NVS

Novartis AG Form 6-K Summary: Third Quarter 2006 Results

Business Context and Reporting Period

This Form 6-K, filed on October 24, 2006, reports the unaudited financial results for Novartis AG for the third quarter and the first nine months ended September 30, 2006. The reporting period is significantly influenced by the April 2006 acquisition of Chiron Corporation, which created a new Vaccines and Diagnostics division and integrated Chiron's pharmaceuticals into the existing Pharmaceuticals division. The company reaffirmed its outlook for record full-year sales and earnings.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Nine-month net sales grew 14% (15% in local currencies), driven by 6 percentage points from volume, 8 percentage points from acquisitions (primarily Chiron, Hexal, and Eon Labs), and 1 percentage point from price increases. Currency translation reduced growth by 1 percentage point.
• Divisional Performance:
  • Pharmaceuticals: Sales up 10% (11% lc), led by double-digit growth in Cardiovascular (Diovan, Lotrel), Oncology (Gleevec, Femara), and Neuroscience franchises.
  • Sandoz: Sales up 38% (38% lc) due to underlying growth and contributions from Hexal and Eon Labs acquisitions.
  • Vaccines and Diagnostics: Reported $501 million in sales for the period since the April Chiron acquisition. Pro forma vaccine sales rose 60% year-over-year.
  • Consumer Health: Sales up 4% (5% lc), supported by OTC and Animal Health growth.
• Profitability: Operating income rose 17% YTD. Excluding Chiron acquisition-related charges, operating income would have advanced 26%. Net income rose 16% (23% excluding Chiron charges).
• Liquidity Shift: Net liquidity of $2.5 billion at the start of the year turned into net debt of $0.7 billion by September 30, primarily due to the $4.0 billion net investment in the Chiron acquisition and $0.6 billion for NeuTec Pharma.

Guidance, Outlook, and Risks

• Outlook: Management reaffirms expectations for double-digit net sales growth in local currencies for the full year 2006 and anticipates record levels of operating and net income.
• Chiron Integration Impact: The company expects Chiron to have a net negative effect on full-year 2006 operating income of $300–350 million and net income of $350–400 million, reflecting integration costs, restructuring, and amortization. Cost synergies of $200 million are expected within three years.
• Pipeline Highlights: US and EU submissions completed for Galvus (diabetes), Tekturna, and Exforge (hypertension). Tasigna (cancer) remains on track for 2006 submissions. FTY720 (multiple sclerosis) is in Phase III trials.
• Risks and Contingencies:
  • Legal: Litigation regarding the Chiron acquisition has been settled. Securities fraud class actions related to Chiron's Fluvirin vaccine have been resolved in principle.
  • Regulatory: Risks associated with the approval of new products and indications.
  • Integration: Risks that cost savings and synergies from acquisitions may not be fully realized or may take longer than expected.

Key Facts for Investor Verification

• Chiron Acquisition Costs: Verify the final purchase price allocation and the specific impact of amortization of intangible assets on future earnings, as current figures are provisional.
• Net Debt Position: Confirm the sustainability of the shift from net liquidity to net debt ($0.7 billion) and the company's ability to service this debt while maintaining dividend payments ($2.0 billion paid YTD).
• Product Pipeline Approvals: Monitor the regulatory approval status of Galvus, Tekturna, Exforge, and Tasigna, which are critical for sustaining the projected growth.
• Sandoz Pricing Pressure: Review the impact of price cuts in Germany and accounting adjustments in France on Sandoz's future margins, despite strong volume growth.
• US GAAP Reconciliation: Note the significant difference between IFRS and US GAAP net income ($5.5B IFRS vs. $4.5B US GAAP YTD 2006) due to intangible asset treatment and pension accounting.