Novartis's (NVS) Management Presents Shareholder Analyst Conference Call (Transcript)

| About: Novartis AG (NVS)

Novartis AG (NYSE:NVS)

Company Conference Presentation

March 31, 2016 08:00 ET

Executives

Samir Shah - Head, IR

Nigel Trotman - Business Planning & Analysis

Paul Penepent - Financial Reporting & Accounting

Analysts

Kerry Holford - Exane BNP Paribas

Alexandra Hauber - UBS

Damien Conover - Morning Star

Operator

Good morning and good afternoon, and welcome to the Novartis updated 2015 segment financials reflecting new division structure conference call and live audio webcast. [Operator Instructions] With that I would like to hand over to Mr. Samir Shah, Global Head, Investor Relations of Novartis. Please go ahead sir.

Samir Shah

Thank you and good morning and good afternoon everybody. With me today we have members from the finance team; Nigel Trotman from Business Planning and Analysis Team; and Paul Penepent from Financial Reporting and Accounting. We also have members of the Investor Relations team from Novartis.

Before I start, I thought I just got to read the Safe Harbor statement. 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 events.

I think you all have the slide sets in front of you which are available on the web and as we announced in our Q4 conference call we are taking steps to further focus our divisions, integrating businesses that shed therapeutic areas to better leverage our development and marketing capabilities. Two key moves are the transfer of the transfer Ophthalmic Pharmaceuticals franchise from the Alcon division to the Pharmaceuticals division and the transfer of selected mature Pharmaceuticals products from the Pharma division to the Sandoz division. We have updated our 2015 financials to reflect these moves and I would like to take a little bit more time to walk you through the details.

The slides are also available on our website and we will have time for your questions at the end of this call. As a frame of reference, Slide 4 to Slide 8 show the updated segment financials for 2015 and for your information we have also provided on Slide 11 to Slide 15 financials as we previously reported them.

If we now turn to Slide 3 which is the summary, the updated full year 2015 segment financial show the impact of the $3.8 billion of Optho Pharma sale moving from the Alcon division to the Pharmaceutical division, and the $0.9 billion of mature product sales moved from the Pharma division to the Sandoz division.

The updated operating income from each segment reflects all costs attributable to the transferred businesses including both the direct cost split by brand and indirect cost which required allocation. Allocation of attributable cost is based on direct activities that they support; for example, in manufacturing, development and G&A. overall for the group no change in the audited consolidated full year 2015 financials. These changes will be reflected form Q1 2016 for financial reporting purposes with the transfer of operational control from April 1, 2016.

If we can now move to Slide 4, looking at the group, you can see on the right hand column of the slide the audited group numbers for 2015. As mentioned the full year 2015 financial group function have not changed with net sales of $49.4 billion, gross profit of $33 billion and operating income of $9 billion and net income of $17.8 billion. Now I would like to take each division in turn and begin with Slide 5 which is the Pharma division.

Okay, on Slide 5 you see the updated quarterly financials with the division and this obviously reflects the transfer in up to $3.8 billion about the Pharma sale and the transfer out of the $0.9 billion mature product sales. Including these moves, Pharma had full year net sales of about $33.3 billion and core operating income of $10 billion. Overall, these moves increased the division's net sales by about $2.9 billion and core margin by about 1.7 points to 32.6%.

Operating income as a percentage of sales declined by 1.6% points. The increase in core margin is due to the addition of the Ophtha Pharma franchise which has lower cost as a percentage of sales compared to the overall Pharmaceuticals divisions. As I said before, all attributable costs for direct and indirect were allocated and I just want to walk you through some of the line items.

Full year 2015 cost of goods increased by about $2 billion as a result of the transfer of the Ophtha products which includes $1.2 billion of amortization related to intangible assets from the Alcon acquisition for the currently marketed Ophtha products and about a $119 million of impairment for Jetrea. However, these items are co-registered to the core cogs for Ophtha Pharma broadly in line with the Pharmaceutical division.

Marketing and sales increased by $0.6 billion for the full year, mainly due to the transfer-in of Ophtha Pharma sales force and promotional spend. R&D cost increased by about $0.5 billion, mainly due to pipeline development programs including RTH 258, NIP programs, and country regulatory related activities.

The increase in G&A was about a $100 million or $0.1 billion as the Pharma division was able to leverage the scale and absorb the Ophtha Pharma franchise without a significant G&A transfer. Should the updated segment financial look backwards it don't include any cost synergies. Moving forward we expect to leverage existing Pharma development and marketing capabilities as we incorporate the Ophtha Pharma products into the Pharma division. We will provide more visibility into it over the next few months.

Okay, if we move to Slide 6 which is Alcon, you can see the updated quarterly financial for Alcon which reflects the transfer out of the Ophtha Pharma franchise with a $3.8 billion of sales in 2015. Now we have a franchise of about $6 billion which is our eye-care division focused on devices and it has core operating income of about $1.2 billion, the core margin of 20.6%.

Core margins for the Alcon division are basically reflecting the surgical and vision care franchises after transfer out of the higher margin Ophtha Pharma products and he margin itself is within the range of the medical devices industry. A few points to know as you review the quarterly numbers. The margin of 20.6% is for the full year and the average across all four quarters. It includes a significantly higher margin in the first quarter which illustrates the potential for higher margins. The high first quarter margin was delivered with higher sales than the average in subsequent quarters.

And surgical sales growth was 6%; vision care growth was 3% during the first quarter. We remain confident that the Alcon growth plans will increase margins mixture long term. The surgical and vision care businesses have strong positions in their respective segments in attractive markets which are expected to grow mid-single digits. With the Alcon growth plan we are making strategic investments to return Alcon to growth, primarily focused on maximizing new IR launches, accelerating toward uptake, further increasing contact lens group through direct-to-consumer, strengthening our customer relationship through training and education and improving basic operations including supply chains.

We will be looking to optimize G&A costs over time while continuing to invest in marketing and sales and in development with the Alcon growth plan. We believe that self-growth should drive mid to long-term expansion for Alcon.

Now, looking more specifically at the line items for Alcon, at 38% core cost of goods sale as a percentage of the sales are broadly in line with the eye care device industry. At the higher end of the general medical devices company. Alcon core cogs reflect the mix from the lower gross margin product line such as surgical equipment and consumer contact lens business and the higher margin contact lens solution and intraocular lens business. The increase in marketing and sales as a percentage of sales from Q2 was driven by investments to drive growth and an increase in provisions for bad debt.

Full year G&A as a percentage of sales is slightly higher in the Alcon structure. And it reflects the transfer out of Ophtha Pharma with that significant G&A. This is just a snapshot and as I mentioned we will be looking to optimize the G&A cost lock overtime while continuing to invest in M&S and developments.

Now with respect to Sandoz which is on Slide 7, again you see updated quarterly financials of Sandoz which reflect the addition of the mature products with about $0.9 billion of sales in 2015 from the Pharma division. It's now made Sandoz a division with just over $10 billion in sales for full year 2015, for operating income of about $2 billion and a core margin which is up 2.2% points to 20.3%. The transfer of these mature products from Pharma to Sandoz will help Sandoz build scale in strategic countries such as Russia and Brazil and in strategic therapy areas particularly pain, central nervous system and respiratory. In total, we moved 19 brands from Pharma to Sandoz. The five largest brands are Aclasta, Foradel [ph], HRT, Žefran and Keratin [ph].

The cost of goods as a percentage of sales -- the cost of goods increased by about $0.5 billion. COGS as a percentage of sales for their mature brand is broadly in line with the rest of the Sandoz division. Core COGS as a percentage of sales excluding amortization is lower than rest of the Sandoz division. The mature products include Coratum [ph] which Novartis found as part of the Malaria initiative with price levels making the product acceptable to those in need. Marketing and sales is approximately 10% of the sales for the mature brands.

Now moving to Slide 8 which is corporate, this just shows the updated financials for corporate. There are no changes in operating income but higher inter-company sales elimination mainly due to sales of mature products to Sandoz which are produced by Pharma.

Finally, I want to check the Slide 9 which is our guidance and I wanted to remind you of the guidance we gave on our Q4 2015 conference call. The restated segment financial form a basis on which the guidance was given. In constant terms, we said we expected Pharma sales to be broadly in line with 2015 to a slight decline, Alcon sales to grow low single-digit and Sandoz sales to grow low to mid-single digits. For the group as a whole we expect both the sales and core operating income to grow broadly in line with 2015 in constant currencies.

In 2016, we expect the generic impact to provide $3.2 billion. This includes key Glivec which lost exclusivity in the U.S. in February and will lose exclusivity in Europe in December. In terms of FX, we said in Q4 that if mid-January exchange rates prevailed for the remainder of 2016, the currency impacts for the full year will be negative 3% on the sales and negative 5% on core operating income resulting from the continued strength of the U.S. dollar against most currencies. For Q1 we said to expect a stronger currency impact, negative 5% on sales and negative 7% on core operating income if mid-January exchange rates prevailed.

A few other reminders of what I said at Q4 to help with your modelling. And just to be perfectly clear we don't have Q1 numbers so this is solely repeating what has been said previously. On the Q4 call Harry highlighted several factors that impact core operating income in 2016 and said to expect core operating income growth in the second half with a decline in the first half. Having said that the decline in Q1 could be double digit in constant currency and would likely mainly be driven by the following factors.

In Pharma, we have U.S. Gleevec generalization and recorded sales of very highly profitable at this point in time. At the same time, Pharma is making full launch investments. The first quarter of 2015 also benefitted from inventory revaluation.

In Alcon, we have a high prior year quarter one core operating income base driven by sales and lower marketing and sales expenses. For Sandoz we have a high prior base in the first quarter with the strong flu season. I also remind that the full year item impact in core net income. Firstly, there were full year core tax rate which is said to be expected in the mid-teens which is consistent with last and prior years and as a reminder the core tax rate last year was 14.6%.

Having said that, core income from associated companies expected to be higher as we expect the OTC joint venture to realize further incentive in 2016. For core net financial income, he said to expect a total expense of about $0.8 billion to $0.9 billion with increased worth in 2015 mainly driven by expected higher net hedging cost. You may recall that last year we benefitted from hedging gains which Harry highlighted on the Q1 2015 earnings call.

Lastly, on Entresto, David said in our Q4 call that our U.S. field force was re-trained in January and provided with new promotional materials. He pointed out that this is really the beginning of the U.S. launch and as a result we expect to relatively modest sales for the brand in the first half of the year which we can also see from the IMS data from the year-to-date in the U.S.

Nonetheless David said in the Q4 call we believe the $5 billion peak sales guidance for Entresto that we gave for this product remains intact due to the value of the medicine and the initial signs around uptick we see outside the U.S. markets.

And with that, I'd like to open the line-up for questions.

Question-and-Answer Session

Operator

Thank you [Operator Instructions]

Samir Shah

From what we see there doesn't appear to be any questions which we could only take oh-- there is one question coming through.

Operator

And the first question comes from the line of Kerry Holford from Exane BNP Paribas.

Kerry Holford

Hi there, yes Kerry Holford from Exane, I have couple of quick questions so just to make sure I interpret what you said correctly. If we look at the remaining Alcon margins, statements, does that carry any additional cost instead of being left behind by the transfer of Ophthal drugs into Pharma or does that actually reflect now the real underlying Alcon margin?

Samir Shah

It reflects the real underlying Alcon margin for everything which is left i.e. like the vision care and the surgical. Everything else has been moved across into Pharma.

Kerry Holford

Okay. So on that basis, mainly the new margin, if lower, you talk about it being in the range of the medical device industry average, can you tell us what the peer group if you are assigned to him? Give us an idea of the comparatives looking at in that comparison and also if you give us any idea of the skew now between the surgical and vision care business margins, that would be helpful?

Samir Shah

Okay. So the sort of benchmarks we have been using are Cooper, Abbott and Codice [ph]. Crude price is at the higher end of the industry, perhaps around 24% but AMO, Abbott and Codice have lower core margins. I am sorry, I am just -- the second part of your question?

Kerry Holford

Yes, so just to understand are we looking at this as 20% or so core operating margin. Wondering whether you give a crude idea as to where surgical and vision care lie on that range? How big is the skew between the two?

Samir Shah

Yes, so we haven't actually given the difference between surgical and vision care and the only thing that we provided some outline was that in terms of the gross margin it tend to be lower for surgical equipment and the consumer contact lens business and somewhat higher for IOLs and contact lens solutions. But we haven't as yet split out vision care from surgical.

Kerry Holford

And then maybe one quick question if I can, when we get your results for Q1 can we expect any more breakdown within the Pharma business for the Ophthalmic drug joining the Pharma business i.e. will you give us some branded sales for products and eye products and so on?

Samir Shah

Okay. It's a very good question which we understand and I think the plan is that we will actually report for Pharma sales like we do for other franchises in Pharma. And if you look through our interim financial reports for some of the other franchises, you will notice that we give the key brand or the key brand family, and we plan with a deal that's same for the Ophtha Pharma brand. So in other words, we may well give Travatan and family, Accrinol [ph] and family and sustain in terms of the actual breakout. So that's a little bit more detail by brands than what we currently got for Alcon in our interim financial reports what we reported previously.

Kerry Holford

Understood, thank you very much.

Samir Shah

Okay. Are there any more questions? Yes, there are some more questions.

Operator

The next question comes from the line of Mauricio Benesconi [ph]. Please go ahead.

Unidentified Analyst

Hi Samir, one quick question on the income from disposal of products for instance the one you announced with Sun Pharma two days ago, will the $293 million be booked all right in Q1? Thank you very much.

Samir Shah

Yes, it will be booked in Q1 is the expectation.

Unidentified Company Speaker

Yes, on that point it will be booked in Q1 but I think you are probably aware of our rule of core versus non-core. So this will be not be core because it's a one-off item.

Unidentified Analyst

Yes I am aware thank you very much.

Unidentified Company Speaker

Okay. Next question please, operator?

Operator

The next question comes from the line of Alexandra Hauber from UBS. Please go ahead.

AlexandraHauber

Hello, good afternoon, just very quick follow up on the short list of questions. Since you were referring to, you have I think Cooper company as a more profitable, would it be therefore correct to conclude that the consumer business is actually higher than the surgical business or do they have a -- Cooper just has a mix of making contact lenses and…

Samir Shah

Yes, I think it is difficult to make those sorts of conclusions at this stage Alexandra because there are several reasons, one of which you know on the contact lens side we are building up our manufacturing capacity for DT1. Secondly, on the surgical equipment side this is just a snap shot in time period. As we move forward it's going to be difficult to say other than we will be looking to optimize our overall cost base to try and make any conclusions of the margins.

AlexandraHauber

Understood, thank you.

Operator

[Operator Instructions]

Samir Shah

Operator, next question please?

Operator

And the next question comes from the line of Damien Conover from Morning Star. Please go ahead.

DamienConover

Hi, great, thanks and thanks for doing the call super helpful. I just had one follow up question when you started to talk a little bit about some of the dynamics within the Alcon products that have transferred into the Pharmaceutical division. Within that $3.8 billion, I know you are not providing guidance specifically on this group but can you talk qualitatively we should keep in mind relative to patent exposure, new product launches, just been thinking about looking at modelling that new group of products within the Pharma group? Thank you.

Samir Shah

Yes, thank you great question. I think what we have actually mentioned previously with respect to the outcome of the Pharma group age. Near term, we do face some issue, we've quantified that issue is about $300 million or so this year. So in the near term, as you think about modelling it, it's important to note that generally there are no obvious growth drivers within the portfolio other than sustained, but sustained won't compensate.

DamienConover

Great, thank you.

Samir Shah

Okay. Okay operator, at this stage I think we will probably close the call but thank you everybody and thank you for your time.

Operator

Thank you for joining today's conference call. You may now replace your handsets.

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