and therefore, here we should see profitability-wise a slight uptick in the next quarters which is reflected in the guidance that is shown here.

On Consumer Health, my request to you is be moderate on your expectations for Q2, profitability-wise it’s tough comparable benchmark that was reported last year in the second quarter. Q3, Q4, we just strive again for better profitability versus previous year.

On Performance Materials, we clearly factor in here a more moderate performance in Q3, Q4 due to the destocking that we assume is going to happen and for that very reason we factored in round about two to three weeks of destocking to unfold in third and fourth quarter, but this I clearly would like to stress is not in our hands.

Our customers take the decision on when to build up stocks and when to release them in the markets. The only thing that we would like to provide to you is the transparency so that you can understand our underlying operational performance.

And I think from the underlying operational performance it should be clear that we like this division, we like this business and for that very reason, we are looking forward to hosting the liquid crystals [Deep Dive Day] on the 26th of June in order to explain this business in more detail and also to reflect a little bit more our audit business which we also possess.

On Merck Millipore, my feedback is the one that I’ve just given to you to Q4 are expected to be profitability-wise better than previous year and with this I think we’ve provided you all granularities so that you can adjust your view on our financial model for Merck.

And with this, I would very much like to open the Q&A session, and please use the devices to make yourself heard.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) The first question comes from Ms. Vincent Meunier by Exane BNP Paribas. Please go ahead.

Vincent Meunier - Exane BNP Paribas

Hello gentlemen. I have three questions indeed. The first one is on the outlook especially looking at 2014 because you have [pulled forward] on the former full year of ’14 guidance by one year and what about indeed the guidance for 2014?

The second question is on net revenue and especially on Rebif, can you give us more color with regards to the ongoing launch of oral drugs, Aubagio and Tecfidera and [Tcelna] the impact in terms of market shares and patient warehousing, and also the pricing expected in the future?

And the last question is on Performance Materials. You say that you have little or limited possibility to control the inventories with your customers. Is this something you can change and improve in the future or not? Thank you.

Matthias Zachert

Vincent, thank you very much for your questions. Let me take them one by one and I start with 2014 target. Well, the positive element I think is here that we were able to do everything execution-wise to deliver ’14 target already ’13.

And now please understand our view, and especially now the view of the CFO. I think if you have a target out there, then you have to make it first of all before you announce something new. This is for me simply a question of credibility. If you start announcing a new target before even having made your first one, then it’s at least a style that I consider as strongly debatable, and for that very reason please understand that we now would like to deliver quarter-on-quarter our ’13 numbers to you.

And then, of course, we have to reconsider our next set of numbers, what we would like to strive for in the future and at the given time, of course, this is something that we will then again convey, so that you know when Merck will head to in the next several years. But let us first of all now continue with execution process and deliver the numbers we have stressed today and that is all I would like to say on the ‘14 targets, which has no turns to 2013 targets.

As far as Rebit is concerned, there is a lot of movements of course in the market. And I’m sure that you are watching this as carefully as we do here in Merck and of course in Merck Serono. And so both products that have come to the market, Aubagio and Tecfidera or BG-12 are being analyzed.

On Aubagio, I think here you don’t see that the market is changing that fundamentally. It’s of course taking the little market share here and there that is desperately the case but the big watch outs has always been I think on your end but also on our ends on Tecfidera.

And Tcelna, just five weeks in the launch periods, now six weeks and I think it’s pretty early to make a call at this point in time. We see that the launch has been successful but on five weeks, you can truly not make a call. So I think this is something that everybody is watching in the industry and so we’ll follow accordingly and then we would communicate accordingly.

And I think in the first place, already a few months ago, highlighted to you that we expect for our product Rebif, first of all, a growth half year, first six months of 2013. And then we are going to see erosion on sales on Rebif in the second half of the year, factoring in a very strong performance of BG 12. If this is not going to come for the entire year, we will have to see but we took a very cautious stands right at the beginning and we keep this cautious stands today.

As far as pricing is concerned, that’s the final part on your Rebif question. We just went out in February with price increase once we launched RebiDose. And now at the current setting of the price regime, we think this is the reasonable price. So in our financial guidance that we have communicated to you, there is no further price increase factored in on our good Rebif products.

Now, the last question on the Performance Materials, we have -- can we change our customers on their stocking habits. It’s the privilege of the customer to decide if he wants to have more stocks or less stocks. What’s Merck never provided in the past was to the financial community transparency on stock levels of the customer side. So this is something that we’re try not with audited statements of course, but this is something that we can try to inform ourselves about and communicate to you so that we can highlight to you is there pressure on the chain or not.

But it’s not up to us to make the customer with stocks or release them. So this is entirely in the hands of the customer and therefore the work that we do is transparency to you so that you can understand. But I think this is all we can provide on this end.

Vincent Meunier - Exane BNP Paribas

Okay. Thank you very much. Very helpful.

Matthias Zachert

You’re most welcome, Vincent.

Vincent Meunier - Exane BNP Paribas

Merci.

Matthias Zachert

[Foreign Language]

Operator

The next question comes from Mr. Holger Blum of Deutsche Bank. Please go ahead.

Holger Blum - Deutsche Bank

Yeah. Holger Blum, Deutsche Bank. First question on the -- on numbers for Merck Serono (inaudible) €50 million, €60 million higher and still went one up year-over-year. Is it related to the threshold milestone payment in Q1? What are the other key drivers for that?

Second question on the Performance Materials division, you have 740 basis points improvement in gross margin. Could you maybe explain a bit more to what extent was normal operational leverage mix or any other special items impacting the quarter?

And then the third and final question, I understand that you do not want to be specific on 2014 but maybe you can demand us on your general ambition how to develop Merck going forward and without providing concrete math with us whether you would be satisfied with (inaudible) of the year is difficult or maybe you can give us a bit of mid-term inspiration? Again, thank you.

Matthias Zachert

Thank you for questions. I have to admit that line was not very clear. So I will address question two and three and have to ask for the first question again. The reasons for the improvement in the Performance Materials gross margin are two-folds. First of all, Pigments went up in terms of contribution. So here we had, at least for my standards in the Pigments industry, nothing but acceptable margins in course of 2012 for basically the entire year.

And we have now seen a visible improvements in the contribution stemming from basically the closure that we have communicated to you a few months ago with Q4 results. So here in the Pigments division, we clearly saw an improvement in the gross margin and this is one that’s not always at the same level. But the structural improvement where we addressed utilization rates upwards to the structural improvement as one that you could -- should also see in the next few quarters.

The other element is of course the bigger business units, liquid crystals in tier where there is 10% organic growth that you have seen. It’s simply the matter of capacity utilization. So the products also contributes PS-VA especially but it’s been secondly a question of the capacity utilization. If the capacity utilization is very high, of course, you earn extra points on the margin.

So these are basically the drivers behind the gross margin improvements with of course the statement on the liquid crystals don’t expect the same capacity utilization running through for the next three quarters.

Now, on 2014, I understand your view and I ask also for your -- I also ask for your patience on 2014. My answer at this point in time would be the following when I look into the management teams of Merck and the divisions -- and if look at the management team at our port, our -- we don’t want to standstill in this company. So we have announced just 12 months ago that we would like to bring Merck forward to improve the company, to introduce a performance culture, to be hungry for success.

And if you assume that this all comes to a standstill with today or with the achievement of 2013 targets then I hope that we would be able to prove you wrong. But let me then come back to, first of all, the announced targets that we have given, this is a target that we first of all need to deliver and then let’s see what we can communicate in terms of appetite for the years to come.

On the first question, I have not understood it. The line was unfortunately not very clear. So please ask -- I ask you to please repeat the question again.

Holger Blum - Deutsche Bank

Yeah. The first question was on Merck Serono R&D was $53 million higher sequentially versus Q4 and just wondered, were that exceptionally high due to the milestone of $30 million of threshold or with other special drivers or what would be the run rate from here going forward. So R&D on Merck Serono?

Matthias Zachert

I understand. So here, what I would like to indicate is that the three elements that I have selected earlier on, we had some of course further increase in costs on the variable side for threshold that is one but also if you look into Phase I, Phase II, we are now more fortunately things through the strong performance of the discovery but also the development organization and through the smart decisions that Annalisa Jenkins and Stefan Oschmann are taken.

We are now in a far better position in Phase I, Phase II so that we spent money in early clinical. But then also the other element that I highlighted, we clearly would like to allocate some money also on local R&D for lifecycle managements. And these two elements contributed but then also we had one-time costs in the R&D line, which we will not specify but of course, when we mentioned them, you can assume that this is not only $1 million but it’s a few million that we took as extra charges in Q1 that will not reoccur in the quarters to come. And the other two elements I mentioned, first, however are ones that will also be visible in the next few quarters.

Holger Blum - Deutsche Bank

Okay. Thank you.

Matthias Zachert

You’re most welcome.

Operator

The next question comes from Mr. Matthew Weston, Credit Suisse. Please go ahead.

Matthew Weston - Credit Suisse

Good afternoon, gentlemen. Thank you for taking my questions. Three if I can, you mentioned in your Q1 report that pharma SG&A was flatted by decisions to postpone selling expenses but they will come through in the second or in the remainder of the year. Can you give us some indication of how much SG&A was postponed and why that decision was taken?

Secondly, also in pharma, you make it clear that you have strategically decided to fully implement your biosimilar strategy and you clearly highlight oncology as the target market. Can you give us some indication as to why strategically you think you will succeed in oncology biosimilars when so many people have recently pulled out. And also some indications of where your programs are in the magnitude of the investment you intend to make?

And then finally, you’re obviously cautioning on LCD trends and the risks of the de-stocking later in the year with clearly a very good way through Q2 already. Can you give us some indication as to whether your caution is because you’ve seen this trend happening already or whether or not you assume it will happen after what people assume has been a strong run up into the Chinese May day holiday?

Matthias Zachert

All very valid questions, Matthew. So let me address them one by one. On Q1 reports, I’m very happy that you have read the Q1 reports, so also my respect for this. And let me explain this paragraph a little bit more on detail. So I clearly stress on this call that we have advanced further on execution of cost savings and this is clearly something that takes -- shows clearly handwriting of the land.

And so the other element that of course Stefan and B'Elanna always looking at, that’s beginning of the year. You accelerate not immediately on all your investments in the commercial space that you see how your overall business is performing. So you’re more carefully at the beginning of the year.

And when you see that the organization is up, the speed numbers are being delivered according to the financial plans than you are more willing to invest in order to fuel the growth for this year, next year. So this is how you basically have to read that, so we keep our ammunition for the next few quarters and reflect in the Q1 reports that we would like to continue strengthening our commercial operations organization and this is therefore, quite rational decision making.

The amounts of money -- I excuse I just announced now indicates. But I think by and large you see that marketing and selling line despite organic growth below previous year, which is predominantly stemming from the savings because last year, we already took the same approach on muted investment in Q1 and then accelerating a little bit in the quarters to come.

Now, on the second question on biosimilars, your statements are all valid. Of course, we indicated we are looking into oncology products, but have stated also that this is not the only field of interest but definitely current products we are looking at are oncology. We also take note of the fact that other competitors have pulled out, that is nice. We had not pulled out like the few others. We would wish that everybody pulls out but us, or only two to three remain in the race. And all of us are still reviewing biosimilars.

I have seen (inaudible) biosimilars where one competitor of ours was extremely bullish. Others are muted. Our view is -- let’s first of all do our groundwork. I think Stefan Oschmann is very specific about that. And the groundwork resets will happen on the next 12 months and before we go into clinical here, of course we first of all have to see if we can truly clone the compound and get the right quality. And once we have done that, we will take further decisions on the investment approach and that’s the game plan we have for biosimilars.

In terms of investments, I highlighted in the March call that for 2013, we assume round about €80 million to €90 million of R&D costs. They have not been visible in Q1. They will gradually move up in the next few quarters solely for the biosimilars initiative and therefore, this is part of our financial guidance.

Now, I would like to address your question on LC trends. I have guided earlier on in the call that our assumption is that the destocking will occur in Q3 or Q4. For that, the reason it implicitly answers your questions. Our expectation is not that this will unfold in Q1. In Q2, the momentum as we have seen so far in April and May is okay. Of course, we are hitting a tougher comparable base versus previous year.

But therefore, we don’t see a lot of destocking happening right now and therefore we look with positive spirits to our capital markets or Deep Dive Day on Liquid Crystals on the 26 and might be able to update you end of June if we not see anything happening in July. And therefore, this will be an ongoing question I think we will have in the next few weeks, when I see all of your or the investment community.

Matthew Weston - Credit Suisse

Thank you.

Matthias Zachert

You are always welcome.

Operator

The next question comes from Mr. Richard Vosser by J.P. Morgan. Please go ahead.

Richard Vosser - J.P. Morgan

Yeah, from J.P. Morgan. Thanks for taking my questions. If I could just ask around the destocking, again in liquid crystals, apologies. It’s the build up in the stock is due to the ramp of the Chinese manufactures, is there a chance that this actually increases for the rest of the year and therefore, I’m just trying to get a handle on what triggers the customer’s reasons to destock general demand in China, or if you could give us some help there that would be very useful?

Secondly, on Liquid Crystals, just clearly your sales are mainly dollar denominated but how does the Japanese yen affect the competitiveness of your competition coming out of Japan? Is that something that we could see in the second half of the year as well, or is that really for contracts decided next year?

And then, finally on FX in more general terms. Just how should we expect the FX to develop in the remainder of the year and in particular, how you see that in Merck Serono and Liquid Crystals? And actually one final question just on Rebif, on the inventories. How are you assessing your inventories with distributors currently? Is there a chance that we see some destocking in the coming quarters? How do you feel about that? Thanks very much.

Matthias Zachert

Well, quite a number of questions. Now, let me address the destocking question first of all. It’s not so much related to only China. I mean, this is something that we saw in Q4, Q3 starting and it is remaining give and take the same level. We simply see that in all the countries where we sell our products to being Taiwan, being Japan, being China, being Korea, we see that stock levels are healthy. Also at the end customer, meaning on the top floor or on the storage and the store, I think that’s the right word.

We see simply that there is -- at the final retailer sites, inventories and also at display sites. And for monetary reason, we cannot guide to only one markets where we see slightly higher levels, but basically see that the chain is round about these three to four weeks. This is not -- don’t get me wrong, this is not something like in 2008 or 2009, when we had I think six, seven, eight weeks of supplies. So this is something that is still at the higher end, but not starting to be the ultimate concern. But it is something that we try to track, communicate also that you understand why we are more cautious here.

And after -- I have read two years ago several reports that analysts were feeling uncomfortable or were asking always for clarity on the stocking side. We introduced this kind of transparency. But unfortunately, I cannot provide more than this information to yourself.

Now, on the second question on the Japanese yen. The first point I would like to make, Liquid Crystals is a product that would eventually not be decided on currencies but quality of the product. This is the differentiating factor. Please recall that Liquid Crystals only makes 2% to 3% of the procurement build for the displays. So it’s not the currency that eventually drives the decision making, or only the price that drives the decision making.

Of course, price is important but the quality is more important. So here we, of course look at the Japanese yen. And as far as the devaluation of the yen is concerned, of course this is not as nice as in the past, but nevertheless we don’t lose with this our overall competitiveness, which we do not only hold because of currencies but because of our international footprint, our innovation and quality leadership that we have and the market access that we have. So that is eventually driving the decision making.

Then, on the third question of the currencies, well, I’m looking at the same currency reports, most likely that you are all looking at the different researches that we have on our major currencies being a U.S. dollar, the Swiss franc and of course Japanese yen. And so our assumption is on the U.S. dollar that we stay at the rate that we have communicated with our guidance. With this, we have made our financial projections and the same we have communicated upon the Swiss franc.

On the Japanese yen, our current assumption is that it stays around this 125, potentially 130. I would like to give the indication, however, that on the Japanese yen, for the next three years. We talked already last year quite cautious positions. So our hedging position in the Japanese yen is round about 40% to 50% in this strike rates that we have concluded or contracts with are between the 100 and 108. So we were already last year quite cautious on the Japanese yen and for that very reason, it does not sent shivers down my spine.

Now, the last question was on Rebif inventories. We guided with March on a softer Q1 momentum on Rebif on the volume side due to the fact that we saw notably in the U.S. higher stocks on Rebif and also on Gonal-f that basically unfolded by one to two days in Q1. So now, we are at moderate levels, as the normal rates, day rates that we have that we currently have. And therefore, we don't consider that in the next few quarters, we will see similar affects like we’ve seen in Q4 and therefore, it’s not an element that we effectively have communicated in our quarterly reports because we consider that this is now normal trading.

Richard Vosser - J.P. Morgan

Thanks very much.

Matthias Zachert

You are most welcome.

Operator

The next question comes from Michael Leuchten by Barclays. Please go ahead.

Michael Leuchten - Barclays

Yeah. Thank you for taking my questions. Two questions on Serono, please. One simply the COGS ratio seems quite favorable in Q1. I was wondering if you could elaborate on that. And then a broader question. If I take your guidance for Serono on the topline and the EBITDA, the implied operating expenses, core operating expenses suggest that not all of the incremental €150 million in savings are all coming from the bottom line this year. If I remember correctly, you insisted that you thought the savings were net savings when you offered those. I was just wondering if something has changed or whether I'm looking at this thing incorrectly.

Matthias Zachert

Let me -- Mr. Leuchten, let me start with the second question immediately. I think what you potentially missing your analysis, is the royalty income that we're going to lose. So this is something that is unchanged and therefore, we have to offset to our savings also other shortfalls that we knew last year and that we communicated to you March this year. They are part of our guidance and remain unchanged. And for that very reason, there is nothing further to add. This is point one.

Then, point two on the COGS side, the statements we make in our report that we had very favorable momentum in the first quarter, but also driven besides pricing initiatives being driven by yields, which you often see in biological pharma production when you have higher utilization rates when you have higher yields on the production chain that you also post more favorable gross margins. And that is something that's, of course with a certain level of volatility. Sometimes moves up months, sometimes moves down according to your internal production schedule.

Michael Leuchten - Barclays

Very clear. Thank you

Michael Leuchten - Barclays

You are welcome.

Operator

The next question comes from Mr. Graham Parry by Bank of America Merrill Lynch. Please go ahead.

Graham Parry - Bank of America Merrill Lynch

Thanks for taking the question. On Rebif guidance, can we read your comments that you’re no longer confident to say that you would expect the product to be stable this year, staying with the prior guidance. Secondly on Performance Materials, could you actually quantify how much of the margin uplift year-on-year is inventory versus mix and of the mix benefits?

How much of that is due to just ordering patterns between PS-VA and IPS and TF-TVA, or is it something just because of this sustainable shift in the market towards those technologies and therefore it makes benefit you would expect to continue throughout the rest of year?

Thirdly, on 2013 guidance, the EBITDA is broadly in line with consensus but EPS is a little bit higher. So, where do you think consensus could be to trending, is that too pessimistic? Is that net financials or tax rates? And then finally, you were alluding on the full year quarter additional savings beyond those announced in Merck Serono, anymore clarity on that at all, or is that something that we should have to wait until full year results of 2013? Thank you

Matthias Zachert

Graham, I only can guess on the question you have raised because your line is -- excuse, my English is extremely bad, if not to say holding. So you need to -- hopefully, it works next time. The first and the last question, I would already start with the second and the third question, but I have not understood at all, question one and four.

So on PM, everything that I have said, please consider this on the gross margin for the next few quarters, i.e. capacity utilization, potential destocking. For Q1, specifically if this was your question, of course the mix was favorable because PS-VA and IPS are mix wise more favorable products to us. They are further refines, they are more differentiated and for that very reason, we would like to post more sets in PS-VA and in IPS.

And so, here we’ve clearly seen and we will explain that in further detail on the 26th of June that there is nice tendency currently toward PS-VA for reasons that we will highlight in June. It’s the high density or ultra-high density that televisions that are currently quite light, point one.

Point two, we see more and more that people most likely outside of Germany are trying to gets televisions that have 800, 100, 20 inches at least in rooms that I have seen in Germany that would be quite challenging so. But they are parts in the world, where 80 to 100, 20 inches are loved. And we love this big television because they often use PS-VA.

So this is definitely positive for the mix in Q1. The second element that is positive to the mix was the thickness business that had higher capacity utilizations and therefore contributing also to the gross margin improvement.

Graham Parry - Bank of America Merrill Lynch

On the PS-VA mix, the question was just whether that was due to particular ordering patterns for the quarter or whether it’s a sustainable trend?

Matthias Zachert

Of course, the comment I have made on the destocking, we assume that PS-VA will have a healthy year in close of 2013. And it had already an uptick in the second half of the last year and it’s continuing with a healthy momentum in 2013. And our assumption is that it is something that will be seen for the entire year, but of course with a caveat that I have made before on the third and fourth quarter.

Now, I come to the EPS question. I think here on that very ends, I think we are simply narrowing the guidance on EPS. We had before the €8.2 to €9 on EPS pre and now we further refine that to €8.5 to €9. And therefore, I think this is not a fundamental change simply of higher precision, like we do with the EBITDA pre. Also, here we went from three -- from 3 to 3.2. We changed to the higher end, 3.1 to 3.2. So you have to see that in line with the EBITDA guidance. And on your first and last questions, I’m sorry again, you need to repeat the question please.

Graham Parry - Bank of America Merrill Lynch

Yeah. So it’s a little bit closer. The first one was on Rebif guidance, just based on the comments that your making earlier on the call, is it fact to say that you wouldn’t confident say expect to -- the product to be stable this year any more which I think is the prior guidance?

Matthias Zachert

Not. There is no change at all to Rebif guidance. So we have no different level of confidence than we had six weeks before. So same level of confidence and we keep the same level of guidance even though we have to clearly state, I think Q1 Rebif performance was a solid one. But of course, we also want to watch further development of competition and then precise the guidance on the course of the year also on Rebif.

Please understand this is just first quarter and so within the first quarter, you don’t want to -- you don’t want to too precise on market environments where you know they’re changing and for that, the reason we have taken a modest approach at the beginning of the year and there is no reason to change this view now with first quarter report.

Graham Parry - Bank of America Merrill Lynch

Great. And then the final question was, you’d alluded on the full-year call traditional cost savings. You only announced cost savings in Merck Serono, just looking for any more clarity on that or do you have wait for the full-year 2013 results reports for that?

Matthias Zachert

This -- let's put it like this. I think it’s rather your sides -- on the analyst’s sides, that’s alluded to further savings and you alluded to the fact that we are well on track. And there was the question raised in Q4, what would we do with further savings? And my answer was if we find more savings, you should also assume that we try to build our future momentum in this group and would invest in our business. And that was the statement and there is no change to the statements compared to six weeks ago.

Graham Parry - Bank of America Merrill Lynch

Okay. Thank you very much.

Matthias Zachert

You’re most welcome.

Operator

The next question comes from Mr. Daniel Wendorff by Commerzbank. Please go ahead.

Daniel Wendorff - Commerzbank

Hey, thanks for taking my questions and two are main and one follow-up question on the performance materials division. And can you potentially quantify the positive margin impact from the efficiency gains you have made in the Pigments business.

And the second question is related to the Merck Millipore division and you mentioned that we should expect better in the adjusted EBITDA margins, EBITDA pre-margins from 2Q -- Q2 to Q4 last year. Is that due to efficiency gains and to the special marketing and selling investments and still burdening Q1 come to an end now as of Q2. So any more color there would help?

And maybe one housekeeping item. On the financial results, can you potentially comment on how this will affect from Q2 to Q4. I assume that Q4 will be rather than the lowest number for the financial expense I would assume? Thank you.

Matthias Zachert

Again, let me address them one by one. I’ll start with performance materials. On Pigments, I think we’ve indicated with Q4 roughly €10 million for the next few quarters. So that is basically the savings that you should factor in for 2013 on the gross margin side because it’s basically having positive implication in this area, however slight efficiency improvement are also in the selling expenses.

On Millipore, I have not alluded to what’s a margin expansion. My feedback was absolute EBITDA. So here, I simply look at the EBITDA reports in Q2 to Q4 last year. And therefore assume that’s the increase in guidance or the EBITDA guidance that we provide on the full year 622 -- 640 is automatically factoring in an increase in EBITDA for the next few quarter and that’s should spread evenly over the next three quarters.

On the financial result, you can basically assume the run rate that we currently have for the next three quarters and the fourth quarter you should then see a reduction due to redemption of the outstanding bonds, which carries a higher coupon. But in the first three quarters, this I mean -- give and take a little here and there on local rates, local financing -- we have some local financing in emerging markets that leap sometimes to million more and million less.

Then of course, you have the pension costs that also run into the financial results that sometimes varies with currency as well or pension rates. You have also in the financial result, the hedging results, parts of them which sometimes vary with Black-Scholes calculations. So there is something that sometime is due to little volatility here and there but the underlying financial expenses stemming from the interest rates are pretty constant over Q1, Q2, Q3 and then you see the drop in the Q4 due to redemption -- the potential redemption of the bonds.

Daniel Wendorff - Commerzbank

Very helpful. Thank you.

Matthias Zachert

You’re most welcome. Any further questions.

Operator

There are no further questions.

Matthias Zachert

We thank you very much for your attention, affiliates to this call. And we are looking forwards to interesting meetings that we will mostly likely have in the next few days while being on the road. And we would strongly like to welcome you and to invite you, first of all on the 25th for a dinner and meeting colleagues of mine. And then on the 26th of June, here in Darmstadt for the liquid crystals, OLED deep-dive day of Merck and so looking forwards to have interesting meetings on the roads and end this meeting with you. Thank you very much. Thank you for attention. Bye-bye for Merck. See you soon.

Operator

Ladies and gentlemen, thank you for your attendance. This call has been concluded. You may now disconnect.

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