Severin Schwan – Chief Executive Officer and Director
Daniel O’Day – Chief Executive Officer of Roche Molecular Diagnostics and President of Roche Molecular Diagnostics
Roland Diggelmann – Chief Operating Officer of Roche Diagnostics
Alan Hippe – Chief Financial Officer and IT Officer
Matthew Weston – Crédit Suisse AG, Research Division
Tim Anderson – Sanford C. Bernstein & Co., LLC., Research Division
Andrew S. Baum – Citigroup Inc, Research Division
Sachin Jain – BofA Merrill Lynch, Research Division
Keyur Parekh – Goldman Sachs Group Inc., Research Division
Michael Leuchten – Barclays Capital, Research Division
Tim Race – Deutsche Bank AG, Research Division
Richard Vosser – JP Morgan Chase & Co, Research Division
Vincent Meunier – Morgan Stanley, Research Division
Roche Holding AG (OTCQX:RHHBY) H1 2014 Earnings Call July 24, 2014 7:00 AM ET
Ladies and gentlemen, good morning or good afternoon. Welcome to the Roche Half Year Results 2014 Conference Call. I’m Stephanie, the Chorus Call operator. [Operator Instructions] And the conference is being recorded. [Operator Instructions] The conference must not be recorded for publication or broadcast. At this time, it’s my pleasure to turn over to Dr. Severin Schwan, Chief Executive Officer. You will now be joined into the conference room. Thank you.
Severin Schwan – Chief Executive Officer and Director
Good afternoon, and welcome to our Roche half year briefing. We had a strong performance in the first half, mainly driven by our new oncology products in the HER2 area, with Perjeta and Kadcyla, also Avastin growing very strongly with 6%, and we see continued double-digit growth for immunodiagnostics driving the diagnostics division as a whole. We’d increased our core EPS earnings by 7% at constant rates, ahead of the sales growth, and we made significant progress in terms of our product pipeline. We almost lose the oversight in terms of priority reviews, breakthrough therapy designations or fast track designations. Actually, in the first half alone, we have 5 of those, and Dan or Dave will cover this in more detail later.
With this progress in the pipeline, we have now 66 new molecular entities in our clinical portfolio, and we moved a number of those into late stage, where we have now 12 new compounds.
Both divisions are growing in all regions, particularly strong performance in the United States, where we have a 5% growth, despite the patent loss of Xeloda earlier this year.
Operating margins are up at 41% on a group level. Operating core profit, up 7%, and this is also very much reflected in our core EPS result, which is up at 7% versus previous year. If we take a deeper look into the development of the core EPS versus previous year, you can see there is a number of one-off items affecting the results. But putting all those one-off items together, actually, they net out overall, so really, a very strong growth of the underlying business for the first 6 months.
Looking forward, there is a number of important clinical data to be presented at upcoming congresses. Let me highlight ESMO, where we will present overall survival data for Perjeta. We’re very excited to share those data. And we are also looking forward to presenting data on the combination of Zelboraf and cobimetinib in malignant melanoma.
Based on the strong results, we are confident to meet our full year targets to grow sales at low to mid-single-digit rates, our core EPS ahead of sales, and on that basis, we should also be able to further increase our dividend. And with this, I hand over to Dan O’Day, head of the pharmaceutical division.
Daniel O’Day – Chief Executive Officer of Roche Molecular Diagnostics and President of Roche Molecular Diagnostics
So good morning, good afternoon, everyone. Pleasure to go over the pharmaceutical results for the first half of the year. Beginning right into the pipeline first, because I think that explains a little bit about the future prospects as well. We had a really terrific first half year in terms of data readouts and regulatory designations. I just want to cover a couple of them here. And throughout my presentation, I’ll be speaking about different medicines here.
But first of all, all of these key data readouts and actually regulatory designations happened in the second quarter. I think the key theme around oncology is that we continue to innovate in terms of new molecules, new medicines in this area. Secondly, we have a really strong immunotherapy, cancer immunotherapy program that I’ll cover in more detail. And of course, the combination strategy is coming together, including the 4 combinations we presented at ASCO and the many more we have in our development labs.
I’ll cover the crenezumab a little bit later as well. I just want to make a point on 2 other compounds here. One is on the ACE910 hemophilia program. This is an opt-in product from Chugai that we now have within our Roche organization. It’s a bispecific antibody that mimics factor VIII for hemophilia. The data were recently presented at the World Society of Hemophilia, and we’re also planning to present this also at ASH. But the data look extremely interesting. And what we saw is in patients, we saw a significant reduction in bleeding in a number of patients within our Phase I trial. And now we’re progressing on with a Phase I/II trial with that compound as well.
On oral octreotide, we had some additional Phase III data plus some regulatory interactions in the second quarter. And we decided to not move that program ahead, so we’ll be removing that program from our Phase III list.
It’s one thing to look internally at the program, but I think as Severin mentioned, when you think about the regulatory perspective on our portfolio, it’s really been a very, very successful quarter. In fact, in July alone, we had 2 priority review designations for Avastin in the United States: one for the ovarian cancer and one for cervical cancer. As you know, we had the breakthrough therapy designation from PDL1, and we just recently received a fast track status for our LptD antibiotic that is in a Phase II currently. And the Phase I data were really quite encouraging relative to our Gram-negative approach here, and particularly for Pseudomonas aeruginosa, looks quite promising at an early stage. So we’re looking forward to also move that product ahead in a Phase II trial.
So with all that data, we had a strong first half for the Pharma division with a 4% increase, this, despite the fact that we have significant erosion from Xeloda going off-patent. The United States’ 5% growth is strongly driven by the oncology franchise, HER2, Avastin and also Actemra. In Europe, strong growth, 3%, really driven again by the oncology franchise and Actemra. And we also had a Tamiflu order in the first quarter. So you can see the sales are moderating a bit as we expected for the half year when you see the effect of the Tamiflu play out over the course of the year.
Japan at 7%, really all the oncology products growing well there, as well as Actemra. And we did also have the effect in the first quarter in Japan of the VAT change. That was quite a large first quarter, moderated a bit in the second quarter, but we see continued growth in Japan for the remainder of the year.
And the international at 2%. We saw increase in the international sales overall in Pharma in the second quarter from the first quarter, and we expect that to continue to accelerate in the second half of the year. Brazil is growing at 11%. In the Middle East, we have a variety of challenges going on with the political crisis in the Middle East and also the nature of some of the tenders there. And in Asia, in China in particular, we have our strategic products growing nicely. We had a Tamiflu effect in the first half of last year that didn’t repeat itself this year, and we also have some local competition in one of our small molecules, Tarceva as well, but we expect that entire international growth and China to continue to accelerate growth in the second half of the year as well.
Now that strong sales performance led to a good increase in the core operating profit at 9%. I just want to take you through a couple of items in the P&L because it’s a little bit different than most years because of some one-off items. First of all, in the royalties and other operating income line, we’ve got, in addition to strong royalties from Lucentis and other products, we have a one-time effect of the return of the Neupogen product to Amgen, which accounts for about CHF 428 million in the first half of the year. You can see the effect that has when you exclude that.
On the cost of sales line, we also booked the charges associated with the full year cost, if you like, of MetMAb and bitopertin into the first half of the year, and that has an effect on cost of sales and also in R&D. And you see M&D really being managed with cost control. We would expect some continued M&D investment in the second half of the year as well.
And then finally, in the G&A, we have the nonrecurring item from the previous year on our pension income, which has, of course, a negative impact in this case, balancing out a little bit the royalty income. Overall, if you exclude those one-off items, and by the way, we don’t exclude MetMAb and bitopertin from this because this is a part of our normal operating cost, you get a core operating profit of 6% for the first half of the year, ahead of sales. And I would expect going to the second half of the year, we have to remember that Xeloda in the United States lost its patent exclusivity in March in the United States, so it really had a 1-quarter effect in the first half. It’ll have a 2-quarter effect in the second half, something to keep in mind. And of course, the Amgen royalty will be then balanced out throughout the course of the year.
Strong sales across all the strategic products. I guess the key message on this slide that I will point out is that, clearly, the innovative products in the company are outgrowing the products that we’re either losing patent on or having significant competition in. You can see here, of course, the full Xeloda effect for the first half of the year. And again, in the second half of the year, we’ll see an even larger impact in the United States. Pegasys, because of the advent of the non-interferon-containing regimens, is declining. But then, you see, of course, the tremendous growth from Perjeta and Kadcyla contributing to more than CHF 600 million of growth in the first half of the year, good strong growth in Avastin and Actemra as well.
So breaking apart the products a bit. Looking first at the oncology franchise, growing by 6% in the first half of the year, really a terrific success story in the HER2 franchise with 20% growth. That’s 30% growth, by the way, on the HER2 franchise in the United States, which is obviously ahead of the rest of the world. We’re rolling Perjeta out to many markets around the world now, in fact, 78 markets around the world for Perjeta, and we’re just beginning a roll out of Kadcyla. In fact, Kadcyla is launched in Germany and Denmark so far, but most of the European countries will launch that in the third quarter of this year, so we’ll see that effect in the third quarter and the second half of this year as well. But truly, you see the benefit in the metastatic setting of Perjeta and Kadcyla, and we have some additional data on that, that I’ll point out as we get into the rest of the presentation.
MabThera is 40%, has improved the growth rate since the first quarter. We see growth in regions across the world, including the U.S., Europe and also some of the emerging market regions. I’ll get back to Avastin. Tarceva continues to do well in the first line, but not completely offsetting the competition that we have in the second line, as you can see there. And as I mentioned, in China, we have an in-class competitor there that is competing with us in China at this stage. Xeloda, as you’d expect. Zelboraf, a tale of 2 stories. On the one hand, we’ve got decline in the United States and we have growth in Europe. However, with the recent announcement that we made on the BRIM7 trial results and the data that you’ll see at ESMO, I’m quite confident we’ll have a competitive combination therapy for patients with melanoma, as you see that data as well.
Avastin, 10 years on the market, another terrific ASCO presentation relative to the fact that it demonstrated that — with the CALGB study that Erbitux is not superior to Avastin in colorectal setting. I think more importantly from that trial, what it emphasized is that there was about 1 year of survival for colorectal cancer patients 10 years ago. And now, again through another larger trial, we can see consistent 2.5-year median survival for patients with colorectal cancer. Great news for patients, and a tribute, I think, to Avastin over the course of many, many years. And of course, we’re the only biologic to have overall survival in the first, second and then treatment beyond multiple lines in colorectal cancer.
Beyond that good news, we have, of course, the platinum-resistant ovarian cancer that’s received priority review in the FDA and has already received CHMP positive opinion. So we would expect in Europe to have that decision in the near-term future. Cervical cancer was also granted priority review in the United States, and we filed it in Europe. Lung cancer, again, another highlight of ASCO, seeing that Avastin and Tarceva combined added an additional 6 months of survival for patients with EGFR+ lung cancer. Again, a strength, I think, of our combination strategy coming through there. And in breast cancer, some interesting data that we’ll be presenting at ESMO on IMELDA and TANIA. These are 2 studies looking at both the HER subset of patients as well as [indiscernible] patients, and I think we’ll be interested in sharing that data with you also at ESMO. So a strong first half for Avastin and continued innovation happening with Avastin.
On the Herceptin side, you can see here the — or the HER2 franchise, you see the 20% growth. What I will mention is that Herceptin is growing at 6%. So we see — and that’s even despite the fact that in some markets around the world, when we do combination pricing, we’re providing a bit of a discount for Herceptin. And of course, the reason I think we see Herceptin growing overall is both the emerging market growth but of course, the combination with Perjeta and the longer duration that patients stay under the Perjeta and Herceptin combination.
Again, terrific market share penetration in the United States with Perjeta. We’re up to basically 60% now in the first line setting, close to 70% in the neoadjuvant setting. And I already mentioned when we expect to roll out Perjeta and Kadcyla in Europe.
The other positive development is to see how well the Herceptin SubQ has picked up in Europe in a very short period of time, so less than a year in every major market. And you can see many of these key markets in both Europe and in Latin America already have between 40% and 50% total penetration of Herceptin in the marketplace. That’s both metastatic and adjuvant. I think it speaks volumes to the convenience factor for patients and the convenience factors for hospitals and health care systems. And as I mentioned in previous reports, when we see hospitals switch or, in some cases, even countries, you literally see an entire switch of the Herceptin franchise within a health care system. And remember, the Herceptin SubQ, the MabThera SubQ that we received approval for and will be rolling out have additional patents associated with these as a way to secure Herceptin and MabThera vis-à-vis biosimilar competition outside the United States in this particular case.
Lucentis, a good first half of the year at 6% growth, stable in AMD, growing in DME. Overall, the market continues to grow with the aging population in the United States. And we will expect some additional competition in Lucentis in the second half of the year in the areas of CRVO and also in DME. So that, we can expect in the second half of the year as well. But we continue to see growth for Lucentis on a full year basis, of course.
Actemra, it’s another success story of, I think, the head-to-head strategy, monotherapy, and you can see the results. We now have 22% growth in the first half of the year, growing in all the regions. The United States is the first mover with the subcutaneous, and we now have almost 80% of the new patients coming on to the subcutaneous. And so as you know, the subcutaneous opens up a larger portion of the market than we’ve had with the intravenous. And I think this subcutaneous now will just begin to roll out in Europe and in other markets as well.
So that’s a look at the in-line products, if you like, for the first half of the year. I’d like to touch base on a couple of key points on the innovation side. And I’ll start with crenezumab, our second anti-amyloid biologic that we have in studying for Alzheimer’s. The data was presented just about a week ago in Copenhagen at the AAIC, and we find the data very interesting. We’re digging into them now to determine how we best proceed with this molecule.
Let me just say the following. There are 2 studies, there’s the ABBY study and then there’s the — I can’t think of the name of the other study now — BLAZE, thank you. BLAZE, which is for the biomarker hypothesis. Data was provided on both of those studies. And in ABBY, although it did not meet the co-primary endpoint of the functional, as well as the cognitive endpoint, when you look into the subsets of the data, there’s some interesting data that suggest activity. And I would say, looking at this graph, if you go from left to right on this graph, what you see is as you get to milder patients, because the ABBY study was done in mild to moderate patients, so the more mild you get, which is this MMSE 22-26, you start to see the curves separate. And what that implies is that you see a more significant difference in the cognitive endpoints in these trials. Interestingly, the functional endpoints didn’t change so much in these announcements but the cognitive did. So as you can imagine, we’re encouraged by this data. We need to dig in to this data. We need to have discussions with regulatory authorities, and then we’ll be determining the next steps on this particular molecule in Alzheimer’s.
Terrific year at ASCO this year for the cancer immunotherapy program. Those of you that are able to attend the Roche event there, we highlighted the fact that we have now 20 projects in the clinic — or preclinically for cancer immunotherapy. We presented, of course, on our bladder cancer in PDL1, which is one of the highlights of the ASCO meeting this year that received breakthrough therapy designation. We also presented on anti-CSF-1R. And we started to expose you to other compounds we have, like anti-OX40, anti-CD40, the anti-IL-2 and our immunotherapy doublet combinations, which again, if you remember the cancer immunotherapy cycle, we remain convinced that it is extremely important to approach cancer immunotherapy with multiple ways of approaching the cancer immunotherapy cycle and with biomarker strategies to determine which patients might be able to best respond. And we continue to make good progress there. I’ll remind you, we have the — another cancer type, so this will be the fifth cancer type for Roche, for cancer immunotherapy in PDL1 that we’ll disclose in the second half of this year.
Just because I can’t get away from this data on the right-hand side here, it was extremely encouraging for bladder cancer patients. Remember, these are patients that are generally over the age of 65, quite compromised. The only available therapy today is chemotherapy and surgery, and many of these patients could not tolerate that. And what we saw in our Phase I single arm is a 43% response rate at 6 weeks. And when you look at that data at 12 weeks, we had a 52% response rate. This is partial response and complete response. Of that, around 7% were complete responses. So as you know, with the breakthrough therapy status, with discussions with the regulatory authorities, we’re now moving very aggressively into a larger Phase II, that’s already enrolling, and planning for a Phase III trial in bladder cancer. So exciting days for this, and we also have FIR and POPLAR on the lung cancer side that we expect to have towards the end of this year and early next year.
So in addition to that, at ASCO, I’ve talked a little bit about the CALGB and GI cancer. On the lung cancer side, we had the Avastin-Tarceva that I mentioned. The ALK inhibitor looks extremely promising, particularly in the brain mets. We’ll be representing more data on the ALK inhibitor later this year as well. So — but that’s being moved now, as you know, into a label-enabling trial.
On the hematology side, we have the Bcl-2 inhibitor, the GDC-0199 data, in 17p deletions and also in combination with MabThera, and we’re expecting to start the combination with Gazyva later this year. The anti-79B was also another one of our combinations that we saw encouraging data, and we’ll be taking that into late stage as well.
And then finally, the most recent one is the Zelboraf MEK inhibitor, cobimetinib combination. We’re looking forward to presenting that data to you, as I said, at the ESMO, the BRIM7 data.
So to close the outlook slides, I would like to say that the Phase III readout so far, you can see on this, we’re still expecting the MARIANNE trial to read out at the end of this year. That’s a trial that would be extremely helpful for determining how Kadcyla and Perjeta play out in the first line setting, but it’s also a trial that will help us with our adjuvant trials that have already begun, as you know.
And then we’re well on track with our Phase III starts. In fact, the ALK inhibitor should start basically any day now enrolling patients. And lampalizumab for dry AMD, we’re on track to begin enrollment by the end of this year.
On the regulatory news front side, it’s been an active quarter with Actemra and MabThera SubQ, new Xolair indication in the U.S. and of course, the filing of Avastin in cervical cancer. I would say that we feel that the Gazyva indication in Europe is imminent as well, so we’re expecting that shortly and looking forward to introducing that to the market.
In terms of the presentation, just in summary, because it’s sometimes hard to keep it all together. At ESMO, we’ll present the Avastin breast cancer data. We’re going to present the OS data on CLEOPATRA with Perjeta, which we’re very much looking forward to sharing with you. I think we’ll continue to reinforce the progress and the uptake of Perjeta. We’ll be presenting the Zelboraf MEK combination. And for anti-PDL1, we’ll be presenting some additional data in bladder with Avastin and also in renal.
In Chicago, we’re going to be presenting the ALK inhibitor data, and this is the Avastin lung data in China. At ASH, we’ll be presenting the GREEN trial. This is the so-called GREEN trial, which is the alternative chemotherapy backbone to chlorambucil, which is particularly important for the U.S. market. We’ll be beginning to present some of the data at ASH, as well as the ACE Chugai compound for hemophilia. And then finally, at the ECNP, we’ll be presenting the results of the Phase II MARIGOLD study in depression.
So with that, I thank you very much and turn it over to Roland for Diagnostics.
Roland Diggelmann – Chief Operating Officer of Roche Diagnostics
Well, thank you, Dan. Good morning, good afternoon, from my side as well. It’s a pleasure to be able to take you through the Diagnostics results for the first half year.
Let me go through the numbers right away. And you can see, as Severin mentioned, strong first half for Diagnostics with a 6% growth, largely supported by our core business and our largest franchise, which is Professional Diagnostics, growing at 9%. Then we see Molecular Diagnostics growing at 4%, and excluding the sequencing results, growing at a very solid 7% — 6%, excuse me. And in Tissue Diagnostics, with 9% growth, also doing very well.
So if we take together the clinical laboratory business, growing at 8%, very positive. And then Diabetes Care with a flat development, which we look at as some positive results as well, in line of the changes in the marketplace. And just to remind you, last year first half in Diabetes Care was minus 4%. So notwithstanding that, we know we operate still in a challenging environment and a volatile environment, especially in the largest diabetes market in the United States.
The growth broken down by geography. First of all, growth across all regions, which is very positive. As you would expect, larger growth in the emerging markets: Latin America, 11%, Asia Pacific, 15%; and the E7 countries, led by China, was very good growth. But also, good growth, positive growth in EMEA, in Japan, and not the last, in the U.S. was a very strong 6% in a market also that has been affected by reimbursement cuts lately, as I pointed out.
Some highlights in terms of the growth by business area, and you can continue to see the strength in Professional Diagnostics, and in particular, in immunodiagnostics, which continues to grow at a double-digit rate now for more than 10 years and 12% for the first half of this year. In Diabetes Care, we continue to see good uptake of the innovative products, the Accu-Chek Mobile growing at 22%. We have also launched the Accu-Chek Insight in Europe, which is a pump combined with blood glucose meter and a bolus advisor, so an integrated system there, which we look forward to bringing to more markets. And then also on the molecular side, I’ll touch a bit further some 2 very specific highlights with the FDA approval of our HPV screening test and then the launch preparations for the high throughput analyzers, cobas 6800 and 8800.
In Tissue Diagnostics, 9% growth, supported by ongoing strength in advance staining with 8%, and also, good demand for our services for companion diagnostics with internal and external partners, of course.
The P&L, you can see the 6% on the top line; the bottom line, flat at a 19.2% margin. Let me take you through some of the base effect that led to this result, and I would like to mention 3, in particular. One was a VAT credit for the first half in 2013 which did not recur in 2014. This had an impact to the tune of about 3%. And you can see, at the bottom also, the PSI impact, which was a one-time impact from last year, a 2% impact here. And then a provision for some transition from first to second generation products to the tune of 1%. So if we add up all the base effects, they add up to about 6%, which means that our underlining (sic) [underlying] profitability grew at the rate of sales.
Noteworthy also in the cost of sales line, we’ll continue to invest in instruments which is funding our future growth, placing instruments in the marketplace. And also, in the R&D line, continuous investments in existing platform developments but then also supporting some of the recent acquisitions in sequencing but also in point of care Molecular Diagnostics.
I’d like to share a couple of highlights by business area, starting with Professional Diagnostics. And I mentioned initially, 12% growth in immuno, and overall, our combined portfolio of serum work area, which is clinical chemistry and immunochemistry, doing very, very well. We continue to be able to leverage our large installed base, and we do this by providing enhanced automation and integrated systems, such as you can see here with the cobas 8100, which really supports the laboratories in their drive towards testing efficiency and rendering their services as efficient as possible. And you can see on the right side, the market share that we have in serum work area was 23% and the clear#1 in this segment.
We are introducing a novel solution in the area of urinalysis, which is, for the first time, a combination of strip analysis and digital microscopy, again, supporting the initial strategy of testing efficiency and higher automation. This system will have the highest throughput in the industry and will also have very high accuracy. So we’re looking forward to entering the market with the urinalysis with the cobas 6500.
Let me switch to Molecular Diagnostics. And I mentioned it, a real highlight for the first half was the approval by the FDA of our HPV test for primary screening, with the recommendation also for the age group 25 and above. And this enhances or enlarges the age group, and at the same time, this is the first and only FDA-approved HPV test for cervical screening. We will work with the authorities and with the associations in translating this into medical guidelines. But you can see already today a very strong uptake, 59% growth of our HPV test in the first half. And we continue to work with governments and authorities across the world to continue to promote the inception of primary screening for HPV.
The second highlight I mentioned in Molecular Diagnostics is the launch preparations we’re fully in right now for the 2 systems that you can see on the bottom left, which is mid and very high throughput molecular instruments, cobas 6800 and 8800, which will really complement the cobas 4800, which you can see at the bottom right of the slide. Again here, the highest automation, the highest throughput capabilities, and we truly believe that we’ll be able to move the standards of molecular testing going forward.
The launch plan foresees [ph] the introduction for blood screening in the third quarter of this year. And then for virology, for the virology menu and platform in the fourth quarter of this year, very excited to continue to penetrate the markets then in 2015 and beyond with these 2 new instrument families.
That brings me to the end. 6 launches in the first half. As you can see again, instruments that we bring to the market and then support that with our leading and largest menu in the industry, adding new assays, adding new tests. I just want to mention syphilis as a really important one to complement our existing menu in Professional Diagnostics, both in serology and across the entire platform.
And with that, I thank you, and I will hand over to Alan for finances. Thank you.
Alan Hippe – Chief Financial Officer and IT Officer
Yes, thanks, Roland. Thanks for handing over. Welcome to everybody. Some comments on the financial situation. I would like to start with the finance highlights. Some of them were mentioned already, the strong core EPS growth of 7%. I will dig in to that a little bit. I think what was not mentioned yet was the free cash flow generation, which improved by 41%, which is quite significant because it’s really driven by the operational free cash flows.
And what is one major contributor, it is Southern Europe, and I will talk about that as well. When you look at the improved financial results, then this is obvious, that this is one of the drivers of the EPS growth. We had a very positive development here of the core net financial results, which improved by 17%.
We have introduced an early bond recall of USD 500 million right at the end of half year 2014 with a charge of CHF 80 million.
With that, let me talk about the half year 2014 performance, and then I would like to put some focus on cash. And when you look really at the comprehensive picture here of our financial figures, I think when you look at sales, I think everything has been mentioned, beside the one that we have quite significant currency effect in the first half on sales, and then you see it goes really through until the core EPS. And this is definitely triggered by the U.S. dollar, certainly. In fact, originally coming from the strengthening of the Swiss franc, but the U.S. dollar contributed, Latin America — the Latin American currencies contributed, as well as the Japanese yen. And these 3 buckets of currencies really contributed 2/3 of the effect that you’re seeing here.
And the operating free cash flow, I’ve mentioned that already, pretty strong, with 11% up in constant currencies, but also, when you look at the actual, 6% up. And then the free cash flow, don’t be irritated by the minuses here, when you look at the percentage changes, that’s a positive. The numbers improved by 41% or in actuals by 26%. We had a couple of one-off effect, and my colleagues, Dan and Roland, referred to that. And I will now try to give some more transparency on these effect and how they impact our actuals.
And here, you see it. That’s the comprehensive picture. Everything on that picture and every number and effect we have mentioned, these are the one-offs that our convention, so to say, when we talk about one-offs, these are the effects we’re referring to. And in fact, these are 3 effects. And the first one, mentioned by Dan already, is the sale of the filgrastim rights, we gave when we returned this product back to Amgen. And you see the impact, and now focusing on the half year on the group column, you see a positive CHF 428 million in the first half of 2014.Then we have a minus CHF 61 million, which is related to this, and this is the core operating profit generated last year by the sales of these products which we have returned to Amgen, just to put that straight in both year, half year 2013, half year 2014. And then we have the mentioned past service income, that’s the second big effect here. Last year, positively CHF 252 million in the core operating profit last year, so this year, in fact, we’re missing that in the base. That’s a negative impact, if you like. And then the third effect is the 340B reserves release, which has no impact in the first half but will hit us, if you like, in the second half. So when you look at the first half and you put all these effects together, you get to an operating profit impact of CHF 115 million. And what it means is that in fact, the actuals are higher, or let’s say, the momentum in the actuals is higher than the adjusted momentum, that you’re seeing underlying. And when you look at it on the core operating profit line, I think we have reported 7.1% core operating profit growth in constant currencies. When you do the adjustment, it brings it down to 6.1% core operating profit growth momentum.
That’s the first half. The second half, it’s a little bit tricky because the effect turns around, and I think that’s important to mention, and it also goes back to the point that Dan has made, certainly, we have a certain dilution effect from the first half impact, especially coming from the return of the filgrastim rights. So what you’re seeing is a negative hit on the operating profit. And what that means for the second half is when you do the adjustments, you will see that the adjustments will show a better momentum compared to the actuals. I think that’s the major message we would like to convey here. So I think be careful, when you do your predictions, these impacts have quite a base effect.
Good. And now let’s try to apply that. And I’ll give it a try, and I think we will have more discussions about that, so let’s go through this. When you look at sales, everything is plain. Then you look at the royalties and the other operating income, and here is the filgrastim deal in with the CHF 428 million. If you exclude that, the royalties and the other operating income increases by 7%, which is quite a momentum. When you look at the cost of sales, an increase of 5%. And as said already, we have here 2 effects from MetMAb and bito: one related to the onerous contract; and the other one related to asset write-offs, as we have done when we stop the programs. This accounts for CHF 82 million negative impact in this line. Then we go through M&D, which is a very reasonable development, and then we go to R&D where, once again, we have a growth rate of 5%. If you exclude the MetMAb and bito impacts of CHF 63 million, we get to a growth rate of plus 4% slightly below the sales growth.
And then G&A, and we will be very sad if G&A were growing by 39%, and that’s the base effect from last year coming from the change of our pension plans, the PSI effect that I’ve mentioned before. I think when we exclude that, you see that the G&A growth goes down to 4%.
When you then look at the core operating profit, and when we just include the one-off items for MetMAb and bito, these are operational effect they stay in the P&L, just excluding the one-off items that I’ve outlined on the slide before, we get to a core operating profit growth of 6%, which is slightly above the sales growth and improves the margin.
And here are the margins. When you look at the margins, I think the group developed very, very well in constant currencies, even in actuals. And when you look at the Pharma division, really going the right direction. When you look at Diagnostics, Roland has given the explanations already. 2 major points to mention here, the VAT tax credit last year in Germany, which boosted, at that time, the results by 30 million, and then this year, the negative charge on the provisions.
Good. With that, let’s get to the core net financial results, which has been further improved, and you see a 180 million improvement, it’s quite significant. And when you look at the debt redemption, we did more debt redemption and took more charges in last year, which is minus 48 and that’s the bridge, the difference. In fact, we had charges of 127 million compared to 79 million in the first half of 2013.
When you look at the interest expenses, you might have seen that gross debt went down half year to half year by 2.3 billion. The interest expenses improved by 110 million. That’s roughly 5%, so that’s pretty reasonable because when we go for the bond buyback, we go for the high coupons. And then you see the currency impact improving, the impact is improving by plus 55. Last year, we had a major charge coming from Venezuela with minus 45 million. We have less charges this year coming from Argentina, from the Ukraine and a small one from Venezuela, so you see an improvement of 55. And then you see the net income from equity securities, which is nice because the Roche Venture Fund was able to divest some of these investments very successfully, and that gave us a positive year of plus 50.
When we look at the tax rate, and already there were some question about the tax rate and why it goes up from 23.1% to 24.1%. And in fact, it’s a pretty, pretty straight, story. Last year, January 2013, the U.S. government approved and granted the U.S. R&D tax credit, in fact, twice, for the years 2012 and 2013. So in the first half of last year, we booked a R&D tax credit 1.5x, one for 2012 and then half year for 2013. The effect for one-time this U.S. tax credit is about 70 million. But when you take that together, it’s 105 million. And then certainly, we had some growth in our business, as you’ve seen, and I think that explains the deviation of 144 million here when you compare the actuals.
For 2014, because you might ask what has happened in 2014, well, in 2014 so far, the tax credit, the R&D tax credit has not been granted. We will see whether this happens until the end of the year. It’s not something which should make me nervous. I don’t think so. Because since 1981, so 15 years in a row, the U.S. government has granted this R&D tax credit really on a yearly basis, so it’s a normal procedure to follow.
So that leaves me to the balance sheet, and I don’t want to talk too much about it. You see that equity has reduced slightly, which is not a big deal, by CHF 1.7 billion. We have paid the dividend, we have solid profits. Dividend was CHF 6.7 billion, and you see the majority of that impact, we have overcompensated already, so we’re really moving in the right direction here.
Let me talk about cash. When you look at the cash development, I would like to direct you first to the first 3 bars on the left-hand side, and you’ve seen that we have increased the operating free cash flow at the half year basis, really, 3 consecutive years. And what you’re also seeing is that the margin has really developed quite nicely. You see it is driven by the Pharma division. You might argue about Diagnostics. Let me say that Diagnostics had a great year last year, already at half year. And the other point is, and you see it here, because when you look at the minus 0.4 percentage points, that’s in constant currencies development, in fact, the Diagnostics division is relatively stable with its cash flow margin. The effect is solely driven by currency.
So where is it coming from? I think the major point to make for the good cash flow development certainly, on one hand, it’s the underlying business which is as well, but on the other hand we also work on the networking capital and especially on the receivables. And the receivables, when you look at the actuals, we have a reduction of CHF 240 million, which is basically driven by southern Europe and you see what has happened since December 2011 on that Slide 55 that we have a reduction there of our exposure of about CHF 1 billion, so quite an achievement here. What I should mention is we had, in the first half of 2014, quite a nice inflow. And based on the Montoro plant, Montoro 2 plant, I should say, in Spain, and certainly that helped us, so don’t expect that we keep that momentum in the second half when it comes to the cash inflow from the receivables side. What does that mean to us? Certainly, I think it helps us terrifically and in decreasing our debt and deleveraging. The 71% of the Genentech-related debt is repaid now. And we had a cash outflow, if you like, for the repayment of bonds of CHF 1.7 billion in the first half. The bond recall we have done right at the end of half year has certainly not paid out yet. This will happen in Q3 2014.
And with that, let’s put it together. You see the net debt at the end of 2013 with minus CHF 6.7 billion, then the nice development of the operating free cash flow, and then you see the nonoperating free cash flow, which is the dividends, the taxes and the treasury points, and that leads really to the net debt development of minus CHF 8.8 billion at the end of June 2014.
The other point to make is how about our target range to be between 0 and 15% net debt to total assets, and with 14% we’re well in that range. You know at the end of the year 2013, we have been at 11%, and my expectation is that at the end of 2014, we will still well be in the range here, and you see how our improvement normally goes.
So with that, let’s come to currency, and this morning, I’ve got some compliments from media guys that we have such a great prediction about what the impact will be for the half year when it comes to currency. And I had to say that in Q2, the currencies didn’t move too much. So that helped us certainly because you know what our prediction is based on. In fact, it is based on the assumption that from June onwards until the end of the year, the currencies are not changing. So what you’re seeing here on that slide and for the full year, and let me read it out here, we expect based on the assumption that the currencies stay at the level they have been at end of June 2014. We expect a minus 4% impact on sales, a minus 6% core operating profit impact and a minus 6% core EPS impact. So we see a certain mitigation compared to half year.
Good. And we’re reconfirming the outlook once again and Severin has done that already, and we are happy to take your questions. Thanks a lot.
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