AstraZeneca - Earnings Call - Q1 2012

Transcript

Speaker 8

Good morning and welcome to AstraZeneca's Q1 results analyst teleconference and webcast. The meeting is scheduled to start in a short while. Firstly, a cautionary statement regarding forward-looking statements. The company intends to utilize the safe harbor provisions of the United States Private Securities Litigation Reform Act, 1995. Participants on this call may make forward-looking statements in respect to the operations and financial performance of AstraZeneca. By their very nature, forward-looking statements involve risk and uncertainty, and results may differ materially from those expressed by these forward-looking statements. The company undertakes no obligation to update forward-looking statements. Information about the principal risks which may affect the company can be found in the company's annual report in Form 20-F information. At the end of today's presentation, there'll be a Q&A session.

You may indicate you wish to ask a question by pressing star one on your telephone keypad at any time during the call. We will endeavor to take as many questions as possible. The meeting will start in a few moments with opening remarks from AstraZeneca's CEO, David Brennan. Please stand by.

Speaker 1

Okay. Hello, everyone. Welcome to our first quarter results call. This is David Brennan. Simon Lowth is also here with me, and he's going to run you through the financial results in just a moment. Before I ask him to do that, I wanted to make a few comments about the announcement about my decision to retire as Chief Executive Officer, which we announced this morning. After more than six years in one of the best jobs in the industry and a challenging job at that, I think the time is right now to stand aside and to pass the reins to a new leader. I think the board made a good decision in appointing Simon as interim Chief Executive as of June 1, and I'll hand over my responsibilities to Simon on that date as well. Putting Simon in place as interim CEO has my full support.

I think the board believes, and we discussed yesterday, that vesting authority in the team that's accountable for the day-to-day running of the business into the future is really the best way to ensure both continuity and clear leadership during the transition period. To me, that makes perfect sense. I believe also the company has an exceptionally strong executive team in place, something that I'm actually personally very proud of, and I believe under Simon's direction, the team will continue to provide strong collective leadership while the board carries out a thorough search, both internally and externally, for my successor. The pharmaceutical sector is experiencing pressures, the likes of which I've not witnessed in my 36-plus years in the industry. Despite that, I really do remain very confident that AstraZeneca has the capabilities, the courage, the determination to be successful in the future.

If we maintain our focus on meeting the needs of patients around the world and on delivering on unmet medical needs with our medicines, I believe that we can and will continue to deliver attractive and sustained returns for our shareholders. The time for reflection on what has been a long and rewarding career for me with AstraZeneca is going to have to wait until I hand over my responsibilities. For now, up until June 1, my attention will remain 100% focused on delivering on our strategy. For the record, I do want to say that I'm proud of what we've achieved over the last six years or so. We built some, I think, some of the world's leading products in Nexium and Crestor and Seroquel and Symbicort, and these products have made a really meaningful difference to the lives of patients around the world.

We've established a leading position in emerging markets and have continued to invest there. We've reshaped research and development, and we've taken some difficult but necessary decisions to reduce our cost base, allowing for increased investment where growth opportunities do exist. We've also returned considerable value to our shareholders. Finally, the other thing I'd point out is that we've led at a sector level too. For example, we have led the debate on restoring trust in the pharmaceutical industry by introducing bold policies on interactions with healthcare professionals, which have been rolled out globally. It's been a genuine privilege for me to lead the company over the last six years or so, and I'm looking forward to a new chapter, including spending some more time with my family, something that's really very precious to me.

With that, let me just turn my attention to why we are here today, which is to talk about first quarter results, and, you know, reflect, I think, what is a very challenging revenue picture for us. In the announcement today, we also highlighted that we've strengthened the pipeline through both our collaborations with Amgen, to co-develop five clinical-stage products in the field of inflammation. It's a good opportunity to invest in innovative science wherever it originates. Earlier this week, we announced the agreement to acquire Ardea Biosciences for about $1 billion in net cash, which brings with it a promising project in phase III development for the chronic treatment of hyperuricemia patients with gout. Lastly, we're very pleased at the stage of a positive opinion approval of Forxiga, which is a brand name for dapagliflozin in our new diabetes medicine.

From our cooperation with Bristol-Myers Squibb, we look forward to bringing it to the market once it receives final approval from the European Commission. Returning to the numbers for just a minute, the revenue performance in the context of the anticipated loss of exclusivity on several brands and challenging market conditions have made for a very difficult start for the year. We're determined to focus on what we can control. We're moving with pace to implement the third phase of our restructuring, as you'll have seen by the extent of the restructuring charge that appeared in the quarter. Delivery on these plans, continued discipline on our operating costs, and the benefits from a lower than projected tax rate is only going to partially mitigate the downward pressure on revenue. As a result, we've lowered our core EPS target for the full year to the range of $5.85 to $6.15.

With that, Simon, I'm going to hand over to you and let you cover the details of the quarter. Have at it.

Speaker 3

Thank you, David, very much indeed. Good morning to everybody on the call. I'm going to focus on five topics. I'll start by summarizing the headline numbers, and I'll cover the revenue performance by region and for selected brands. Third, I'll turn to the core operating performance with an emphasis, obviously, on the key drivers of operating profit and margin. I'll briefly touch on cash distributions to shareholders. Finally, I'll close with our thoughts on guidance for the full year. Onto the headline results. Total company revenue was $7.3 billion in the quarter, an 11% decline in constant currency terms. Exchange rates were neutral for the first quarter revenue. Another dominant feature of our revenue profile for the year will be the impact from the loss of exclusivity on several brands.

In the first quarter, 8% of the revenue decline is attributable to generic erosion, chiefly for Nexium in Europe, Arimidex and Merrem globally, and for Seroquel IR in the U.S. Generics for Seroquel IR launched at the end of March, in line with our established practice following a generic launch. A returns reserve was taken against the estimated trade inventories, and this amounted to $223 million. Although the prescription declines won't affect the product until the second quarter, we have already experienced some of the impact in first quarter revenue. The disposal of Astra Tech accounted for 1.7 percentage points of the revenue decline, as there was $141 million in revenue in the first quarter of last year. We had a small impact on revenue, just under 1%, from disruption in our supply chain associated with the implementation of a new enterprise resource planning system at our plant in Sweden.

The underlying problems have now been largely resolved. We do anticipate further limitation in the supply chain in some markets in the second quarter as production responds to ongoing demand for filling back orders and restoring normal inventory levels. Government interventions continue to impact AstraZeneca and indeed the biopharma industry generally. We estimate that our revenue impact at around $370 million in the quarter. I'll discuss the regional and brand revenue performances shortly, but let's continue with the headline numbers. Core operating profit in the quarter was down 18% in constant currency to $3 billion, chiefly on the revenue decline. Also, core gross margin in the first quarter last year benefited from a $131 million gain from settlement of some patent disputes with PDL Biopharma. Core earnings per share in the quarter were $1.81 compared with $2.23 last year. That is a 19% decrease in constant currency terms.

Again, a large one-off in the prior year period has had a big impact. Last year's first quarter benefited by $0.39 as a result of agreements reached between the U.K. and U.S. governments over certain tax matters. If we exclude the one-offs in gross margin and tax from the prior period, core EPS in the first quarter would have increased by 2% versus last year. Adjustments to core earnings are significantly higher in the first quarter of 2012 due to the restructuring charges. The 19% decline in core EPS becomes a 39% decrease in reported EPS. Those are the headlines for the first quarter. Returning to the first quarter revenue performance, and when I refer to growth rates, they'll be on a constant currency basis. Revenue in the U.S. was down 12% compared with the first quarter last year. I already mentioned the Seroquel returns provision. U.S.

healthcare reform had a $205 million impact. It includes around a $38 million adjustment in the Medicare coverage gap discounts related to 2011 utilization. We had been accruing based on estimates, and now that the actual utilization is known, we do need to make a catch-up provision. Revenue in Western Europe was down 19% in the quarter, largely due to further penetration from generics for Nexium, Arimidex, and Merrem. There was downward pressure on prices from government interventions. Revenue in established rest of the world was down 9%. Japan was down 10%. This was on general destocking ahead of the biannual price reductions and the quarterly phasing of shipments to marketing partners for Crestor and Symbicort. The in-market demand for both products was up year on year. Canada's 8% decline is largely due to generic competition for Nexium and Atacand. Revenue in emerging markets was up 1% in the quarter.

You'll recall in our full-year results in February that we expected a weak first quarter in emerging markets. China was up 13%. Three markets, Brazil, Turkey, and Mexico, account for more than 40% of the shortfall from our recent double-digit growth rates. Brazil is down 15% on loss of exclusivity for Crestor and Seroquel IR. Turkey is down 18%, chiefly on government price interventions, and Mexico is down 25% on some challenging market conditions. We expect a rebound in emerging markets over the remaining three quarters of the year. Whether we'll be able to claw back all of the first quarter shortfall and achieve double-digit growth for the full year is hard to call at this point, but there's no question that it will be a challenge. This slide provides a snapshot of revenue for our key brands.

Grew revenues for the key brands that retain market exclusivity, except for Symbicort, which would have been up were it not for the phasing of shipments in Japan that I've already mentioned. Crestor was up 2% to $1.5 billion. We had double-digit growth for Seroquel XR and Onglyza revenue more than doubled. As you can see on the bottom of the slide, loss of exclusivity has taken its toll on Nexium, Seroquel IR, Arimidex, Toprol XL, and Merrem. Detailed commentaries on brand performances are in the press release, but I want to provide some additional color on two products: Crestor's performance in the U.S. following the launch of generic atorvastatin, and an update on the Brilinta launch. As to Crestor, we now have four full months of data on the statin market post-generic Lipitor. In its wake, Crestor's performance has remained resilient.

Crestor total prescriptions in the first quarter 2012 were up 2.1%, slightly higher than the 1.8% increase in the total statin market. This is largely due to stability in the 94% of the Crestor volume that is continued therapy. We thought that there would not be significant switching for patients who are doing well on Crestor. That has been our experience to date. We thought that there would be some churn in the 6% of the volume, which is dynamic. That's around 4% from new starts and around 2% from patient switches from other therapy. That's the thin sliver at the bottom of the first chart, which we've blown up into a larger scale on the next slide. Crestor volume of patients who are new to statin therapy is holding up very well, which is the area in red.

The purple wedge is switches to Crestor, and that has eased somewhat as some of the pool of patients that used to switch to Crestor from simvastatin has moved to atorvastatin. As we expected at the outset, there was some increase in patients switching from Crestor to atorvastatin on economic grounds. There has been some recovery in that trend in recent weeks. All in all, the market is evolving in line with our expectations. A quick note on the ex-factory sales in the U.S.: they were flat in the quarter, with the increase in prescriptions offset by a slight decline in realized prices, and that's attributable to the Medicare discount adjustments that I mentioned earlier. Turning to Brilinta, sales were $9 million in the quarter. Brilinta is really starting to pick up steam in Germany, which is the major market with the most launch experience.

Brilinta is reported to be on protocol in 79% of target hospitals in March. Latest market research data indicates that in these hospitals, we're now the leading product for initial therapy for ACS patients, with a market share of 37% of new starts. In the U.S., there were no reported ex-factory sales as we continue to work down the launch stocking that remains in the channels. We continue to make steady progress on the leading indicators. Brilinta is now on formulary in 68% of the top 400 target hospitals. Protocol access in these institutions is now 20%, and that's up from 14%. Trial rates amongst all interventional cardiologists have increased to 15.4%. As you can see on the left-hand chart, as we rolled out the full complement of promotional materials in November of last year, understanding of uptake, differentiating attributes, and cardiovascular mortality reduction is starting to gain traction.

Our latest market research indicates that 17% of interventional cardiologists rank Brilinta as providing the greatest cardiovascular mortality benefit of any oral antiplatelet agent. We know from our experience in Germany that as awareness and belief in this differentiating attribute increases, trial and adoption follow. On the right-hand side of the slide, in the first quarter, we have seen an encouraging inflection point in Brilinta total prescriptions from the trend line upon which we exited 2011. Based on the PLATO data, Brilinta has the potential to save thousands of lives if used instead of the current standard of care, but we would have liked to have seen a faster uptake. Because of the complex steps to achieve hospital access, we knew that this would be a slow journey to adoption.

Having worked with many key institutions in the U.S., we know it can take up to a year to ensure new medicine is widely available for use in a particular institution. Process friction is real, but so is our belief that Brilinta's clinical profile will ultimately drive strong usage. You'll have seen yesterday's announcement of our collaboration with the Medicines Company, starting with a co-promotion agreement in the U.S. They're a respected organization with a strong network in interventional cardiology, and we look forward to their support of our promotional efforts. On our turn to the first quarter P&L, I'll focus here on core margins and profit. Press releases, of course, contain the strategy numbers and a detailed reconciliation to the core measures. As with sales, when I refer to growth rates, they'll all be on a constant currency basis. Core gross margin in the quarter was 82% of sales.

That is down under 90 basis points compared with the first quarter last year, but more than 80% of this is related to the PDL settlement. Core SG&A expense was down 9% compared with the first quarter last year, as restructuring benefits and overall lower sales and marketing expenses in developed markets more than offset selected investments in emerging markets. A slight increase in the excise tax from U.S. healthcare reform. Core other income was 25% higher than the first quarter last year. This is largely the result of the Zomig deal in the U.S., where marketing rights have been licensed to Impact Laboratories. As a result, we now recognize the commercial contribution from Zomig in other income, not sales. That leads to a core pre-R&D operating margin of 55.5% of revenue. It's above the top of our 48% to 54% planning range.

It is down 170 basis points compared to the first quarter last year. The revenue and gross margin was only partially offset by the lower SG&A expenses and the higher other income. Core R&D investment in the quarter was just under $1.1 billion. That's a 2% increase, largely attributable to a net increase in intangible asset impairments compared with last year. We took the remaining $50 million impairment related to TC5214. In the first quarter this year, the full year, I expect core R&D expense will be lower than last year in constant currency terms, both on an overall basis and if you exclude the impact from intangible impairments from both periods. This leads to a core operating profit of $3 billion in the quarter, 18% lower than last year. Core operating margin was 48.8% of revenue, and that's down 360 basis points.

Turning to our productivity program, one-third of the projected $2.1 billion total cost for the phase three of restructuring was taken in the first quarter. It's an indication of the pace at which the organization is implementing these plans. In particular, R&D, which accounted for $445 million of the $702 million charged in the quarter. Most of the restructuring costs will be taken in 2012, and we remain on track for delivering the estimated $1.6 billion in annual benefits by the end of 2014. Cash generated from operating activities was $1.5 billion compared with $1.9 billion in the same period last year. With the benefits arising from our disciplined management of working capital, we were able to partially offset the reduction in operating profit and the $500 million contribution to the pension fund.

Net cash distributions to shareholders in the first quarter were more than $3.4 billion through a payment of $2.5 billion of second interim dividends from 2011 and net share repurchases of $912 million, all in line with the pace required to complete the $4.5 billion target for the full year. Another potential call on cash in 2012 is the merged shares option, or the second option, as it's also known by. Now, beginning in May, we have a six-month window to exercise the shares option, the first of three opportunities to do so. A notice of exercise would trigger an appraisal process to establish the value payable on closing of the option, which is largely based on the net present value of the future annual contingent payments on Nexium and Prilosec in the U.S. and some other items. We've not yet decided whether we will exercise this year or not.

From a pure strategic freedom to operate perspective, our preference would be to exit the arrangement at the earliest juncture. Ultimately, a decision as to whether we exercise in 2012 will be informed by whether the range of values that will emerge from our modeling of the various appraisal scenarios are attractive in economic terms. Finally, let's turn to guidance. We knew it was going to be a challenging year with the main elements of the revenue profile being the loss of exclusivity on several products, particularly Seroquel IR. Disposal of Astra Tech and the ongoing disposal of the Aptum business also contribute to the decline in revenue. There are several other factors, however, which, while individually not large, collectively do exert downward pressure on our revenue expectations for the full year.

We certainly expected government interventions on pricing to continue, but they are now looking to be at the upper bounds of what we'd anticipated, both in Europe as well as the impact in the U.S. from the Medicare coverage gap adjustments. We continue to have confidence in and will vigorously defend our intellectual property. Now, we prevailed in the U.S. trial on the Seroquel XR patent, but we have also had an adverse judgment in the U.K., and we had some mattress launches in Europe, and we have rulings in other jurisdictions pending. We expected the revenue trends in emerging markets to be phased towards a weak Q1, and I've called out the three markets that are the main drivers of the variance. While we're aiming for double-digit growth for the year, it will be a challenge to get there.

Finally, we've seen an impact from our supply chain issues in the first quarter, and there will be some carryover of this into the second and possibly the third quarter. That's why, on balance, we've revised our revenue expectations to now be in the range of a low to mid-teens decline in constant currency terms rather than the original low double-digit guidance. Second and third quarters are likely to be the toughest. Now, against the backdrop of this challenging revenue picture, we're proceeding at pace with the third phase of the restructuring, and we will, of course, exert discipline in our operating expenses. We expect core pre-R&D margin to be in the upper half of our planning range, but below last year. We will not compromise on the investments that will drive growth and value.

We'll continue to make sales and marketing investments behind new launches and in our growth markets. We'll continue to invest, progress the late-stage pipeline, and in business development opportunities, counting on productivity and restructuring to mitigate the investments behind these projects, which is why I expect R&D expense to be down in constant currency terms for the year. Finally, we'll also invest to rebuild inventories in the supply chain following the implementation of the enterprise resource system in our plant in Sweden. There's a change to the tax rate, which is now expected to be lower than the 24% we projected at the beginning of the year, now estimating a 22% effective tax rate for the full year. That's the result of the UK tax rate reduction, the resolution of some tax audit issues in the first quarter, and variations in the levels and mix of profitability in different jurisdictions.

However, the delivery on restructuring, ongoing discipline on operating expenses, and the lower tax rate will only partially mitigate downward pressures on revenues. As a result, we have felt it prudent to lower our core EPS target for the full year to the range of $5.85 to $6.15 per share. Currency was neutral to the first quarter core EPS, but I'd remind you that the forward look is based on the January 2012 average exchange rates upon which our guidance was based. It takes no account of the likelihood that average exchange rates for the remainder of the year may differ materially from the January 2012 average. In summary, it has been a tough quarter as we face the challenges of generic competition and government action on pricing and the other factors that I just discussed.

We continue to drive the performance of brands that retain exclusivity, quickly implementing the third phase of restructuring. Our resilient cash generation supports investment in innovation as well as strong cash distributions to shareholders. In the last few weeks, we've announced a significant collaboration with Amgen, an agreement to acquire Ardea Biosciences. These are examples of the kinds of opportunities that we'll continue to pursue to create value. With that, I think we'd now be delighted to take your questions. For those who are taking part via the telephone, you can press star one on your keypad to alert the operator that you wish to ask a question. Those listening via the webcast, you'll find a text box on the webcast page to type your question. We'll try and answer as many questions as possible. If that's the case, we can have the first question, please.

We'll have the first call here from Sachin at Bank of America. Sachin, over to you.

Speaker 1

Hi, afternoon, and thanks for your question. Just three if I may. First on the whys, you've been quoted as saying your annual strategy review is ongoing and outcome in the second half. I wonder if you could just kind of allude to the questions that are being asked as part of that. Is the scope of that review any different to how it normally would be given the business pressures that you're facing? Second question on emerging markets. We've seen most of the companies that are reported so far have struggling in emerging markets low to mid-single-digit growth rate. I just wonder if you could reappraise us of what emerging market expectations you've got within your long-term guidance and a confidence in that. The final question is on M&A. Clearly, you have hand deals and you're alluding to deals of similar nature.

I wonder if you could just remind us of the scope of M&A that you're looking at. I think David had commented at the full-year call that there were no upper limit deals. I wonder if you could just triangulate those comments. Thank you very much.

Speaker 3

Sachin, thanks very much indeed for the question. First of all, let me deal with them perhaps in that order. In terms of annual strategy, it's an annual process through which, as an executive team and a board, we review our strategy, our investment plans, and our outlook as a business. We always ask ourselves pretty broad-based questions about where we think the sector's heading, the sorts of options that we could explore as a company. We test those pretty hard and, as you expect, engage the board on those questions. This year, we'll follow the same process, and I'm certain that the sort of breadth of questions will be as broad as we've seen. Obviously, you know we expect to have new board members and a new chairman, and I'm sure they'll bring some fresh ideas, fresh perspectives to sort of stimulate our thinking.

That's the process that will be underway as we go into the summer and last part of the year, and sure, we'll be broad in scope. In terms of emerging markets, I think we continue to see very strong fundamentals for the growth of our business out into the future. We've talked, Sachin, about this before. The populations are expanding. People are living for longer. They're more affluent and are more demanding of the standard of healthcare and the medicines that they wish. That provides a huge driver to our business. We continue to see very strong healthy growth in markets like China or in Russia or in the Middle East, and indeed underlying growth in markets like Brazil. We will continue to invest very hard to realize that opportunity. We're investing in our sales and marketing resources and expanding those.

We're investing in market access plans in markets like China and Russia. We've also, as you've probably seen, recently acquired a business in China to broaden our product portfolio in order to access the broad market. We'll continue to invest behind that opportunity. We've seen a weak first quarter, and as I mentioned, it's going to be a challenging year to sort of bring back to our double-digit expectations. That really does reflect the prior year comparators in the context of some generic entry in Brazil, a very important market for us. Pricing, as I cited Turkey, we've had pricing of smaller scale in one or two other markets and some tough conditions in Mexico. We'd anticipated much of that, albeit it's probably been a bit tougher than we'd expected. I think it's a near-term issue, but we remain very confident in the prospect for our emerging markets business.

In terms of your final question, our priorities in terms of business development and M&A, I think, are clear and ones that we've been pursuing very actively. The first is to complement our late stage and strengthen our late stage pipeline. That's through peer collaborations such as the one that we announced recently with Amgen. It's through more traditional licensing deals, and we're very active in a number of situations. It's also where we can see strong products that complement our capabilities, whether that's commercially or development, to acquire attractive late stage assets. You saw us do that with Ardea Biosciences with the acquisition we'd announced earlier this week. That's the first priority: strengthen the pipeline. The second is we've got a very strong commercial capability around the world. We actively look for portfolios of marketed product to bring into the company.

We've done some smaller acquisitions in our emerging markets, but that's an area we continue to look for good opportunities. We're very active at the moment. I'm sure we'll be doing more over the course of this year.

Speaker 1

Just a quick follow-on.

Speaker 3

For the question, we've got a second call come up, Alexandra from JPMorgan. Alexandra, over to you.

Speaker 9

Thank you very much. Three questions, please. Firstly, is your long-term revenue guidance, the $28 billion to $34 billion range, at risk? I mean, if you're declining this year by low to mid-teens and then some more in 2013, as Seroquel and Crestor Canada have to analyze, and the Atacand erosion comes on top, you should fall below $28 billion in 2013. The second question is coming back to the emerging market point because I think all of us asked ourselves a critical question whether this is indeed just phasing or the long fear, dramatic slowdown of emerging market sales. Is all the usual headwinds of pricing and generics eventually also play out in these markets?

I hear you on the one side arguing drivers are a growing more affluent population, but you know the European driver was always going to be an aging population, and that doesn't result in rising sales either. I mean, what markets other than China do you really see growing double-digits in the next few years sustainably? Just any sort of reassurance that you think that something close to double-digits is possible. It's quite interesting, by the way, that you're talking in terms of Brazil for underlying growth. That isn't really confidence-inspiring in the growth potential of this market. The third question is about the deal you announced last night with The Medicines Company.

There seemed to be some indication that you may think about a collaboration also on Cangrelor, which I actually find difficult to understand, given that if the phase III for that product works out, it would probably compete for shares with Brilinta. Can you just maybe tell us under which conditions there would be a collaboration on that product or not?

Speaker 3

Okay. Alexandra, thanks very much for those questions. Let me start with your first one and just talk about the revenue. As we've described, we'd expected to see low double-digit.

Speaker 9

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Speaker 8

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Speaker 9

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Speaker 8

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Speaker 3

The Middle East is a market we've been investing in heavily, increasing, and then actually some smaller markets which are growing very fast for us. I call out Vietnam. I call out India as being a couple of markets where we've seen strong growth over the last 12 months. We're investing hard in those markets. Probably, Christopher, your question prompts me to realize that I didn't answer Alexandra's second question about emerging markets. Alexandra, forgive me for that. We were in the middle of that experiencing some technology issues here in making sure the phone calls come through, which we'll update you on in a moment. Coming back to your question on emerging markets, we continue to see, as I mentioned, very strong fundamentals driving underlying prescription growth, underlying demand for medicines. That's why we feel confident about the future prospects and why we're investing hard behind them.

You're right, though, Alexandra, that there are pricing pressures in a number of markets. We'd anticipated those. It's.

Speaker 8

Once again, ladies and gentlemen, please continue to stand by. Once again, ladies and gentlemen, please continue to stand by.

Speaker 3

Peter, you've asked if we can talk a bit about capital allocation and capital discipline, given the revenue challenges being faced and the sort of public comments about the willingness to pursue business development more actively. Linked to that, what leverage we're comfortable taking on and how we would see the opportunities potentially impacting the progressive dividends and buybacks. Peter, thanks very much for that question. I think the starting point as we think about capital allocation is to recognize the strong and resilient cash generation capability of our business. You've seen that again during this quarter, notwithstanding it's been a demanding quarter. You saw that our cash flow held up very well, notwithstanding the decline in operating profit. Of that cash being generated from our core business, we reallocate into in-house R&D, but also in licensing of late-stage compounds, something like 40 to 50%. That's the guidance we provided.

The residual is therefore available to fund our progressive dividend policy, which we remain absolutely committed to. The remainder is available for investment in the business in further BD activity. Where we don't see good opportunities in a 12-month period, we will return that through our buyback program. The investment of 40 to 50% back into the late-stage pipeline is the first plank. We certainly have, given the cash balances we have and the residual cash after our progressive dividend policy, the flexibility to pursue our BD and bolt-on strategy where we see good opportunities. If we do not see opportunities that meet our sort of value criteria, of course, we will return cash to our shareholders through our share buyback program. Peter, hopefully, that gives you what you were looking for on that question. We've got another question coming up from Boler at UVA. Boler, please go ahead.

Speaker 2

Hi. I think those of us on the line were all cut off, so apologies if these two questions have been asked already. On your revenues, the shortfall was pretty broad on products and on geographies. Could you comment on whether reduced promotion was a possible factor for the broad shortfall and whether it signals other effects later this year on your financials? Secondly, on emerging markets again, we saw Crestor go generic in Brazil and previously in Eastern Europe, affecting your growth. Are there other major drugs that will go generic in major emerging markets in 2012 and 2013?

Speaker 3

Let me deal with your first question. The answer is absolutely not. We continue to invest very hard in sales, marketing, and promotional activity behind our brands where we see growth potential and particularly where they're protected with patents, where they're protected with brands in emerging markets. We're investing as hard in those areas as we have always done. Indeed, we're developing sort of multiple channels for promotion alongside that. Where we have been removing, reducing our sales and marketing level and resource has been in the wake of genericization, for example, Seroquel IR in the U.S. The most attractive returns and paybacks we get as a business is investing behind our brands where we've got growth. That's what we remain absolutely committed to. Given the efforts we're making on restructuring and productivity, we're able to do that while bringing our SG&A costs down, as you saw.

That's the first, I think, question. No, absolutely, we continue to invest very hard behind brands where we see growth. Your second question is, are there other generic risks in emerging markets? I would say that the two that have characterized the latter part of last year and this year, where we have seen some generic entry often at risk, and we therefore continue to take action through the courts to respond to that, are Crestor where we're protected by formulation, not substance, amount of patents, and the same on Seroquel. I think we've called out already the main ones that we see, and you'll see those in our legal proceedings note. Ed, I don't know if there's anything else you could add to that answer.

Speaker 7

Yeah, it's important to mention that in Eastern Europe, there actually was no patent estate there. It's a question of when the data exclusivity expired in those markets, we attracted the generic competition. I'd say on balance, if you look going forward, most of the patent expiry in emerging markets are probably similar to what we're going to see in the developed world, which is the Nexium in selected markets. You've got Atacand coming up at the back end of this year and Seroquel IR, as we expected.

Speaker 3

Yeah. I think that the distinction often in those markets is that, while we may lose patent section, we continue to drive and compete effectively with brands, recognizing the premiums that are frequently paid in those markets for the brand. James, you had something to add for that, having led a number of our emerging markets.

Speaker 0

Yeah, as we've talked about as well, a number of markets like China and also in Russia and across the Middle East and Africa, we already see multiple generics, and we have never had patent protection for a number of our products. We've even entered the market after the generics have entered the market in certain cases. The key issue is really threefold: our brand quality and our ability to drive a commercial brand across a country at large, the strengths of the competition in many of those markets don't have strong competition, unlike Brazil and Mexico, where you've got very strong local players, and also the structure of the reimbursements and copay arrangements. Brazil and Mexico, to some degree, are relatively sophisticated in the structure of the market, whereas a number of our other markets don't have those systems in place.

That's why we believe there is a strong sustainability in the branded medicine, irrespective of the patent estate at large.

Speaker 3

Very good. Let me pick up Steve from TD Cowen's on the line, but I thought I might just pick up a couple of email questions, just work through those, Steve, before I come back to you, if I may. I had a question from Tim Franklin, and I'm going to pose this one. Ed, you may be able to pick this up. Tim's been asking, can we provide the prescription growth of Crestor in Japan? If we have that to hand, I'm going to ask Ed if he can pull that out for you, Tim. If not, we will absolutely get that to you post the call. Another question also from Tim was the fall in the strong constant currency growth in the rest of the world markets for Crestor. How much of this is explained by the phasing of shipments to Japan and generic competition in Brazil?

Are there any other rest of the world factors that explain the CER growth contraction for Crestor? The answer to that is this is predominantly the impact in Japan and Brazil. I think those are the two main drivers of the year-to-year comparison of Crestor rest of the world. Overall, we continue to see strong growth in demand for Crestor above and beyond the statin market. Ed, do you have the Japan's prescription growth there for us?

Speaker 7

Yeah, the underlying market demand, which is aside from the phasing of shipments, is something in the mid-teens.

Speaker 3

Thanks, Ed. Finally, on just one other question picking up here from the calls, I got Lars Heffron from Enskilda. Lars, you'd asked the rationale between first firing a quarter of the U.S. sales force and then bringing in another company's sales force to promote your biggest development ever, Brilinta. This really reflects the differing capabilities that we're looking for. We reduced our sales force at the back end of last year, particularly in anticipation of the Seroquel IR patent expiration. We've continued to drive Brilinta very hard and been comfortable with the level of resourcing. The opportunity with the Medicines Company is to bring alongside a very experienced sales force in that particular market area in the U.S., but also to explore, as Ed mentioned earlier, a much broader program of development and commercialization. We look forward to that. Lars, you asked a second question. U.S.

dollar $350 million in sales lost to government interventions in Q1 approximates 5% of revenues. How does that compare with longer-term assumptions? It's a good question. Perhaps I can refer you to the two bits of guidance we've provided on this in the past, which is we've seen the impact of U.S. healthcare reform running around about $700 million a year. We've said that price interventions in Europe have typically been in the low to mid-single digits historically, but we really have been seeing price interventions at the mid-single digit range, in that sort of 5% range, and indeed tipped a little bit higher than that in the last few months. The sort of decline due to government interventions of 5% you've described is in the assumptions we've made looking forward, but it is fair to say we're up there at the top end of our expectations.

With that, Steve, you've been waiting patiently. Let me come back to your question, Steve.

Speaker 5

Okay. Thank you very much, Simon, and apologies if it was answered during the technology issues. You mentioned the ketchup provision for the donut hole. Would you expand on why it's larger than expected? Is there any particular product that is the culprit? Do you think the dynamics here are unique to AstraZeneca because this has not been mentioned by other companies? That's the first question. The second question is, on what date in May does the AZLP option to window open? Given that the window, I assume, could open as soon as next week, I am a bit surprised that AstraZeneca hasn't made the decision yet as to whether to exercise. Is there any information you're waiting for that could be forthcoming in the next week that would help you make the decision? Thank you.

Speaker 3

Thank you very much indeed. Let me add, I don't know if you'd like to comment on the coverage gap rules.

Speaker 7

Yeah, I mean, clearly, that's an area where it's difficult to estimate what patient behavior will be once they reach the coverage gap, whether they take advantage of the opportunity to get the discounted branded product or whether they are motivated to go to a generic alternative to capture even lower out-of-pocket exposure. Like any managed care adjustments that we do in our revenue calculations, you make some assumptions about what that utilization will be, and then you're looking through the rearview mirror as you get actual utilization data from either the managed care plans or, in this case, the government. You look at what you've already provided for and whether you've got to make either a true up one way or the other.

In this case, based upon the whole of 2011, we saw a slightly bigger exposure to the Medicare coverage gap, and we had to make a catch-up provision in Q1. As you might expect, the products that are probably the biggest drivers are Crestor and Nexium because they're the big primary care products that have a lot of utilization in that patient population.

Speaker 3

Thanks for that. Steve, in terms of the Merck situation, it starts in May. I don't know exactly which date in May, but the window is for a six-month period, May to October. I think I shared with you the evaluation of the 2012 option in my remarks. I can't elaborate upon that, simply to say that we're going to weigh up our decision, balancing the fact that from a few sort of strategic freedom perspective, we'd obviously prefer to exit the arrangement at the earliest time, and that would be 2012. Ultimately, that decision is going to be based upon how we weigh up the value. More to come on that, Steve, and we'll obviously keep you informed as we go forward. I think we've probably got time for one more question, and we've got Tim on the call. Tim, over to you.

Speaker 4

Thank you. This is Tim Anderson at Bernstein. With a change-up in management in the board, I'm wondering if you can assure us that whatever AstraZeneca's strategy is going forward, that the dividend is absolutely safe and that no business development will be pursued that puts this at risk. On Symbicort sales in ex-U.S. markets, your press release said that 60% of the sales decline was due to Japan, but I'm wondering what the other 40% was due to. On Combiglyze, if I'm not mistaken, that product is being sold in the U.S., but in Europe, your press release says it won't launch until later because of manufacturing issues. I'm wondering if you can add some clarity there.

Speaker 3

Yes, that's indeed. First of all, yes, we're absolutely committed to our progressive dividend policy. As I mentioned in my earlier remarks, in terms of investment to drive future growth and value through business development and bolt-on, we weigh up against the share repurchase program. Dividend is an absolutely core part of our proposition to our investors. Our commitment to the progressive dividend policy remains absolute. In terms of the Symbicort decline, Ed, do you want to just pick up? Obviously, 60% was that movement in the stocking in Japan. Do you want to just call out any other key items?

Speaker 7

Yeah, it was down year on year in Western Europe as well, and that's a combination of volume in some markets where you've got the Foster product taking a bit of share. Also, we don't usually attribute any individual price intervention to a particular product, but the European pricing interventions in Europe in general hit your larger products. Symbicort's obviously one of our larger products in the European market.

Speaker 3

Thank you. Carl, do you want to pick up the technical issue on Combiglyze in Europe?

Speaker 6

Yeah, we have actually... Hello, Tim. We have two different products here. In the U.S., we are selling Combiglyze XR, which is a once-daily extended release formulation, a fixed dose combination, that we launched successfully in January last year, whereas the product which is approved in Europe in November last year is an immediate release product called Combiglyze. We have said that the launch is now expected in 2013 due to some technical manufacturing issues. The responsible company behind the production here is BMS. They might be able to explain it better than we are.

Speaker 3

Okay. Thank you. Carl, thanks very much indeed. I think we've just about reached the end of the call in terms of time. We did, and we had two further email questions coming in, which we didn't get to. Let me just try and deal with these quickly to make sure we've addressed your questions. The first came from Luisa Hector at Credit Suisse, who asked us to expand on Brilinta. The German hospitals start translating to ongoing prescriptions once patients are out of hospital, or could they be switched to generic Plavix? Ed, do you want to pick that up very swiftly?

Speaker 7

Yeah, we're clearly now starting to see the outpatient utilization now reflect the inroads that we've made in the inpatient acute market share. We are not seeing any. As

Speaker 8

far as I'm aware, any material leakage of hospital starts not being persistent on Brilinta outpatient therapy.

Speaker 1

James, sorry, you had something to add to that?

Speaker 3

Yeah, I think it's worth reiterating. The placebo data is impressive, and it's particularly impressive when you look at the separation of the mortality benefit, which actually increases over the 12 months. The benefits of using Brilinta are seen in particular as you progress with the therapy, and of course that's going to apply to patients in the outpatient setting.

Speaker 1

Thanks. Who's had a second question, which is, Ed, how many plans in the U.S. are reimbursing Brilinta in sort of % of second tier?

Speaker 8

I don't have a precise allocation. We have unrestricted access, I believe, to well over 60% of the covered lives. I think we have a fairly good representation in tier two, but we do have some tier three access as part of that as well.

Speaker 1

Finally, I had a question from Simon King of First Web Pharma. Simon's asking, reflecting on the fact that Crestor's holding up impressively against generic Lipitor, and asks what our projections are once the U.S. 180-day exclusivity period expires and additional versions of generic Atorvastatin become available. I think I'd reiterate the comments I made on the call. I think Crestor's proven itself to be very resilient to the entry of generic Atorvastatin, and I think we feel that that reflects the very clear positioning that we've established for Crestor in the market as the right treatment choice for high-risk patients.

I went through the dynamics that we've experienced being very much in line with our expectations. There will come a bit more competition, clearly, when we've got a broader set of generics available, and I think where we'll see that is more likely as we come into the contracting round for 2013. We continue to believe that Crestor has a very important role to play in statins in the marketplace. Just one finally, also from Simon, any specific challenges in Western Europe regarding pricing and reimbursement? I think that was probably for Crestor, but more generally, Simon, the challenges in pricing and reimbursement in Europe are predominantly concentrated in those markets where we're seeing budget deficit issues to be addressed and where governments are looking at healthcare and medicines as a particular area where they may be able to achieve savings.

That's been something that we've seen stepped up over the last few months. That probably covers all of the questions. Our apologies that we had some technical issues on the call. I hope we did get to all of your questions, but if not, I'm sure that the IR team would be delighted to take some if you can get in touch with them. Let me bring the call to a close. Just a few sort of final comments really. It's been a tough quarter as we face the challenges of generic competition and government action on pricing. We continue to invest very hard behind brands and markets where we see growth potential. We've got a very full portfolio of brands such as Crestor, Symbicort, Seroquel XR, Faslodex, Onglyza, Forxiga, where we can see strong growth and we're investing hard behind them.

We're continuing to make progress to improve productivity in our research and development. We've made significant change, and I'm sure there's more effort to come. Thirdly, we've really seen real progress on our business development agenda in the last month, and I'm sure we're keen to see more of that to come. Significant activity in the company to really drive growth into the future. Of course, our core pre-R&D margins remain, notwithstanding the dividend position, up there above the top end of our guidance range in the first quarter, with cash flow remaining very resilient and a clear commitment to our cash returns to our shareholders. With that, we'll bring the call to a close. Thanks very much for the questions and good day to all of you.

Speaker 9

Ladies and gentlemen, that does conclude our conference for today. Thank you for participating. You may all disconnect.