NVS

Novartis AG Form 6-K Summary: Third Quarter 2011

Business Context and Reporting Period

This Form 6-K reports the unaudited financial results for Novartis AG for the third quarter and nine months ended September 30, 2011. The Swiss-based pharmaceutical company operates across five divisions: Pharmaceuticals, Alcon (Eye Care), Sandoz (Generics), Vaccines & Diagnostics, and Consumer Health. The reporting period reflects the full consolidation of Alcon, Inc., which was completed in April 2011.

Key Financial Metrics

Note: Net debt increased to USD 18.3 billion as of September 30, 2011, driven by dividend payments, Alcon-related share repurchases, and treasury share purchases.

Material Changes vs. Prior Period

• Sales Growth: Net sales rose 18% (12% in constant currencies) in Q3 2011, driven by recently launched products which contributed 25% of total sales. The weakness of the US dollar provided a 6% benefit to reported sales.
• Profitability: Core operating income grew 11% (15% cc) to USD 4.1 billion. However, reported operating income margins were compressed by currency impacts and exceptional items, including impairment charges of USD 134 million and restructuring costs of USD 93 million.
• Divisional Performance:
  • Pharmaceuticals: Sales up 9% (3% cc); core operating income up 1% (6% cc). Growth driven by Oncology (Glivec, Tasigna, Afinitor) and Neuroscience (Lucentis, Gilenya).
  • Alcon: Pro forma sales up 12% (7% cc); core operating income up 20% (13% cc). Strong performance in non-US markets and ophthalmic pharmaceuticals.
  • Sandoz: Sales up 6% (1% cc); core operating income down 12% (10% cc) due to a strong prior-year base for enoxaparin and increased R&D investments in biosimilars.
  • Vaccines & Diagnostics: Sales up 4% (-2% cc); significant drop in 9M sales (-48%) due to the absence of A(H1N1) pandemic flu vaccine sales recorded in 2010.
• EPS Dilution: Reported EPS growth (3%) lagged net income growth (7%) due to an increase in the share count following the Alcon merger.

Guidance, Outlook, and Management Commentary

• 2011 Outlook: Management expects full-year constant currency sales growth in the low double-digits. Pharmaceuticals is projected to grow in the low- to mid-single digits, while Alcon is expected to grow at a mid- to high-single digit rate on a pro forma basis.
• Productivity Initiatives: Novartis announced accelerated cost reduction activities to be executed over three to five years. This includes closing two sites in Switzerland and one in Italy, and restructuring the development organization. Approximately 2,000 positions will be reduced (mostly in Switzerland and the US), offset by 700 new positions in low-cost countries. A restructuring charge of approximately USD 300 million is expected in Q4 2011.
• Pipeline Progress: Key approvals include Afinitor/Votubia for additional indications in the EU, Gilenya in Japan, and a positive CHMP opinion for Rasitrio. Phase III data for Afinitor in breast cancer and QTI571 in pulmonary arterial hypertension showed positive results.
• Risks: Risks include currency volatility (strong Swiss franc), generic competition (e.g., Diovan losing exclusivity in Europe in Q4), and regulatory delays (e.g., ACZ885 for gouty arthritis).

Investor Verification Checklist

• Constant Currency Adjustments: Verify the impact of the strong Swiss franc on reported margins versus constant currency performance, as currency headwinds significantly impacted reported operating income.
• Restructuring Costs: Monitor the execution of the announced 2,000 job cuts and the associated USD 300 million Q4 charge to assess future cost savings.
• Patent Expirations: Track the impact of Diovan's loss of exclusivity in Europe in Q4 2011 on the Pharmaceuticals division's revenue.
• Alcon Integration: Review the realization of synergies and the performance of the Alcon division post-merger, particularly in emerging markets.
• Net Debt Trajectory: Assess the company's ability to manage net debt levels (USD 18.3 billion) amidst dividend payments and share repurchases.