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Novartis AG (NVS)

Q2 2007 Earnings Call

July 17, 2007 8:00 am ET

Executives

Raymund Breu - CFO

Richard Jarvis - IR

Thomas Ebeling - CEO of Pharma

Joerg Reinhardt - CEO Novartis Vaccines and Diagnostics

Andreas Rummelt - CEO Sandoz

Alex Gorsky - Head of North America Pharma

David Epstein - CEO Novartis Oncology

James Shannon - Head of Pharma Development

Analysts

Andrew Baum - Morgan Stanley

Alexandra Hauber - Bear Stearns

Chris Schott - Banc of America Securities

Graham Parry - Merrill Lynch

Andrew Weiss - Bank Vontobel

John Murphy - Goldman Sachs

Mario Corso - Summer Street Research

Karl-Heinz Koch - Bank Vontobel

Marcel Brand - Cheuvreux

Jo Walton - Lehman Brothers

Michael Leacock - ABN AMRO

Jaime Ruben - Morgan Stanley

Steve Scala - Cowen & Company

Mark Purcell - Deutsche Bank

Presentation

Operator

Good morning and good afternoon. This is the Chorus Call conference operator. Welcome and thank you for joining the Novartis First Half Results 2007 Conference Call. As a reminder, all participants are in listen-only mode and the conference is being recorded. After the presentation there will be an opportunity to ask questions. (Operator Instructions).

At this time I would like to turn the conference over to Mr. Raymund Breu. Please go ahead sir.

Raymund Breu

Thank you. Good morning and good afternoon. On behalf of Novartis I, welcome you to this conference call on the second quarter and the first half of 2007. With myself on the conference call, we have Thomas Ebeling, the CEO of Pharma, Joerg Reinhardt, the CEO of Novartis Vaccines and Diagnostics, Andreas Rummelt, the CEO of Sandoz, Joe Jimenez, the CEO of Consumer Health, Alex Gorsky, the head of our North America Pharma Business and David Epstein, the CEO of Novartis Oncology. And in additional, we have a fairly large team from investor relations supporting us.

Before we go into our presentation, I would like to ask Richard Jarvis from Investor Relations to read an important message.

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Richard Jarvis

Thank you. The information presented in this conference call contains forward-looking statements that involve known and unknown risks, uncertainties and other factors that 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. Thank you.

Raymund Breu

I would now like to start a short summary and analysis of our performance in the first half. We are referring to the slides that are available on the internet and that you probably have in front of you. I'm starting right away with slide number five.

You can see that the group has achieved strong results in the first six months of 2007. We had double-digit growth rates in sales and in operating income and net incomes of 14%, 10% and 14%. We have achieved a good performance in Pharmaceuticals, I have to say outside General Medicines in the US, which was impacted by the Zelnorm suspension and the Lotrel generics, and we had seen very dynamic growth in Vaccines and Diagnostics and Sandoz, as well as solid growth in consumer health.

On slide 6, we showed the same numbers, on a continuing basis that means excluding, nutrition and a Santé Medical Nutrition and Gerber. The growth rates of 15%, 13%, and 17% for sales operating income and net income are even slightly higher than for the entire group, the number of associates increased only at 9%.

On slide 7, you can see that for the continuing group, net sales increased 11% in local currencies driven by Sandoz up 13%, Vaccines up 39% on a comparable basis and supported by Pharma, which increased 9%. Consumer Health on a comparable continuing basis was up 6% in local currencies.

In US Dollars, the numbers are approximately 3 to 6 percentage points higher, as the currencies against the US dollar in general have appreciated.

On slide 8, we see that the group operating income on continuing basis increased 13% in dollars and was driven mainly by Sandoz and by Pharmaceuticals. In Sandoz we see a good performance despite strong investment in a research and development and marketing and selling. And in Sandoz the performance is driven by volume and productivity gains that have been achieved.

Slide 9, the operating margins for Sandoz has increased by one percentage point and Pharma has almost maintained at the high level despite the Zelnorm and Lotrel impact. The group operating margin was reduced by 0.4%.

And on slide 10, we give an analysis of the contributing factors. We had positive elements: Other revenues increased the margin by 0.7% due to a strong contribution from Vaccines and Diagnostics, and these also include an $83 million exceptionally coming from settlements that we've achieved in this division.

Also positive was the development in other income and expense, as the comparable period in 2006 included the one-time restructuring cost in the Pharma and Vaccines businesses related to the acquisition of Chiron.

On the negative side, cost of goods sold reduced the margin by 0.9%. This is largely a mix-effect as Vaccines and Sandoz now take a larger share of their business, and their cost of goods traditionally is higher than Pharma or Consumer Health.

Another negative development was in research and development, where the margin was reduced by 1.7%. This is only negative in accounting terms. Obviously, there is a significant larger investment in late-stage trials that are positive in the sense that they reflect a very strong pipeline.

On slide 11, cash flow from continuing operating activities was up 9% to $3.9 billion and the free cash flow after dividend was reduced by approximately $570 million. One has to say that this reduction is entirely due to an increase in dividend, because the number for free cash flow is after dividends and thus you remember we increased our dividend by approximately $550 million.

On slide 12, the net liquidity was reduced by $560 million in the half-year related mostly to the purchase of own shares, which led to a cash outflow of just below $1 billion. The net liquidity at the end of June stood at $89 million.

Finally on slide 13, we wanted to remind you of our cash distribution policy. Our policies are that we would return up to one-half of the free cash flow after dividends and acquisitions via share buybacks. At the end of last year, or to be precise at the AGM, at the end of February this year, we had approximately $4 billion of approved buyback programs still outstanding.

We intend to complete these buyback programs by the AGM in February 2008 and in the first six months of 2007. We have already repurchased approximately $0.8 billion via the second trading line on the stock exchange.

With this, I hand it over to Thomas Ebeling.

Thomas Ebeling

Pharma had strong sales growth in local currency, driven by our key brands doing well, specifically Diovan and Gleevec. Our newly launched products are performing well and Pharma has achieved several major approvals as well as an early positive CHMP opinion on Rasilez.

On page 16, you can see that Pharma had double-digit US dollar sales and operating income growth and return on sales of approximately 30%, is spite of the negative impact of Zelnorm and Lotrel.

On page 17, you see the IMS May year-to-date growth and you can see that Pharma. As compared to the market, had a very dynamic performance.

Page 18 illustrates the growth performance of Pharma in different regions. In the first half of the year, all regions performed very well, specifically Latin America, Europe and emerging growth markets. US performance was impacted by Zelnorm and Lotrel. Our key franchises are performing very well. The top three franchises also show double-digit growth for oncology, cardiovascular, and neuroscience.

Our top ten brands on page 20 illustrate that Diovan and Gleevec have a very dynamic performance, and our major brands have leading share positions in their segments. Diovan is now the number one antihypertensive worldwide. This has achieved not only the number one position in the US as well in China, and it's the most successful pharmaceutical product in Brazil. So, Diovan is out and out a big success.

On page 22, you can see the US market share development. It's a market share in TRx of total antihypertensive market. You can see that since Tekturna was launched, the positive development of Diovan and Diovan HCT continued. And Tekturna is actually, in our opinion, doing well, compared to launch analog on weekly sales. It is always ahead of Benicar and that seems to us a good indicator of the potential of Tekturna.

Processes launched in February and March, most recently in the US, are three months ahead of what we planned. It's a very strong data. Our launch experience in European markets, specifically Germany and Switzerland, where the drug is already four to five months on the market, is positive.

In the UK, the Diovan share has not impacted at all. It actually continues to perform very well. So, Exforge is adding to the Diovan market share, and less than 10% of Exforge sale is coming from Diovan. So, we are very, very positive about the initial performance of Exforge.

Prexige is doing well, and the market where we have launched Prexige, specifically in emerging markets like Brazil, the performance as a percent of share of the COX-2 category is very, very good and actually the COX-2 category in those markets continue to grow.

Tasigna had positive clinical news flow and here we expect a decision both by FDA and EMEA in quarter four.

A quick update on Galvus is on page 27. On April 27, we had a meeting with the FDA. We submitted a protocol for additional trial in June and we expect the FDA feedback by end of August. In Europe, we expect the CHMP’s opinion in quarter three. And the submission in Japan is planned for April 2008.

On page 28, you can see our approval performance. So far we have seven major approvals in US and Europe, in adition to a positive opinion for Rasilez and that certainty will allow us to start our growth performance relatively soon. And we will continue to have strong pipeline and news flow.

On page 29, you can see the intended filings over the next three years and, based on our current assumptions, it looks like in every single year between 2008 and 2010 we will have between five and six filings.

In terms of sales growth, we expect a slowdown in the balance of the year and in the first half of 2008, driven by basically three major factors. First of all generics, were we have seen the Lotrel competition, Lamisil in the US and in France and Trileptal in the US, and the continued impact of Zelnorm suspension. And in terms of accounting, we will stop booking Betaseron sales as of the closing of the Bayer-Schering deal. And we had in quarter three, 2006, a favorable one-time benefit from Tricare. So, all of these factors together will have in 2007 a significant negative impact in our gross rate in the second half of the year.

As of the second half of 2008, we expect an acceleration of growth, and you can see on page 31 that most negatives regarding prior year comparisons will be in the first half of the year. In the second half of the year, there will be only the negative comparison regarding the introduction Trileptal generics and we expect a significant ramp up of our launches. And based on this, we expect a dynamic growth phase starting in the second half of 2008, with high single-digit growth in the years 2009, 2010 and 2011. We expect double-digit growth, so that you will have a dynamic double-digit growth CAGR from 2008 to 2011.

Obviously, our margin will be impacted by generics, by the Zelnorm suspension, and by our investment in growth. Well, just to give you a dimension, we have lost sales of $1.5 billion in 2007 relative to 2006 based on Zelnorm marketing suspension, generic competition for Lotrel, Lamisil and Trileptal US generics.

We have a 40% increase of patients enrolled in Phase III and Phase IV trials relative to 2006 and we have five-fold increase in number of launches in the top 12 countries. We will have 60 launches in 12 markets, so this will almost average out of five launches in any of our top 12 countries as compared to only one launch in the country in 2006.

So, we have the unfortunate negative effect of the losses. In addition, we have the impact of increased R&D and M&S investments, which will ultimately safeguard our goals trajectory.

So, this is substantial impact on margin, which we would try to offset by ongoing productivity initiatives, which are on page 34, are covering all functions of our business: Marketing and Sales Development, Tech Ops, Sourcing, IT and Finance. And all of these initiatives together will offset more than half of the impact, which I have detailed on page 33, and this will allow us to contain the margin decline in 2007 by 2 percentage points relative to the margin we had at the end of 2006 which of 29.7.

So the outlook for the full year, barring unforeseen events, we expect continued strong regulatory newsflow. The generic impact on Zelnorm suspension will lead to a low single-digit full year growth rate.

The intensive launch program and our robust late-stage pipeline will fuel double-digit CAGR from 2008 to 2011, as an acceleration of gross as of the second half of 2008 and the continued acceleration of productivity initiative, limit to 2007 margin impact to 2% points. At this, I would like hand over to J. Reinhardt.

Joerg Reinhardt

Thank you, Thomas. On slide 37, the key messages for the first half of this year for V&D, and as the sales growth continues to be good, obliviously the full year performance will depend a lot on the influenza season about to start. So far the influenza production has significantly increased as compared to 2006.

With our innovation programs, are on track with two approvals in the second quarter of this year. And, in addition to that, we established a Novel strategic alliance with Intercell that will significantly strengthen our pre-clinical and clinical pipeline. Overall, the ongoing turnaround efforts are successful.

On page 38, you see the numbers for these first six months period. Net sales are at $482 million, which is on a comparable basis to an increase of 45% versus last year. This was mainly driven by strong sales of tick-borne encephalitis vaccine, but also of the meningitis C, diphtheria, and tetanus vaccines that are part of several pediatric vaccines.

The operating income after the amortization effect is at $7 million for the first six months.

Now on slide 39, you will see the anticipated influenza production for the US for this year but also for the years 2004 to 2006 was as a significant growth of production volume each year after year. This year, as announced a few weeks ago, we believe that we can achieve a 30% higher output than we did in 2006.

On page 40, you see our pipeline as it stands at the moment. We did get two approvals for Optaflu and Focetria. Quinvaxem is in the process of being approved in a number of countries. The Japanese encephalitis program that was won by Intercell is about to be filed in US later this year, and our two meningitis programs: :Menveo, which is just meningitis ACWY and the MenB program, are forecasting for the clinical trials, either in Phase III or in Phase II.

On page 41, you have the number of pipeline highlights. We got the first approval for the cell culture-based influenza vaccine across Europe, which was achieved in June of 2007, which was a little bit earlier than what you would have expected. We will launch this product in a focused way in Germany and Austria in the season of this year.

Aflunov is our H5N1 a pre-pandemic vaccine, which was submitted last year as the first pre-pandemic vaccine to EMEA. We expect regulatory feedback very much before the end of the year. At the moment, we are in discussions with the EMEA on number of questions, but I believe that we should be able to answer all of them adequately so that the decision should be given around end of the year.

Menveo, I mentioned this before, our meningitis ACWY vaccine, is running nicely through Phase III. We have two programs ongoing, one in adolescents, and the other in infants. The adolescent program will be completed significantly ahead of the infant program. We do expect first Phase III data to be available before the end of this year.

On page 42, the Intercell strategic alliance is a novel way of interaction between two vaccine companies. It will give us access to more than 10 pre-clinical and early stage pipelines that Intercell currently has in its pipeline; among those two products like IC43 for prevention of hospital-acquired pseudomonas infections, or IC47 for prevention of pneumonia infections. Altogether, in addition to the pre-clinical and clinical programs, we will also get access to a very novel adjuvant IC31. We will initially use this adjuvant in combination with our influenza vaccines, maybe also in combination with our existing MF59 adjuvant, and that still needs to be further explored. We will, for all of these programs, assume responsibility for Phase III development and manufacturing, as well as commercialization, and of course we will book sales for these products as well.

On page 43, you see a more detail pipeline of Intercell as it stands today. You see a number of projects in clinical developments, some of them are partnered with other vaccines companies, so those products are unaffected. And then you see a substantial number of earlier and later stage pre-clinical projects that should reach clinical status in the next 12 to 18 months.

Altogether on page 44, from a news flow perspective, we do still expect to see some additional and clinical data before the end of the year for meningitis B, as well as for ACWY, Optaflu and our Fluad, the adjuvanted flu vaccine. We have actually started the pediatric program where we expect Phase II data also relatively soon. We did complete a head-to-head study of our TBE vaccine, Encepur, against the only major competitor which showed that we have significantly stronger immune response than the competitive product.

From a submission and decision perspective, we received two approvals, I mentioned those and we still expect one decision on Aflunov in Europe before the end of the year. We will submit Aflunov to the US as well before the end of the year.

And with that, I hand over to my colleague Andreas Rummelt.

Andreas Rummelt

Thank you, Joerg. Sandoz showed a strong performance in the first half of 2007. Sales are up 19% in US Dollars, mainly driven by the US, where sales are up 27%. Operating income increased by 26%, mainly driven by a volume growth, which was more than offsetting the price erosion, especially in Germany. We had productivity gains in marketing and sales. So, overall operating margin reached 16.4%, which is a percent point up versus our previous year.

On slide 48, I'll show some more details. Our retail generics business contributes about 90% to the overall business with a growth of 14% in local currencies. Key growth drivers are as mentioned, in the US, but also had a strong performance especially in Eastern Europe, Canada, Latin America, Japan and China.

In the anti-infectives business, we had significant productivity gains in production, which is driving up our gross margins, so that the business unit is contributing significantly to bottom-line. And in biopharmaceutical, due a strong cooperation business, we could bring the sales up nearly 40% to $69 million.

Let’s look into US a little bit more in detail. Here, the performance is really driven by new launches, the launches from the end of 2006 and early 2007 account now for 25% of our total US sales. We also launched the generic Lotrel in mid-June and have a good sales performance here.

We had strong contribution mainly from products with few competitors. These are in two categories, one is the difficult to make products like the Metoprolol or the Bupropion. And then products launched under co-exclusivity, I already mentioned the Lotrel and here then also Ondansetron from GSK.

Sandoz continues to be at the forefront of bringing biosimilars to the patients worldwide. You know that we had the approval and the launch of Omnitrope, first in the US and then in Europe in 2006. Now, we've received, as the first company, a positive CHMP opinion. So, the European regulators for Epoetin Alfa will generate a significant market. Currently more than 250,000 patients in Europe are treated with Erythropoietin. And as I have mentioned before, we have several biosimilars project in our pipeline in various stages of development.

Concluding, we had strong results in the first half, driven by a successful launch of new products including the Lotrel authorized generic in the US. Sandoz is well positioned in the top markets in our key countries, and this broad presence limits the dependency on individual countries and the volatility there.

We are pioneers in biosimilars, in addition to this, we have a strong portfolio with broad coverage of difficult-to-make technologies. Thus of course there is ongoing uncertainty in some markets. especially in Germany, where the healthcare reform is evolving overtime, but nevertheless I can confirm that we will have a double-digit sales and operating income growth target for the full year barring unforeseen events, and with this I hand back to R. Breu.

Raymund Breu

Thank you, Andreas. We are on slide 53 and I will cover briefly the outlook for the group now for the entire year. We expect that the portfolio restructuring deals will close before year end and as result of these ,we will realize approximately $5.3 billion in after tax gains from these divestments of the nutrition businesses.

The Medical Nutrition sale to Nestle closed on July the 1st and we expect there and after tax gain of $1.5 billion to be booked in the third quarter. The Gerber sale to Nestlé is expected to close before year end and should generate an after tax gain of approximately $3.8 billion.

Excluding these exceptional gains the outlook for 2007, on a continuing basis is as follow: Group sales are expected to grow in the mid single-digits in local currencies, and group operating and net income on a continuing basis are expected to be at record levels, obviously all these statements excluding any unforeseen events. With this, I would like now to open up the conference call to questions.

Question-and-Answer Session

Operator

Excuse me, this is the Chorus Call conference operator, we will now begin the question and answer session. (Operator Instructions) First question from Mr. Andrew Baum, Morgan Stanley. Please go ahead sir.

Andrew Baum - Morgan Stanley

Good afternoon. Three questions if I may, firstly on Galvus, perhaps James could give us an update on the issues, it seems to be delaying the FDA setting out the clear roadmap for you to follow. And presumably given you have submitted a protocol, perhaps you could share with us in terms of number of patients and how it impacts the time line. On the same theme of new products, just can you give us some color on the Tasigna delay whether it's cardiovascular safety?

And then for Raymund, just so I understands, when you are talking about the Pharma margin with a 200 basis point pressure during '07, is that on a reported basis so it goes from 29.7 down to 27.7, if I have I understood that correctly? And then finally, you referred to targeted investments in your press release, I think, you have may clear that you looked Medimmune given the significant cash position, you will have on your balance sheet, could you give some sense of scale as to what you are looking at, going forward ,as you seek to enrich your earlier stage pipeline?

Raymund Breu

James?

James Shannon

Andrew, we did meet with the FDA as Thomas mentioned at the end of April to discuss what the concerns were. And in summary, as I mentioned in the previous call, the concern related to the fact that we have seen this skin lesions in primates at approximately five times the proposed concentration, which would be equivalent to our therapeutic dose.

And in normal volunteers in our Phase I, we saw skin lesions at four to six times the proposed therapeutic dose. And the FDA are concerned that in susceptible populations we may get to those levels. So they have asked us to put together a safety study in renally-empiric patients, in moderate-to-severe patients, and indeed we have submitted a proposed protocol to FDA in June time.

The FDA will not be totally definitive about what it was exactly they wanted to see but we did submit a protocol to them. They did tell us that that study should be several hundred patients in size and should last for a minimum of six months follow-up. We are expecting to hear back from the FDA somewhere before the end of August, assuming they agree with our proposal. We will start that study in the fourth quarter of 2007. It will likely take at least until the end of 2008, to complete and then we would propose to resubmit the dossier to the FDA sometime in mid 2009.

Andrew Baum - Morgan Stanley

Thank you.

Raymund Breu

David on Tasigna.

David Epstein

Andy, this is David Epstein. During the course of the Tasigna review, we submitted additional data on the patients originally in the NDA, as well as additional patients to the NDA. And the FDA advised us simply that they want more time to review that new data and run some additional analysis. There is no one specific point that they seem to be focused on, rather they are still coming to reaps with the overall benefit risk profile for the drug, and we think the three months should be enough time to finish that analysis.

Raymund Breu

Okay. And then Andrew just the preview on the pharma margin, that's on the reported basis. And I think you have seen that when we say two percentage points, it is really approximately two percentage points. So, I think we don't want to indicate that our forecast is exactly 2%.

Regarding the targeted investments, I think that says that we are looking at acquisitions and the investments that we can make that as normal. I don't want to speculate here as to what is on our radar screen, of what size it is. I think that will be not in the interest of an investor to be too open or upfront about the things that we are studying. So, Andrew you have to accept that all we are saying is that we intend to invest again in our areas in acquisitions.

Andrew Baum - Morgan Stanley

Thank you.

Raymund Breu

Next question please.

Operator

Next question is from Mr. Alexandra Hauber, Bear Stearns. Please go ahead, madam.

Alexandra Hauber - Bear Stearns

Good afternoon. I have four questions please. Firstly, on the share buybacks, Raymund I wonder whether next year at the AGM, you're going to ask for a larger authorization for share buybacks because just doing the math, it seems like you're not going to come close to your policy of spending 50% of free cash flow this year and that's only with assuming you don't do a significant assessment in the second half. So therefore, I think there possibly could be some catch-up next year.

Second question on Glivec, the second quarter U.S. sales performance was quite strong. Has there as been any uptake in adjuvant? Just something which we haven't seen in the U.S. Can you just comment on that and just a follow-up question to Andrew's question? David you said, you did submitted additional Tasigna data. Was that data submitted on FDA request or just on your own motivation?

Third question on Lucentis, could you just tell us in which EU countries it has rolled out and when exactly it was launched? And then the final question for Joerg on [Manvel]. Could you just, sorry, I was not quite sure exactly about your development and filing plans. When you talk about the adolescent population, I mean, are we actually distinguishing, I believe, two different populations, the two to 10 year olds and then those older than 10 years. Are you combining those two under the term “adolescence” and are you planning to filling those first and then file in the infant significantly later only after you had approval for the other groups, if you could elaborate on that please?

Raymund Breu

Okay. Thank you, Alexandra. On the first question, I think share buyback, all we can say at this point in time Alexandra, is that we intent to use up the approved programs until the next AGM and obviously it will be up to the Board to decide what it is going to propose to the AGM beyond February 2008.

Alexandra Hauber - Bear Stearns

But, are you not going to put a proposal in to the Board or?

Raymund Breu

I don't want to speculate Alexandra.

Alexandra Hauber - Bear Stearns

Fine.

Raymund Breu

But obviously if we continue this policy, you know that we need additional programs. I don't want to speculate what we will do and how large, and I think that’s up to the Board to decide when we approach the next AGM. Then on Glivec and Tasigna, I think…

Joerg Reinhardt

Yes Joerg. Alexandra, I would say Glivec sales were robust both in the U.S. as well as the rest of the world during the second quarter and that's primarily due to the same reason accrued during the first quarter, which increased penetration in metastatic GIST. Some of the new rare indications are now contributing and continue to improve survival for the CML patient.

As far as adjuvant GIST, we really haven’t seen any kind of noticeable impact yet. As you recall, the data was just first released during June at ASCO and certainly outside the US, it would not be paid for and until get the NDA approval, which we would hope to file early next year. Regarding Tasigna, the file I must say was a little bit on the light side with the initial submission and the chronic phase patients. There was under eight months of follow-up data with the additional data that was submitted at the 120-day update. We now have almost the year’s worth of data in the chronic phase and we feel that this data set is more robust for the FDA to take this final decision.

Alexandra Hauber - Bear Stearns

Okay.

Thomas Ebeling

Well the Lucentis was launched in Switzerland, Germany, UK, France, Spain, Australia and Denmark.

Alexandra Hauber - Bear Stearns

Sorry, that was very quick, yes. I am guessing, I am going to get that.

David Epstein

Yeah Alexandra, you are, of course, right. I think when you look at the [Manvel] clusters, there are three different age populations. And what I can tell you is that we will submit in a staggered way and we intend to start submissions next year.

Alexandra Hauber - Bear Stearns

But in principal, will you have to wait for one approval before you can submit the next?

David Epstein

Well, we are not working on this.

Alexandra Hauber - Bear Stearns

Okay.

Raymund Breu

Okay. Next question please.

Operator

The next question is from Mr. Chris Schott, Banc of America Securities. Please go ahead sir.

Chris Schott - Banc of America Securities

Great, thank you. Just three quick questions. First going back to Galvus and the competitive dynamics from DPP-4 market. In your understanding that the renal impairment studies of this magnitude will be required for all new entrants sources to be kind of like case-by-case basis.

Second question is regarding to Prexige, do view the lack of a FDA panel in this drug as a positive or negative? And then finally, in regards to your cost structure with the setbacks for Galvus, Lotrel, Zelnorm, just talking little bit about your decision to keep your SG&A structure intact here. Is there any opportunities in form of other attrition or reduction of contract sales reps there? Thank you.

James Shannon

Well, thanks Chris. For the DPP-4 inhibitor class, I am not familiar and I can't speculate what the FDA will ask other DPP-4 inhibitor molecules to do. So, we do know that they have seen the same skin effects with other molecules, but other than that I can't speculate further.

On the Prexige piece, the fact that we do not have an Advisory Committee meeting, again, we cannot read anything into it right now. The discussions with the FDA are ongoing, but it's too early to speculate on which direction FDA will go again.

Andreas Rummelt

Okay. In terms of SG&A cost structure, I just would like to remind you that we have already in 2007 on average, launched a number of five products in any of our top 12 markets. So, our sales reps have certainly lot of products to sell. And nevertheless, we will use the opportunity of having now a strong cardiovascular category with Exforge, Diovan, and Rasilez or Tekturna to really optimize efficiency in the sales force.

In terms of oncology, we have anyway a very efficient sales reps organization. So, the key opportunity or the key area to look at is basically in the US and here we will wait until the end of the quarter, until we have really all the feedback from the different products that we really understand what our portfolio is, and then we would take a look if and how we should optimize our SG&A.

Raymund Breu

Okay. Next question please.

Operator

The next question is from Mr. Graham Parry, Merrill Lynch. Please go ahead sir.

Graham Parry - Merrill Lynch

Thanks for taking my questions. And just the first question relates to Dave, and I am just wondering if you can give us an update for where with inventories. Now, you've had two quarters in a row where is growth is ahead of both the combination of volume and price increases. Is there any overstocking in that product that may come out through the rest of the year.

And secondly on Exforge, could you just give us an update on the progress and your expectations for reimbursement to the products in the EU. And then finally, just going back to Raymund's questions on investments, do they seem more inquisitive again? So, could you just give us a feel for what sought of size of investments you are talking about? Previously, you've put some big deals at the bottom of your category of preferences and presumably, with 4 billion in share buyback still intended by February, these are something you're still thinking in next year timeframe rather than next year? Thanks.

David Epstein

In terms of Diovan, I think in the US we have a very robust prescription growth which is around 10% and then you obviously have a bit of pricing. And we have a little bit of inventory as well, not dramatic, but a little bit of inventory, Diovan US number.

Graham Parry - Merrill Lynch

Do have an update on how many weeks of inventory wholesalers have?

David Epstein

Alex, do you have the weeks' data?

Alex Gorsky

Yeah, Graham, we estimate that we are at about 0.5 weeks or 0.5 months on hand inventory.

Graham Parry - Merrill Lynch

Okay, thanks.

Alex Gorsky

Well within normal range.

Raymund Breu

And almost on Exforge reimbursement in Europe?

Alex Gorsky

Yeah, I would say Exforge review reimbursed in line with combination products in the hypertension markets for the key countries there. We are not sure if we will get speedy in terms of the reimbursement in Italy, but in all, because in Italy combination products are really not reimbursed. In all other markets we see no reasons why Exforge should not to reimburse and so far everything is running well and the performance in Germany and Switzerland was very good.

Raymund Breu

Then, Graham, on your question regarding investments, I have to repeat what I said before to Andrew. And that is that our acquisition or investment policy is unchanged that we look at many opportunities that come up. You know that from our past history that we are very disciplined in our approach but I don't want to indicate these specific areas or the specifics sizes, I think that would be not in our interest to speak in terms of concrete target to you.

Graham Parry - Merrill Lynch

Okay. Thank you.

Raymund Breu

Would we have the next question please?

Operator

The next question is from Mr. Andrew Weiss, Bank Vontobel. Please go ahead sir.

Andrew Weiss - Bank Vontobel

Yes, thank you gentlemen, for taking my question. I have a quick one on your newly launched products in the cardiovascular space export in Tekturna. .Your press release indicates that in the first quarter you had $16 million of revenues, and in the second quarter you have $24 million of revenues. Could you give us a bit of granularity of how much of that is export, how much of that is Tekturna, how much of that is actually sold to consumers and how much of that is inventory build up? Thank you.

Raymund Breu

I think we don't give this split, secondly on for Exforge, for Tekturna in the US. We can assume that the inventory build up is basically gone for Exforge, as we have just recently launched this. There may be a little bit of inventory build up in their. You should really take a look at the prescription performance in the US, which for both products promising Exforge a little bit early. We don't want to be too optimistic but for both brands the prescription performance is very promising and again we don't communicate the split, unless these products then become really meaningful in terms of size and the we would glad to share the numbers.

Andrew Weiss - Bank Vontobel

Thank you.

Raymund Breu

Next question please.

Operator

Next question from Mr. John Murphy, Goldman Sachs. Please go ahead sir.

John Murphy - Goldman Sachs

Yeah, thanks very much indeed. Just a single question, Raymund, and it’s just on tax rate. You and your team have done right sort of job this quarter and in that regard, can we make any assumptions now in terms of impact on full year and also going forward whether the level we see in the second quarter is annually sustainable level?

Raymund Breu

Thank you John. I think our hard work for the second half of the year is in line with rate that you have seen in the first half. John, this is actually the way we established the tax rate as we go through the year, we always work hard to tax burden for the full year, and we didn't apply that rate to year-to-date numbers. Obviously, this year the tax rate was positively impacted by what I will call wrong time event, we have the restructuring from the tax point of view of the Vaccines and Diagnostics division and that's just let to a wrong time tax benefit.

In addition, we are forecasting a reduction of the German tax burden from something like 7.5% to 28.5% this year, and this would lead to a reduction in our deferred tax liability on the books and that has a longtime positive impact too. So, the reduction that you have seen in the first half and in the second quarter for the tax rate is almost entirely due to these long time events. So, going forward beyond 2007, we think that the range that we have communicated to you in the past as an average tax rate is still very much valid, somewhere in the region of 16% to 18%, excluding special long-time events, should be achievable.

John Murphy - Goldman Sachs

Thanks very much indeed.

Raymund Breu

Thank you John. Next question please?

Operator

The next question is from Mr. Mario Corso, Summer Street Research. Please go ahead, sir.

Mario Corso - Summer Street Research

This question on Galvus. How do you see the vildagliptin data influencing the regulatory progresses, will that be filed right away, or you wait for the renal resubmission to do that as well? And then secondarily, what could you say your level degree of confidence is on your pre-approval at this point? Thank you.

Raymund Breu

James.

James Shannon

So, we are in discussion with the FDA, and as I mentioned, we will expect to get feedback by the end of August. We will file reports to the FDA as they become available, but it is the intention to file a comprehensive submission probably in mid 2009. As far as Europe is concerned, the review is ongoing. And at this stage, I wouldn't speculate on what the outcome will be at this time.

Raymund Breu

Okay. Could we have the next question then?

Operator

Our next question is from Mr. Karl-Heinz Koch, Bank Vontobel. Please go ahead, sir.

Karl-Heinz Koch - Bank Vontobel

Good afternoon. Thanks for taking my questions. On the margin, once more, could I just check with you how you treated Prexige in that 2 percentage point margin decline outlook for 2007, has that potential launch been within the range of our forecast? And on the growth guidance you have given for the second half of 2008, I noticed you became slightly more conservative on your high single-digit growth, is that simply because Trileptal generic erosion shifted out somewhat, is that just purely mathematical, or is there anything else that has changed?

And then lastly, on the acquisitions, and I know that you don’t want to go out of the way to say what you are going to buy, but could I just check with you how you understand your business structure today? Healthcare is a broader definition, could that be acquisitions, do they have to be necessarily within the areas of activities, where you are right now, or could they be in the broader healthcare sector as well? Thank you.

Raymund Breu

No, I think in our guidance we have included all different launches in our view. So, basically that’s our guidance and we will operate within this guidance for 2007. In terms of the second half of 2008, it still the high single-digit, but the observation is correct that Trileptal has been shifted out and Trileptal is actually the only one-time negative in the way of prior year comparison, which will impact us in the second half of 2008, that is high single-digit.

And then, Karl-Heinz, regarding the portfolio structure we have finished with the divesture of the nutrition businesses. We now think that the four divisions that we have are all strategic and that means that we have no plans in order to acquire businesses outside these four strategic areas, but obviously we look at that positions in all four of these areas since they are strategic for us. Okay?

Karl-Heinz Koch - Bank Vontobel

Thanks.

Raymund Breu

The next question please.

Operator

Next question is from Marcel Brand, Cheuvreux. Please go ahead, sir.

Marcel Brand - Cheuvreux

Yeah good afternoon, thanks for taking my question. Two very quick ones here, maybe gross margins are still very good in pharma in spite of some generic erosion and in spite of the very weak dollar. Could you comment on that, and also what we should expect for the remainder of the year in that respect?

And then in generics, I didn't understand, maybe you have commented, if the other operating income expense was unusually high could explain why that is?

And then, last question, how do you expect marketing costs in generics to go forward with the launch of biogenerics, maybe also changes in the distribution channels particularly, in view of upcoming changes in Germany? Thanks.

Thomas Ebeling

I assume you refer to the gross margin that we spend the--

Marcel Brand - Cheuvreux

The gross margin in pharma? The cost of--

Thomas Ebeling

Yes.

Marcel Brand - Cheuvreux

The gross margin was higher, sorry cost of goods was low, yeah.

Thomas Ebeling

Yeah now I think the cost of goods obviously products like Zelnorm and Lotrel we have a little bit of negative mixed effect on quantity, but we were able to offset this mixed effects with productivity initiative. So, going forward for this full year, don't expect major changes, maybe a little bit left and right, but directionally there will be no dramatic changes in the cost of goods.

Marcel Brand - Cheuvreux

And generics.

Thomas Ebeling

Okay. In generics, the other income and expense in the second quarter of 2007 was impacted by one-timers and here I can especially mention, an asset impairment our Momenta shares and the restructuring cost, which was related to a divestment of an active ingredient manufacturing plant in Eastern Germany. So this was the main negative impact on other income and expense.

With respect to a biosimilar’s marketing and distribution costs, of course, in countries where we still have a model comparable to Pharma with the field force, we will use this field and focus the field force on biosimilars and visit hospitals and physicians to promote and sell these seeds products. In countries where it's closer to a key account model, I think there are different ways of building and marketing and distribution of skills and I think here we are currently evaluating country-by-country, what we have in terms of either building up our own resources or teaming up with somebody else or with Pharma. I think that’s a couple of options which we are having and which we are currently looking into.

Marcel Brand - Cheuvreux

So the longer term, as a percent of sales, would you expect that to trend up as per percent of sales now because of biosimilar in particular or what is your current view on that?

Thomas Ebeling

Well, then, it’s difficult to say right now. I think you have mentioned, namely in Germany, the changes as the results of the healthcare reform. I think trends in Germany will be important that we are listed with our products and we are talking about erythropoietin now in dialysis centers and we are focusing our efforts on getting listed there. This will have not such a major impact on marketing and distribution cost. In other countries it remains to be seen what we can achieve.

Marcel Brand - Cheuvreux

Okay. Thanks.

Raymund Breu

Yes. Next question please.

Operator

Next question from Ms. Jo Walton, Lehman Brothers. Please go ahead, madam.

Jo Walton - Lehman Brothers

Three quick product questions and one financial question, please. Looking at the data, Lucentis was a very strong contribution in the quarter with over $70 million. Is that representative of your income stream from Lucentis is going secondly on flu. You tell us about the increase in number of doses that you are able to supply to the US, and therefore if we make some guesses on pricing then presumably we can get a pretty good fix of what your sales should be this year. Can you give us some idea of any change in your ability to supply the ex-US market as well?

And finally for products, could you just remind us what has happened to one product that doesn't seem to be listed anymore, LIC477 for schizophrenia?

And my financial question is one to do with margins. You are clearing cutting costs in the face of a decline in underlying Pharma sales this year. You are expecting the sales to grow again, but from newer younger products, presumably requiring more marketing. Do you think that a 29% to 30% operating margin is going to be a sustainable rate of operating margin over the next few years?

Thomas Ebeling

Okay. I mean Lucentis, I apologize, I have not calculated the percentage of Lucentis we will have as part of our portfolio. But, you can assume that we expect a very, very positive development of Lucentis and I think this drug will be a positive surprise this year. Obviously, it depends, and speed of reimbursement is critical. But, we are very, very positive about the dynamic performance of Lucentis.

And in terms of the margin question, I think we have said that you have to expect a reduction by 2% and approximately that will be something around 27.7%. And as we will continue to launch a lot of products in several markets in 2008, and we continue to invest in R&D as well next year very competitively, I don't think that 29%, 30% is maybe e necessarily as an assumption you should have for 2008.

Obviously, our objectives beyond 2008 is to go back to the level we have accomplished in the first half of this year, which was 30%. And again, launching eight products is costly as you've said, having one of the most attractive late-stage pipelines with significant number of patients enrolled in late-stage trails cost us real money and we have to deal with the impact of Zelnorm and Lotrel.

Jo Walton - Lehman Brothers

Thank you.

James Shannon

From a flu volume perspective, outside of the US what we expect is pretty much the same level of production capacity in Italy and slightly increased capacity in Germany, slightly increased just may be at a level of 10%. So, outside of the US, it's certainly not at the same level than what we see as an increase for US.

Jo Walton - Lehman Brothers

Thank you.

James Shannon

So, for LIC this was a compound actually, Jo, which was in bipolar disorder and schizophrenia. I think what we communicated may be just over a year ago that the first trial in bipolar had failed, and that stage not, but still I think, he said he was not highly optimistic on the future of this compound. In fact, the second trial also did not show positive results and so that program has been terminated.

Jo Walton - Lehman Brothers

Thank you.

Raymund Breu

Fair. Next question please.

Operator

Next question is from Mr. Michael Leacock, ABN AMRO. Please go ahead sir.

Michael Leacock - ABN AMRO

Good afternoon. Thank you for taking my question. And a couple of brief ones if I may. I understand, James, either I want to comment on the outcome of the EMEA review at all. But just wanted in terms of process and there is a four day meeting, I am going on this week and the next CHMP meeting is at the end of September. So you have given your expect decision in Q3, do you know if is it on the agenda for July or for September? And secondly, if I could ask on your productivity program, I think you had $700 million over $1 billion, sort it out by the end of 2006, and give way you have stated now in terms of productivity. Is there more to give beyond that $1 billion or really is this just tiding up to get up to the $1 billion?

Raymund Breu

Okay, James.

James Shannon

I'm sorry, I guess I take that question. So the CHMP meeting, yes that's correct there is meeting this week and the next one is in September, if you have followed CHMP, you know that sometimes the agendas are not so specific and sometimes things are diverted. Our team is in London this week for discussion with CHMP but I can't speculate on whether they will reach a recommendation this week or whether it will be September but they are there.

Michael Leacock - ABN AMRO

Okay.

Thomas Ebeling

To target the head was to create $1 billion productivity achievements by the end of the 2007 relative to the cost base, we had in 2005. The end of the 2006, we have basically realized 500, we are confident that we will realize the second 500 in this year. And going forward, I think, there's always room around for productivity, but we would then have to start completely new program, which would then include major functions even more like marketing and sales, where we still spend the 30%, the majority of all our investments. So, we will sit together at the end of this year, we'll take a look of every stand in terms of approvals and we'll identify the next productivity program. We will start that in 2008.

Michael Leacock - ABN AMRO

Thank you very much.

Raymund Breu

Next question please.

Operator

Next question is from Mr. Jaime Ruben, Morgan Stanley. Please go ahead sir.

Jaime Ruben - Morgan Stanley

Thank you. It's Ms. Jaime Ruben. Anyway, two questions, first is on Galvus, if you are not planning now a launch until May 2010, do you know the agenda that would have been on the market for at least three years and there could be a couple of other DPP force on the market by then too. What do you see as your point of differentiation at this point, I mean, given the sort of said skin tox signals and the renal studies, how do you see differentiating your product from what looks to be a pretty think pack of DPP force at that point? And my second question relates to Gleevec, just curious to know, what inroads you are seeing from Sprycel particularly in the European market, where Sprycel has just been launched and where physicians seem to be more accepting of new therapies? Thanks.

David Epstein

That should be right. The DPP for our market looks on paper very crowed but we have to realize it for the time being, there's only one compound in the market and who knows what type of findings emerged for every compound which is in the field? So it’s very difficult to predict how the market will shape out. What we know by now is that our key differentiation is clearly our efficacy data, especially relative to [TZBs] and so far I have not seen other compounds, which have matched this. So, we have to wait how the market finally will play out. For the time being, efficacy is our key differentiator, and it's a good one. David?

Raymund Breu

David, on Sprycel.

David Epstein

Yeah, so, Gleevec, we are seeing actually strong volume gains in the US and Europe. In the US, Sprycel shares according to IMS seems to fluctuate between 5% and 6%. In Europe, it's our understanding that a fairly large number of patients have come off their clinical trials and have now moved onto commercial drugs. So that will be helping their volume, but it doesn't seem to be coming at our expense. So, we continue to do very well in Europe as well.

Jaime Ruben - Morgan Stanley

As Bristol continues to develop data in frontline CML, how do you see the market shakeout between the two of you?

David Epstein

I think as I have said before to get a new frontline CML drug, you need to have really an extraordinarily good balance of efficacy and safety, which Gleevec has demonstrated now with over five years data, but unclear whether any other drug will get into the first-line setting. Having said that, we think to think that that have a shot, and will start Phase III trials in de novo CML patients later this year.

Raymund Breu

Okay. As time is very advanced, I think we can take only two questions. So, could I then ask for the next question please?

Operator

The next question is from Mr. Steve Scala, Cowen. Please go ahead, sir.

Steve Scala - Cowen & Company

Thank you. I have two questions regarding Sandoz. First on Lotrel, what is likely to be the rate of decline given that Teva is likely to be the only generic until probably 2009? Additionally, Teva's share appears to have surprisingly stalled in the mid 60s vicinity. Could Novartis retain a share perhaps greater than other brands have been able to maintain given the dynamic that's played out so far?

And secondly, do you have any visibility on the outlook for your Zosyn ANDA and or the status of Wyeth's citizens petition? Thank you.

Raymund Breu

Andreas? Okay, so Andreas is on the first one.

Andreas Rummelt

Well, on the--

Raymund Breu

Lotrel.

Andreas Rummelt

On the first one, Lotrel I think basically what we have launched, the Lotrel generic, in the mid of June and what we expected by competitive pricing that we will see from market share of more than 30% and that's currently what we are aiming at and what we are achieving currently in the market.

Raymund Breu

Could you repeat the second question? We had difficulty understanding the second one.

Steve Scala - Cowen & Company

Do you have any visibility on the outlook for your Zosyn ANDA and or the status of why citizens petition blocking your approval?

Andreas Rummelt

No, nothing, which we could share.

Raymund Breu

Okay. Could we then have the last question please?

Operator

The last question is from Mr. Mark Purcell, Deutsche Bank. Please go ahead sir.

Mark Purcell - Deutsche Bank

Yes, thanks very much. Just two quick questions. On Galvus, do you have a opportunity to launch the 50 mg dose? Has the FDA decided that's acceptable?

And then secondly, could you try and help us quantify the sampling behind that tender in particular and exposure when we talked about new treatments starts discussions that we would accompany just at the level of new treatments policies way in excess of the IMS recorded TRx and NRx data. So a comment there would help a lot? Thanks.

Raymund Breu

Okay. James?

James Shannon

Mark, the letter from the FDA you refer to the 50 and 100. We are still pursuing the 50 and 100 doses at the FDA. As I mentioned, we put in the proposal for the renal failure protocol, which again covers the 50 and 100 and we are expecting overall feedback from FDA by end of August. So at this stage I can't go beyond that.

Mark Purcell - Deutsche Bank

So there’s a possibility then that paid anyway 100 mg doses is a part of the renal impairment study?

James Shannon

Say again.

Mark Purcell - Deutsche Bank

Sorry. So there's a possibility that the 50 mg dose may not need to be studied in the renal patients, and in all cases based on those studies won't need to be.

James Shannon

No there is no indication of that whatsoever, that. Just the approvable letter referred both the doses, 50 and the 100, so…

Mark Purcell - Deutsche Bank

Okay. Thank you.

Raymund Breu

And then Alex, do you want to take the question regarding Tekturna and Exforge?

Alex Gorsky

Yeah Mark, we don't see any major difference between the uptake in terms of samples and prescriptions regarding Tekturna and Exforge versus other analogs that we are seeing. It's pretty much going as you would expect at this point for both of the launches.

Mark Purcell - Deutsche Bank

Okay research talks pf 30% of patients on a sample.

Alex Gorsky

Yeah. We are to verify that data with you, but that's pretty consistent with what we are saying.

Raymund Breu

Okay. Then I would like to close this question session and I would like to thank all of you for attending this teleconference call. We look forward to seeing you on our business and brand update on September the 12th in the U.S., and until then I wish you a nice vacation period.

Operator

Ladies and gentlemen the conference call is now over. And you may disconnect your telephones. Thank you very much for joining. Good bye.

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Source: Novartis Q2 2007 Earnings Call Transcript
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