20-F 1 a2166684z20-f.htm 20-F
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As filed with the Securities and Exchange Commission on January 30, 2006



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington D.C. 20549


FORM 20-F

o REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR 12(g) OF THE SECURITIES EXCHANGE ACT OF 1934
OR
ý ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 for the fiscal year ended December 31, 2005
OR
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
OR
o SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number 1-15024

NOVARTIS AG
(Exact name of Registrant as specified in its charter)

NOVARTIS Inc.
(Translation of Registrant's name into English)

Switzerland
(Jurisdiction of incorporation or organization)

Lichtstrasse 35
4056 Basel, Switzerland
(Address of principal executive offices)

Securities registered pursuant to Section 12(b) of the Act:

 
   
Title of class
American Depositary Shares
each representing 1 share,
nominal value CHF 0.50 per share,
and shares
  Name of each exchange on which registered
New York Stock Exchange, Inc.

Securities registered or to be registered pursuant to Section 12(g) of the Act:

None

Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act:

None

        Indicate the number of outstanding shares of each of the issuer's classes of capital or common stock as of the close of the period covered by the annual report:

2,335,916,500 shares

        Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

Yes ý No o

        If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.

Yes o No ý

        Note—checking the box above will not relieve any registrant required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 from their obligations under those sections.

        Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes ý No o

        Indicate by check mark which financial statement item the registrant has elected to follow.

Item 17 o Item 18 ý

        If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o No ý





TABLE OF CONTENTS

INTRODUCTION AND USE OF CERTAIN TERMS   1

FORWARD-LOOKING STATEMENTS

 

1

PART I

 

2

 

Item 1.

 

 

Identity of Directors, Senior Management and Advisers

 

2

 

Item 2.

 

 

Offer Statistics and Expected Timetable

 

2

 

Item 3.

 

 

Key Information

 

2
  3. A   Selected Financial Data   2
  3. B   Capitalization and Indebtedness   5
  3. C   Reasons for the offer and use of proceeds   6
  3. D   Risk Factors   6

 

Item 4.

 

 

Information on the Company

 

16
  4. A   History and Development of Novartis   16
  4. B   Business Overview   21
  4. C   Organizational Structure   74
  4. D   Property, Plants and Equipment   75

 

Item 4A.

 

Unresolved Staff Comments

 

81

 

Item 5.

 

 

Operating and Financial Review and Prospects

 

81
  5. A   Operating Results   81
  5. B   Liquidity and Capital Resources   117
  5. C   Research & Development, Patents and Licenses   122
  5. D   Trend Information   122
  5. E   Off-Balance Sheet Arrangements   122
  5. F   Aggregate Contractual Obligations   122

 

Item 6.

 

 

Directors, Senior Management and Employees

 

124
  6. A   Directors and Senior Management   124
  6. B   Compensation   132
  6. C   Board Practices   141
  6. D   Employees   147
  6. E   Share Ownership   148

 

Item 7.

 

 

Major Shareholders and Related Party Transactions

 

149
  7. A   Major Shareholders   149
  7. B   Related Party Transactions   150
  7. C   Interests of Experts and Counsel   151

 

Item 8.

 

 

Financial Information

 

151
  8. A   Consolidated Statements and Other Financial Information   151
  8. B   Significant Changes   156

 

Item 9.

 

 

The Offer and Listing

 

156
  9. A   Listing Details   156
  9. B   Plan of Distribution   158
  9. C   Market   158
  9. D   Selling Shareholders   158
  9. E   Dilution   158
  9. F   Expenses of the Issue   158
             


 

Item 10.

 

 

Additional Information

 

158
  10. A   Share capital   158
  10. B   Memorandum and Articles of Association   158
  10. C   Material contracts   162
  10. D   Exchange controls   162
  10. E   Taxation   163
  10. F   Dividends and paying agents   167
  10. G   Statement by experts   167
  10. H   Documents on display   167
  10. I   Subsidiary Information   168

 

Item 11.

 

 

Quantitative and Qualitative Disclosures about Non-Product-Related Market Risk

 

168

 

Item 12.

 

 

Description of Securities other than Equity Securities

 

172

PART II

 

173

 

Item 13.

 

 

Defaults, Dividend Arrearages and Delinquencies

 

173

 

Item 14.

 

 

Material Modifications to the Rights of Security Holders and Use of Proceeds

 

173

 

Item 15.

 

 

Controls and Procedures

 

173

 

Item 16

A

 

Audit Committee Financial Expert

 

174

 

Item 16

B

 

Code of Ethics

 

174

 

Item 16

C

 

Principal Accountant Fees and Services

 

174

 

Item 16

D

 

Exemptions from the Listing Standards for Audit Committees

 

176

 

Item 16

E

 

Purchases of Equity Securities by the Issuer and Affiliated Purchasers

 

176

PART III

 

177

 

Item 17.

 

 

Financial Statements

 

177

 

Item 18.

 

 

Financial Statements

 

177

 

Item 19.

 

 

Exhibits

 

178


INTRODUCTION AND USE OF CERTAIN TERMS

        Novartis AG and our consolidated affiliates ("Novartis" or the "Group") publish consolidated financial statements expressed in US dollars. Our consolidated financial statements found in Item 18 of this annual report on Form 20-F ("Form 20-F") are those for the year ended December 31, 2005. In this Form 20-F, references to "US dollars", "USD" or "$" are to the lawful currency of the United States of America; and references to "CHF" are to Swiss francs.


        In this Form 20-F, references to the "United States" or to "US" are to the United States of America, references to "Europe" are to all European countries (including Turkey, Russia and the Ukraine), references to the European Union ("EU") are to the European Union and its 25 member states and references to "Americas" are to North, Central (including the Caribbean) and South America, unless the context otherwise requires; references to "Novartis" or the "Group" are to Novartis AG and its consolidated subsidiaries; references to "associates" are to employees of our affiliates; references to the "FDA" are to the US Food and Drug Administration. All product names appearing in italics are trademarks of Group companies. Product names identified by a "®" or a "™" are trademarks of other companies. You will find the words "we," "our," "us" and similar words or phrases in this Form 20-F. We use those words to comply with the requirement of the US Securities and Exchange Commission to use "plain English" in public documents like this Form 20-F. For the sake of clarification, each operating company in the Group is legally separate from all other companies in the Group and manages its business independently through its respective board of directors or other top local management body. No Group company operates the business of another Group company nor is any Group company the agent of any other Group company. Each executive identified in this Form 20-F reports directly to other executives of the company by whom the executive is employed, or to that company's board of directors.


        We furnish to registered holders of Novartis AG shares ("shares") annual reports that include a description of operations and annual audited consolidated financial statements prepared in accordance with International Financial Reporting Standards ("IFRS"). IFRS differs in certain significant respects from US Generally Accepted Accounting Principles ("US GAAP"). See "Item 18. Financial Statements—note 34" for a description of the significant differences between IFRS and US GAAP. The financial statements included in the annual reports are examined and reported upon by our independent auditors. We make available to our shareholders, on our web page, quarterly interim press releases that include unaudited interim consolidated financial information prepared in conformity with IFRS with a reconciliation to US GAAP.


FORWARD LOOKING STATEMENTS

        This Form 20-F contains certain "forward looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, which can be identified by the use of forward-looking terminology such as "will" or "expected", or similar expressions, or by express or implied discussions regarding potential new products, potential new indications for existing products, or regarding potential future revenues from such products, potential future expenditures or liabilities, or by discussions of strategy, plans or intentions. Such forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause actual results to be materially different from any future results, performance or achievements expressed or implied by such statements. There can be no guarantee that any of the development projects described will succeed or that any new products will be brought to market. Similarly, there can be no guarantee that Novartis or any future product will achieve any particular level of revenue. In particular, management's expectations could be affected by, among other things, uncertainties involved in the development of new pharmaceutical products, including unexpected clinical trial results; unexpected regulatory actions or delays or government regulation generally; the company's ability to obtain or maintain patent or other proprietary intellectual property protection; competition in general; government, industry, and general public pricing pressures; uncertainties regarding necessary levels of expenditures in the future; and uncertainties regarding judicial or other investigatory proceedings. Some of these factors are discussed in more detail herein, including under "Item 3. Key Information-3.D. Risk factors," "Item 4. Information on the Company," and "Item 5. Operating and Financial Review and Prospects." Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those described in this Form 20-F as anticipated, believed, estimated or expected. We provide the information in this 20-F as of the date of its filing. We do not intend, and do not assume any obligation, to update any information or forward looking statements set out in this Form 20-F.

1



PART I

Item 1.    Identity of Directors, Senior Management and Advisers

        Not applicable.


Item 2.    Offer Statistics and Expected Timetable

        Not applicable.


Item 3.    Key Information

3.A  Selected Financial Data

        The selected financial information set out below has been extracted from our consolidated financial statements. Our consolidated financial statements ("consolidated financial statements") for the years ended December 31, 2005, 2004 and 2003 are included elsewhere in this Form 20-F.

        Following the adoption of a number of new IFRS from January 1, 2005, as required by IFRS, the 2004 and 2003 consolidated financial statements have been restated. Not all of the new standards required retrospective application of the new accounting and reporting requirements. See "Item 18. Financial Statements—Note 32" for a more detailed discussion.

        In order to assist our investors and analysts in their understanding of our results by having comparable information, pro forma 2004 and 2003 consolidated income and cash flow statements are provided that include additional adjustments compared to the audited restated 2004 and 2003 consolidated income and cash flow statements. See "Item 5.A Operating Results—2004 and 2003 Pro Forma Consolidated Financial Information" for a more detailed discussion.

        All financial data should be read in conjunction with "Item 5. Operating and Financial Review and Prospects". All financial data presented in this Form 20-F are qualified in their entirety by reference to the consolidated financial statements and such notes.

        The consolidated financial statements used to create the selected consolidated financial data set forth below were prepared in accordance with IFRS. IFRS differs in certain respects from US GAAP. For a discussion of the significant differences between IFRS and US GAAP, see "Item 18. Financial Statements—Note 34."

2


 
  Year Ended December 31,
 
 
  2005
  2004(1)
Restated

  2004(2) Pro Forma
  2003(1)
Restated

  2003(2) Pro Forma
  2002(1)(3) Restated
  2001(1)(3) Restated
 
 
  ($ millions, except per share information)

 
INCOME STATEMENT DATA                              
Amounts in accordance with IFRS:                              
Net sales   32,212   28,247   28,247   24,864   24,864   20,877   18,762  
   
 
 
 
 
 
 
 
Operating income   6,905   6,152   6,289   5,635   5,666   5,028   4,329  
Result from associated companies   193   68   177   (279 ) (182 ) (18 ) 53  
Financial income   461   486   488   621   621   807   502  
Interest expense   (294 ) (261 ) (261 ) (243 ) (243 ) (214 ) (238 )
   
 
 
 
 
 
 
 
Income before taxes   7,265   6,445   6,693   5,734   5,862   5,603   4,646  
Taxes   (1,124 ) (1,065 ) (1,092 ) (947 ) (957 ) (925 ) (821 )
   
 
 
 
 
 
 
 
Net income   6,141   5,380   5,601   4,787   4,905   4,678   3,825  
   
 
 
 
 
 
 
 
Attributable to Shareholders of Novartis AG   6,130   5,365   5,586   4,743   4,861   4,664   3,813  
Minority interests   11   15   15   44   44   14   12  

Basic earnings per share in $

 

2.63

 

2.28

 

2.37

 

1.99

 

2.04

 

1.93

 

1.54

 
Diluted earnings per share in $   2.62   2.27   2.36   1.97   2.01   1.89   1.54  
Cash dividends(4)   2,107   1,896   1,896   1,659   1,659   1,311   1,222  
Cash dividends per share in CHF(5)   1.15   1.05   1.05   1.00   1.00   0.95   0.90  
Operating income per share:                              
  basic earnings per share in $   2.96   2.61   2.67   2.37   2.38   2.08   1.75  
  diluted earnings per share in $   2.95   2.60   2.66   2.34   2.35   2.03   1.75  

 
(1)
Data has been restated as a result of adopting new IFRS accounting standards. See "Item 18. Financial Statements—Note 32."

(2)
Data is pro forma. See "Item 5.A Operating Results."

(3)
Unaudited.

(4)
Cash dividends represent cash payments in the applicable year that generally relate to earnings of the previous year.

(5)
Cash dividends per share represent dividends proposed that relate to earnings of the current year. Dividends for 2005 will be proposed to the Annual General Meeting on February 28, 2006 for approval.

3


 
  Year Ended December 31,
 
  2005
  2004(1) Restated
  2003(1) Restated
  2002(1)(2) Restated
  2001(1)(2) Restated
 
  ($ millions, except per share data)

BALANCE SHEET DATA                    
Amounts in accordance with IFRS:                    
Cash, cash equivalents and current marketable securities   10,933   13,892   12,621   12,050   12,639
Inventories   3,725   3,558   3,346   2,963   2,449
Other current assets   6,785   6,470   5,677   5,316   4,716
Non-current assets   36,289   28,568   26,734   24,012   19,981
   
 
 
 
 
Total assets   57,732   52,488   48,378   44,341   39,785
   
 
 
 
 
Trade accounts payable   1,961   2,020   1,665   1,266   1,077
Other current liabilities   13,367   9,829   8,254   7,560   7,797
Non-current liabilities   9,240   9,324   9,416   8,064   5,936
   
 
 
 
 
Total liabilities   24,568   21,173   19,335   16,890   14,810
   
 
 
 
 
Total equity available to Novartis AG shareholders   32,990   31,177   28,953   27,385   24,913
Minority interests   174   138   90   66   62
   
 
 
 
 
Total equity   33,164   31,315   29,043   27,451   24,975
   
 
 
 
 
Total liabilities and equity   57,732   52,488   48,378   44,341   39,785
   
 
 
 
 
Net assets   33,164   31,315   29,043   27,451   24,975
Outstanding share capital   848   849   862   863   888

Amounts in accordance with US GAAP:

 

 

 

 

 

 

 

 

 

 
Income statement data                    
Net income   5,190   4,793   3,624   3,816   2,396
Basic earnings per share   2.22   2.03   1.52   1.58   0.97
Diluted earnings per share   2.22   2.02   1.50   1.54   0.97

Balance sheet data

 

 

 

 

 

 

 

 

 

 
Total equity   38,300   37,733   34,568   32,950   29,918
Total assets   65,101   59,843   56,200   50,016   44,724

(1)
Data has been restated as a result of adopting new IFRS accounting standards. See "Item 18. Financial Statements—Note 32."

(2)
Unaudited.

4


Cash Dividends per Share

        Cash dividends are translated into US dollars at the Reuters Market System Rate on the payment date. Because we pay dividends in Swiss francs, exchange rate fluctuations will affect the US dollar amounts received by holders of ADSs.

Year Earned

  Month and
Year Paid

  Total Dividend
per share

  Total Dividend
per ADS

 
   
  (CHF)

  ($)

2001   March 2002   0.90   0.54
2002   March 2003   0.95   0.68
2003   February 2004   1.00   0.80
2004   March 2005   1.05   0.93
2005(1)(2)   February 2006   1.15   0.87

(1) If the Swiss franc amount for 2005 is translated into US dollars at the rate of $0.76 to the Swiss franc, the Total Dividend per share and Total Dividend per ADS in US dollars would be $0.87. This translation is an example only, and should not be construed as a representation that the Swiss franc amount represents, or has been or could be converted into US dollars at that or any other rate.
(2) Dividend to be proposed at the Annual General Meeting on February 28, 2006 and paid in March 2006.

Exchange Rates

        The following table shows, for the years and dates indicated, certain information concerning the rate of exchange of US dollar per Swiss franc based on exchange rate information found on Reuters Market System. The exchange rate in effect on January 25, 2006, as found on Reuters Market System, was CHF 1.00 = $0.79.

Year ended December 31,

  Period End
  Average(1)
  Low
  High
2001   0.60   0.59   0.55   0.63
2002   0.71   0.65   0.58   0.72
2003   0.80   0.75   0.70   0.81
2004   0.88   0.81   0.76   0.88
2005   0.76   0.80   0.75   0.88

Month end,

 

 

 

 
August 2005   0.78   0.80
September 2005   0.77   0.81
October 2005   0.77   0.79
November 2005   0.75   0.78
December 2005   0.76   0.78
January 2006(2)   0.76   0.79

(1) Represents the average of the exchange rates on the last day of each full month during the year.

(2)

The high and low US dollar/Swiss franc exchange rate is current as of January 25, 2006.

3.B  Capitalization and Indebtedness

        Not applicable.

5


3.C  Reasons for the offer and use of proceeds

        Not applicable.

3.D  Risk Factors

        Our business faces significant risks. You should carefully consider all of the information set forth in this Form 20-F and in our other filings with the SEC, including the following risk factors which we face and which are faced by our industry. Our business, financial condition or results of operations could be materially adversely affected by any of these risks. This Form 20-F also contains forward-looking statements that involve risks and uncertainties. Our results could materially differ from those anticipated in these forward-looking statements as a result of certain factors, including due to the risks we face as described below and elsewhere. See "Forward-Looking Statements" on page 1.

Risks Faced By Our Pharmaceuticals Division

We face intense competition from new products.

        Our products face intense competition from competitors' products. This competition may increase as new products enter the market. In such an event, our competitors' products may be safer or more effective or more effectively marketed and sold than our products. Alternately, in the case of generic competition, they may be equally safe and effective products which are sold at a substantially lower price than our products. As a result, if we fail to maintain our competitive position, this could have a material adverse effect on our business, financial condition or results of operations.

Our research and development efforts may not succeed.

        Like other major pharmaceutical companies, in order to remain competitive, we must continue to launch new and better products each year. To accomplish this, we commit substantial effort, funds and other resources to research and development, both through our own dedicated resources, and through various collaborations with third parties. Our ongoing investments in new product launches, new technologies and research and development for future products could produce higher costs without a proportional increase in revenues.

        In the pharmaceutical business, the research and development process can take up to 12 years, or even longer, from discovery to commercial product launch. This process is conducted in various stages. During each stage there is a substantial risk that we will encounter serious obstacles or will not achieve our goals and accordingly we may abandon a product in which we have invested substantial amounts of time and money. If we are unable to maintain a continuous flow of successful new products and successful new indications or brand extensions for existing products sufficient to cover our substantial research and development costs and to replace sales that are lost as older products approach the end of their commercial life cycles or are displaced by competing products or therapies, this could have a material adverse effect on our business, financial condition or results of operations.

        Our dependence on research and development makes it highly important that we recruit and retain high quality researchers and development specialists. In addition, our dependence on collaborations with third parties for a portion of our research and development leaves us at risk should those third parties fail to perform their obligations. We commit substantial efforts and funds to these purposes. Should we fail in our efforts, this could have a material adverse effect on our business, financial condition or results of operations.

We face intense competition from lower-cost generic products.

        Our Pharmaceuticals Division also faces increasing competition from lower-cost generic products. Our Pharmaceuticals Division's products are generally protected by patent rights which are expected to

6



provide us with exclusive marketing rights. However, those patent rights are of varying strengths and durations. In addition, in some countries, patent protection is significantly weaker than in the US or the EU. Even in the US and the EU, political pressures to reduce spending on health care has led to legislation which encourages the approval of generic products. As a result, although it is our policy to actively defend our patent rights, generic challenges to our products can arise at any time, and we may not be able to prevent the emergence of generic competition for our products.

        Loss of patent protection for a product typically leads to a rapid loss of sales for that product and could affect our future results. In addition, proposals emerge from time to time in the US and other countries for legislation to further encourage the early and rapid approval of generic drugs. Any such proposal that is enacted into law could worsen this substantial negative effect on our sales.

        Patent protection is at issue in major markets for the following of our Pharmaceuticals Division's products.

    Diovan.    The active ingredient in Diovan is covered by a compound patent through 2012 in the US, and through 2011-13 in other markets. In the US additional patents covering the marketed formulation have been challenged, however, we have not filed a suit at this point in time.

    Neoral.    Patent protection exists for the Neoral micro-emulsion formulation and other cyclosporin formulations through 2009 and beyond in major markets. Despite this protection, generic cyclosporin products competing with Neoral have entered the transplantation market segment in the US, Germany, Japan, Canada and elsewhere. Patent infringement actions are pending against manufacturers of some of these generic products. At present, there are no injunctions in place against any of the manufacturers that we have sued.

    Sandostatin.    Basic patent protection for the active ingredient of Sandostatin SC has expired in the US, Japan, Germany, France and the UK, and it will expire in May 2007 in Italy. Generic versions of Sandostatin SC have been approved in the US and elsewhere. Patent protection for the Sandostatin LAR formulation extending to 2010 (and 2013 and beyond in the US) continues in major markets. Sandostatin LAR is a long-acting version of Sandostatin which represents a majority of our sales in this product family.

    Lotrel/Cibacen/Lotensin/Cibadrex.    The basic benazepril substance patent protection for Lotrel/Cibacen/Lotensin/Cibadrex expires in June 2007 in France and in December 2008 in Italy and has expired elsewhere. Lotrel, which is a combination of benazepril and another anti-hypertensive, also is protected by an additional patent in the US until 2017. Teva and Dr. Reddy's Laboratories have challenged this patent. Dr. Reddy's is seeking marketing approval for a slightly different benazepril combination product. Because of this difference, the Dr. Reddy's product, if brought to market, would not be automatically substitutable in the US for Lotrel. However, Teva is seeking marketing approval for the same benazepril combination as Lotrel, and is thus seeking to bring a fully substitutable product to the US market. We have sued Teva and Dr. Reddy's in the US for patent infringement. The Dr. Reddy's case is currently stayed.

    Lamisil.    The active ingredient in Lamisil is covered by a compound patent family which expires in the US in December 2006, in August 2007 in France and has expired elsewhere. The US patent had been challenged by Dr. Reddy's Laboratories in the US. Dr. Reddy's has since withdrawn its suit and conceded that this patent is valid and enforceable.

    Miacalcin/Miacalcic.    The specific Novartis formulation of this product is covered by patents which will expire in the US in 2015. However, patents on the Novartis formulation have expired in a number of major countries and will expire in Italy in December 2006. Apotex has applied to the FDA for the right to sell a generic version of Miacalcin using the Novartis formulation. We have sued Apotex for patent infringement. Two other companies have applied to the FDA for the right to sell a generic version of Miacalcin based on a different formulation. We have not sued these

7


      companies. Unigene's recombinant salmon calcitonin product is approved in the US, but would not be automatically substitutable in the US for Miacalcin.

    Exelon.    The active ingredient in Exelon is covered by a compound patent (granted to Proterra AG), which in the US presently expires in August 2007, and has been determined by the FDA to qualify for patent term extension until 2012, and which expires in 2011-13 in the major markets. In addition, we hold an isomer patent on Exelon which expires in 2012-14. Dr. Reddy's, Sun Pharmaceuticals and Watson Pharmaceuticals have filed applications to market a generic version of Exelon in the US. Together with Proterra, we have sued all three parties for patent infringement.

    Focalin.    The drug dosage form of Focalin and its use in attention deficit hyper-activity disorders are covered by patents (granted to Celgene Corporation and licensed to us) through 2015 in the US and 2018 in other markets. Teva has challenged these patents and has filed an application for a generic version of Focalin in the US. Together with Celgene, we have sued Teva for patent infringement under a use patent.

    Trileptal.    Patent protection for Trileptal's active ingredient has expired in major countries. In the US, New Chemical Entity data exclusivity under the Hatch-Waxman Act of 1984 has expired in 2005. We have also pending patent filings relating to our marketed formulations of Trileptal, which, if granted, would expire in 2018 in major countries, including the US. In Europe this formulation patent is being challenged by three generic companies.

    Starlix.    The active ingredient in Starlix is covered by Ajinomoto patents. The basic US patent will expire in 2009. Several parties have informed us that they have filed an ANDA application to market a generic version of Starlix in the US upon expiration of the basic patent in 2009. In Europe basic compound protection exists in Germany, France, the UK and Switzerland and will expire in 2011.

    Foradil.    Patent protection for Foradil's active ingredient has expired in major countries. In the US, Hatch-Waxman data exclusivity is currently scheduled to expire in February 2006.

    Voltaren.    Voltaren is off-patent. As a result, revenue from Voltaren has declined, and may decline significantly further over the next few years.

    Famvir.    The active ingredient in Famvir is covered by a compound patent which expires in 2010 in the US, in 2008 in Europe and 2006 in Canada. Other method of use patents expire in 2014 and 2015. Teva has challenged these patents in the US and has filed an application for a generic version of Famvir in the US. We have sued Teva in the US for infringement of the compound patent.

    Zaditor/Zaditen.    Apotex has filed for approval for a generic version of Zaditor in the US. The Zaditor formulation is covered by a patent in the US. We sued Apotex for patent infringement. However, we subsequently withdrew our suit and there is now no lawsuit pending.

Price controls and other pressures may prevent us from setting prices for our products at levels high enough to earn an adequate return on our investments in them.

        In addition to normal price competition in the marketplace, the prices of our Pharmaceuticals Division's products are restricted by price controls and other pricing pressures imposed by governments and health care providers in most countries. Price controls operate differently in different countries and can cause wide variations in prices between markets. Currency fluctuations can aggravate these differences. The existence of price controls and other pricing pressures can limit the revenues we earn from our products and may have an adverse effect on our business, financial condition or results of operations.

    Direct efforts to control prices.

    United States.    In the US, ongoing political debates over prescription drug pricing and recent Medicare reform legislation will increase pricing pressures. In particular, recent Medicare

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        reform legislation has resulted in the creation of a new voluntary drug benefit for patients who are eligible for Medicare. It is too soon to predict the full impact of this new legislation with certainty. While it is possible that this legislation, which went into effect in January 2006, will increase the volume of our sales, we expect that this increase will be all or partially offset by the requirement that we extend price discounts to additional patients. In addition, unless this newly-enacted drug benefit is deemed to be a success, we expect there to be continuing political pressure to amend this legislation to enable the US government to use its enormous purchasing power to demand additional discounts from pharmaceutical companies.

      Europe.    In Europe, our operations are subject to significant price and marketing regulations. Many governments are introducing health care reforms in a further attempt to curb increasing health care costs. In the EU, governments influence the price of pharmaceutical products through their control of national health care systems that fund a large part of the cost of such products to consumers. The downward pressure on health care costs in general in the EU, particularly with regard to prescription drugs, has become very intense. As a result, increasingly high barriers are being erected against the entry of new products.

      Japan.    In Japan, the government generally introduces price cut rounds every other year, during which the government mandates price decreases for specific products. In 2005, the National Health Insurance price calculation method for new products and price revision rule for existing products were reviewed, and the resulting new drug tariffs are effective beginning April 2006. The Japanese government is currently undertaking a health care reform initiative with a goal of curbing national medical expenditures, and is continuing its review of the pricing methods used.

    Regulations favoring generics.    In response to rising health care costs, many governments and private medical care providers, such as Health Maintenance Organizations (HMOs), have instituted reimbursement schemes that favor the substitution of generic pharmaceuticals for more expensive brand-name pharmaceuticals. In the US, generic substitution statutes have been enacted by virtually all states and permit or require the dispensing pharmacist to substitute a less expensive generic drug instead of an original branded drug. We expect that the pressure for generic substitution will increase as a result of the implementation of the Medicare prescription drug benefit in 2006.

    Cross-Border Sales.    Price controls in one country can also have an impact in other countries as a result of cross-border sales. In the EU, products which we have sold to customers in countries with stringent price controls can legally be re-sold to customers in other EU countries with less stringent price controls, at a lower price than the price at which the product is otherwise available in the importing country. This risk could increase due to the addition of 10 nations to the EU in 2004. In North America, products which we have sold to customers in Canada, which has relatively stringent price controls, are sometimes re-sold into the US, again at a lower price than the price at which the product is otherwise sold in the US. Such imports from Canada and other developed countries into the US are currently illegal. However, there are ongoing political efforts at the federal, state and local levels to change the legal status of such imports, and we expect those pressures to continue in 2006.

        We expect that pressures on pricing will continue and may increase. Because of these pressures, there can be no certainty that in every instance we will be able to charge prices for a product that, in a particular country or in the aggregate, enable us to earn an adequate return on our investment in that product.

Public pressure on the pharmaceuticals industry could affect our business, financial condition or results of operations.

        There is considerable public sentiment against the pharmaceuticals industry, and the industry is under the close scrutiny of the public and the media. In addition there is significant pressure on our

9



industry from certain less developed nations to make our products available to their people at drastically lower costs. Any increase in such negative public sentiment or increase in public scrutiny or pressure from such less developed nations could lead, among other things, to changes in legislation, to changes in the demand for our products, additional pricing pressures with respect to our products, or increased efforts to undercut intellectual property protections. Such changes could affect our business, financial condition or results of operations.

Risks Faced By Our Sandoz (Generics) Division

The success of Sandoz depends on our ability to successfully develop and commercialize additional generic pharmaceutical products.

        To a significant degree, the future results of Sandoz, our generics Division, depend upon our ability to successfully commercialize additional generic pharmaceutical products. We must develop new generic products, and prove that they are the bio-equivalent of the originator products. Once developed, we must successfully manufacture and bring these new products to market. The development and commercialization process is both lengthy and costly and involves a high degree of risk. Our products currently under development may not be approved by regulatory authorities, or may not be approved as quickly as expected. In addition, we may not be able to successfully and profitably produce and market such products. Delays in any part of the process or our inability to obtain regulatory approval of our products could adversely affect our operating results by restricting or delaying our introduction of new products. The timely and continuous introduction of new generic products is critical to our business.

Our revenues and profits from any particular generic pharmaceutical products decline as our competitors introduce their own generic equivalents.

        Selling prices of generic drugs typically decline, sometimes dramatically, as additional companies receive approvals for a given product and competition for that product intensifies. To the extent that we succeed in being the first to bring to market a generic version of a significant product, our sales and our profits can be substantially increased in the period following the introduction of such product and prior to a competitor's introduction of an equivalent product. Our ability to sustain our sales and profitability on any product over time is dependent on both the number of new competitors for such product and the timing of their approvals. The overall profitability of Sandoz depends, among other things, on our ability to be the first to bring significant new products to market. There can be no guarantee that we will achieve this goal in the future.

Our generic pharmaceutical products face intense competition from brand-name pharmaceutical companies that sell or license their own generic products or successfully extend their market exclusivity period.

        Competition in the generic pharmaceutical market continues to intensify as the pharmaceutical industry adjusts to increased pressures to contain health care costs. Brand-name pharmaceutical companies have taken aggressive steps to counter the growth of the generics industry. In particular, certain brand-name pharmaceutical companies continue to sell their products to the generic market directly by acquiring or forming strategic alliances with generic pharmaceutical companies. No significant regulatory approvals are required for a brand-name pharmaceutical manufacturer to sell directly or through a third party to the generic market. In addition, certain brand-name companies continually seek new ways to protect their market franchise and to decrease the impact of generic competition. These efforts by the brand-name pharmaceutical industry have had, and likely will continue to have, a negative effect on the results of operations of Sandoz.

Recent changes in the US regulatory environment may prevent us from utilizing the exclusivity periods that are important to the success of our generic products.

        Under US law, the FDA awards 180 days of market exclusivity to the first generic manufacturer who challenges the patent of a branded product. However, amendments to the Hatch-Waxman Act will affect

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the future availability of this market exclusivity in many cases. These amendments now require generic applicants to launch their products within certain time frames or risk losing the marketing exclusivity that they had gained through being a first-to-file applicant.

Sandoz's success may depend on its ability to successfully challenge patent rights held by branded pharmaceutical companies or others.

        At times we seek approval to market generic products before the expiration of patents held by others for those products, based upon our belief that such patents are invalid, unenforceable, or would not be infringed by our products. As a result, we often face significant patent litigation. If we are unsuccessful in such litigation, then our ability to launch new products will be substantially limited. In addition, depending upon a complex analysis of a variety of legal and commercial factors, we may, in certain circumstances, elect to market a generic product even though litigation is still pending. This could be before any court decision or while an appeal of a lower court decision is pending. Should we elect to proceed in this manner, we could face substantial damages if the final court decision is adverse to us.

We may fail to successfully integrate Hexal and Eon Labs into our business.

        In 2005, we significantly expanded the scope of our Sandoz Division through the acquisition of Hexal AG and Eon Labs, Inc., and we began our efforts to integrate them with our own operations. Should we ultimately fail to successfully integrate Hexal and Eon with the existing operations of Sandoz, or should the achievement of a successful integration significantly divert management's attention away from the operation of our business, then our business, financial condition or results of operations could be materially adversely affected.

Risks Faced By The Entire Novartis Group

Government regulation may adversely affect our business, financial condition or results of operations.

        Like our competitors, we are subject to strict government controls on the development, manufacture, marketing, labeling, distribution and pricing of our products. We must obtain and maintain regulatory approval for our pharmaceutical and many of our other products from regulatory agencies in order to sell our products in a particular jurisdiction.

        Risks regarding the development of new products.    Our research and development activities are heavily regulated. If we fail to comply fully with applicable regulations, then there could be a delay in the submission or approval of potential new products for marketing approval. In addition, the submission of an application to a regulatory authority does not guarantee that a license to market the product will be granted. Each authority may impose its own requirements and delay or refuse to grant approval, even when a product has already been approved in another country. In our principal markets, the approval process for a new product is complex, lengthy and expensive. The time taken to obtain approval varies by country but generally takes from six months to several years from the date of application. This registration process increases the cost to us of developing new products and increases the risk that we will not succeed in selling them successfully.

        Risks regarding the manufacture of our products.    The manufacture of our products is heavily regulated by governmental authorities around the world, including the FDA. If we or our third party suppliers fail to comply fully with such regulations then there could be a government-enforced shutdown of production facilities, which in turn could lead to product shortages. A failure to comply fully with such regulations could also lead to a delay in the approval of new products. In addition, because our products are intended to promote the health of patients, any supply interruption could lead to allegations that the public health has been endangered, and could subject us to lawsuits.

        Risks regarding the marketing of our products.    The marketing of our products is also heavily regulated by governments throughout the world. In many countries, particularly those in Europe, we are prohibited

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from marketing many of our products directly to consumers. In the US, some direct-to-consumer marketing practices are permitted, but the scope of allowable marketing practices is still significantly limited. Most countries also place restrictions on the manner and scope of permissible marketing to physicians and other health professionals. The effect of such regulations may be to limit the amount of revenue which we may be able to derive from a particular product. In addition, if we fail to comply fully with such regulations then civil or criminal actions could be brought against us.

        Risks regarding the safety and efficacy of our products.    Regulatory agencies may at any time reassess the safety and efficacy of our products based on new scientific knowledge or other factors. Such reassessments could result in the amendment or withdrawal of existing approvals to market our products, which in turn would result in a loss of revenue, and could serve as an inducement to bring lawsuits against us.

        Risks arising from the decreasing risk tolerance of the public and of governmental agencies.    In recent years, the public and various governments appear to have become less tolerant than in the past of the risks posed by products of the type sold by companies such as ours. This apparent trend could in the future result in more stringent regulatory requirements, including more difficult approval processes for products of the type we sell. This in turn could increase our costs of developing new products, limit our ability to promote and sell our existing products, or lead to market withdrawals of existing products.

        Other regulatory and legal risks.    Changes in worldwide intellectual property protections and remedies, trade regulations and procedures, product counterfeiting, unstable governments and legal systems, intergovernmental disputes and possible nationalizations could also materially adversely affect our business, financial condition or results of operations.

We operate in highly competitive and rapidly consolidating industries.

        We operate in highly competitive and rapidly consolidating industries. Our principal competitors are major international corporations with substantial resources for research and development, production and marketing. Our competitors are consolidating, and the strength of combined companies could affect our competitive position in all of our business areas.

Lawsuits, investigations and other liabilities could adversely affect our business, financial condition or results of operations.

        Like our competitors, we are subject to a variety of lawsuits, governmental investigations and other potential liabilities arising out of the normal conduct of our business.

        Risks regarding product liability claims.    Product liability claims are potentially a significant commercial risk for us. Substantial damage awards have been made in some jurisdictions against companies such as ours based upon claims for injuries allegedly caused by the use of their products. We are involved in a number of product liability cases claiming damages as a result of the use of our products. See "Item 8. Financial Information—8.A Consolidated Statements and Other Financial Information—8.A.7 Legal Proceedings." We maintain product liability insurance policies with third parties, covering claims on a worldwide basis. However, changes in the product liability insurance market for originator pharmaceutical products have made the purchase of such policies uneconomic for such products. For certain pharmaceutical substances, coverage cannot be obtained at all. To cope with this change, we have established provisions for these product liability risks up to certain limits. From January 1, 2006, these provisions provide our sole means for affirmatively managing the product liability risks of our Pharmaceuticals Division. Product liability insurance coverage for all other Divisions will continue to be acquired from third parties. We believe that our insurance coverage and provisions are reasonable and prudent in light of our business and the risks to which we are subject. However, events may occur which in whole or in part, might not be covered by insurance or the provisions that we have put in place. While no such losses are presently expected, there can be no guarantee that we will not also face a loss which far exceeds available insurance and provisions.

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        Risks regarding other lawsuits and investigations.    A number of our affiliates are the subject of litigation and investigations arising out of the normal conduct of their business. As a result, claims could be made against them which, in whole or in part, might not be covered by insurance. While, in our opinion, the outcome of these actions will not materially affect our financial condition, the outcome of these actions could be material to our results of operations in a given period. See "Item 8. Financial Information—8.A Consolidated Statements and Other Financial Information—8.A.7 Legal Proceedings."

        Risks regarding patent claims by third parties.    We take all reasonable steps to ensure that our products do not infringe valid third-party intellectual property rights. Nevertheless, third parties may assert claims against us for infringement. As a result, we can become involved in extensive litigation regarding our products. If we are unsuccessful in defending ourselves against these suits, we could be subject to injunctions preventing us from selling our products, or to damages, which may be substantial. Either event could have a material adverse effect on our consolidated financial position, results of operations or liquidity.

        Risks regarding environmental liabilities.    In our product development programs and manufacturing processes, it is sometimes necessary for us to use hazardous materials, chemicals, biologics, viruses and toxic compounds. These programs and processes expose us to risks of accidental contamination, events of noncompliance with environmental laws and regulatory enforcement, personal injury, property damage and claims resulting from these events. If an accident occurred, or if we discover contamination caused by prior operations, we could be liable for clean-up obligations, damages or fines, which could have an adverse effect on our business, financial condition or and results of operations.

        The environmental laws of many jurisdictions impose actual and potential obligations on us to remediate contaminated sites. These obligations may relate to sites:

    that we acquire, own or operate;

    that we formerly owned or operated; or

    where waste from our operations was disposed.

        These environmental remediation obligations could significantly reduce our operating results. In particular, our financial provisions for these obligations may be insufficient if the assumptions underlying the provisions—including our assumptions regarding the portion of the waste at a site for which we are responsible—prove incorrect, or if we are held responsible for additional contamination.

        Stricter environmental, safety and health laws and enforcement policies could result in substantial costs and liabilities to us, and could subject our handling, manufacture, use, reuse or disposal of substances or pollutants to more rigorous scrutiny than is currently the case. Consequently, compliance with these laws could result in significant capital expenditures as well as other costs and liabilities, thereby harming our business, financial condition or operating results.

The manufacture of our products is technically highly complex, and sometimes sole-sourced, and a supply interruption or delay could adversely affect our business, financial condition or results of operations.

        The products we market, distribute and sell are either manufactured at our own dedicated manufacturing facilities, or through toll manufacturing arrangements or supply agreements with third parties. Many of our products are the result of technically complex manufacturing processes, and are sometimes dependent on highly specialized raw materials. In addition, for certain of our products, and certain key raw materials, we have only a single source of supply. As a result, we can provide no assurances that supply sources will not be interrupted from time to time. For these same reasons, the volume of production of any product cannot be rapidly altered. As a result, if we should fail to accurately predict market demand for any of our products then we may not be able to produce enough of the product to meet that demand, or may produce too much of the product, either of which could affect our business, financial condition or results of operations. In addition, because our products are intended to promote the

13



health of patients, any supply interruption could lead to allegations that the public health has been endangered, and could subject us to lawsuits.

An inability to attract and retain personnel could adversely affect our business, financial condition or results of operations.

        We highly depend upon our key personnel at all levels of our organization. The loss of the service of any of the key members of our organization—particularly members of our senior management and scientific teams—may delay or prevent the achievement of major business objectives. Our ability to attract and retain qualified personnel, consultants and advisors is critical to our success. We face intense competition for qualified individuals from numerous pharmaceutical and biotechnology companies, universities, governmental entities and other research institutions. We may be unable to attract and retain these individuals, and our failure to do so would have an adverse effect on our business, financial condition or results of operations.

Foreign exchange fluctuations may adversely affect our earnings and the value of some of our assets.

        A significant portion of our earnings and expenditures are in currencies other than US dollars, our reporting currency. In 2005, 42% of our sales were made in US dollars, 27% in Euro, 8% in Japanese yen, 2% in Swiss francs and 21% in other currencies. In 2005, 34% of our costs were generated in US dollars, 26% in Euro, 16% in Swiss francs, 5% in Japanese yen and 19% in other currencies. Changes in exchange rates between the US dollar and other currencies can result in increases or decreases in our costs and earnings. Fluctuations in exchange rates between the US dollar and other currencies may also affect the reported value of our assets measured in US dollars and the components of shareholders' equity. We seek to minimize our currency exposure by engaging in hedging transactions where we deem it appropriate. To mitigate some of these risks, we may hedge certain foreign currency positions for 2006. We cannot predict, however, all changes in currency and interest rates, inflation or other factors, which could affect our international businesses.

The impairment of long-lived assets could adversely affect our business, financial condition or results of operations.

        We regularly review our long-lived assets, including identifiable intangible assets and goodwill, for impairment. Goodwill, in-process research and development, and acquired development projects not yet ready for use are subject to impairment review at least annually. Other long-lived assets are reviewed for impairment when there is an indication that an impairment may have occurred. If the balance sheet carrying amount of the asset exceeds the higher of its value in use to Novartis or its anticipated fair value less the cost of sale, we will recognize an impairment loss for the difference. The impairment analysis is principally based on an estimate of discounted future cash flows.

        In making such estimates, changes in the discount rates used could lead to impairments. Impairments could also result from lower-than-anticipated sales for acquired products; from lower-than-anticipated sales of products with capitalized patents or trademarks; from lower-than-anticipated future sales resulting from acquired research and development; or from the closing of facilities or changes in the planned use of buildings, machinery or equipment. Any significant impairments could adversely affect our results of operations.

Changes in tax laws could adversely affect our business, financial condition or results of operations.

        Changes in the tax laws of Switzerland, the US, or other countries in which we do significant business, as well as changes in our effective tax rate for the fiscal year caused by other factors, including changes in the interpretation of tax law by local tax officials, could affect our net income. While certain changes were enacted to the tax laws of major countries during 2005, those changes are not expected to materially impact our net income. It is not possible to predict the impact on our results of any tax legislation which may be enacted in the future.

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Earthquakes could adversely affect our business, financial condition or results of operations.

        Our corporate headquarters, the headquarters of our Pharmaceuticals Division, and certain of our major Pharmaceuticals Division production facilities are located near major earthquake fault lines in Basel, Switzerland. In the event of a major earthquake, we could experience business interruptions, destruction of facilities and/or loss of life, all of which could materially adversely affect us.

Product counterfeiting or tampering could adversely affect our business, financial condition or results of operations.

        There are increasing reports of the illegal counterfeiting of and tampering with health care products. Should such reports significantly impact our image or the confidence of our customers in our products, then our business, financial condition or results of operations could be materially adversely affected.

Public sentiment against our industry could adversely affect our business, financial condition or results of operations.

        There is considerable public sentiment against the pharmaceuticals industry, and the industry is under the close scrutiny of the public, the media and other stakeholders. Rising expectations are especially noteworthy in the areas of improving access to our products for the underprivileged both in our established markets and in less developed nations; business conduct in our supply chain; fair marketing practices; bio-ethical challenges; working conditions and human rights. While we seek to manage these risks through various pro-active measures, there can be no assurance that in the future such risks will not cause our business, financial condition or results of operations to be materially affected.

Terrorism and related military activity could impact global economic conditions and thereby adversely affect our business, financial condition or results of operations.

        In the recent past, major terrorist attacks have had an impact on global economic conditions. Any additional major terrorist attacks which may occur in the future, and any related military activity around the world, could have a similar impact, which could materially affect our business, financial condition or results of operations.

The price of our ADSs and the US dollar value of any dividends may be affected by fluctuations in the US dollar/Swiss franc exchange rate.

        Our American Depositary Shares (ADSs) trade on the New York Stock Exchange in US dollars. Since the shares underlying the ADSs are listed in Switzerland on the SWX Swiss Exchange (SWX) and trade on the European trading platform virt-x in Swiss francs, the value of the ADSs may be affected by fluctuations in the US dollar/Swiss franc exchange rate. If the value of the Swiss franc decreases against the US dollar, the price at which our ADSs trade may decrease. In addition, since any dividends that we may declare will be denominated in Swiss francs, exchange rate fluctuations will affect the US dollar equivalent of dividends received by holders of ADSs. If the value of the Swiss franc decreases against the US dollar, the value of the US dollar equivalent of any dividend will decrease accordingly.

Holders of ADSs may not be able to exercise preemptive rights attached to shares underlying ADSs.

        Under Swiss law, shareholders have preemptive rights to subscribe for cash for issuances of new shares on a pro rata basis. Shareholders may waive their preemptive rights in respect of any offering at a general meeting of shareholders. Preemptive rights, if not previously waived, are transferable during the subscription period relating to a particular offering of shares and may be quoted on the SWX. US holders of ADSs may not be able to exercise the preemptive rights attached to the shares underlying their ADSs unless a registration statement under the US Securities Act of 1933, as amended, is effective with respect to such rights and the related shares, or an exemption from the registration requirements thereunder is available. We would evaluate at the time of any share offering the costs and potential liabilities associated

15



with any such registration statement, as well as the indirect benefits of enabling the exercise by the holders of ADSs of the preemptive rights associated with the shares underlying their ADSs, and any other factors we would consider appropriate at the time, and then would make a decision as to whether to file such a registration statement. We cannot guarantee that any registration statement would be filed, or, if filed, that it would be declared effective. If preemptive rights could not be exercised by an ADS holder, JPMorgan Chase Bank, N.A., as depositary, would, if possible, sell such holder's preemptive rights and distribute the net proceeds of the sale to the holder. If the depositary determines, in its discretion, that such rights could not be sold, the depositary might allow such rights to lapse. In either case, the interest of ADS holders in Novartis would be diluted and, if the depositary allows rights to lapse, holders of ADSs would not realize any value from the granting of preemptive rights.


Item 4.    Information on the Company

4.A  History and Development of Novartis

        Novartis is a world leader in offering medicines to protect health, treat disease and improve well-being. Our goal is to discover, develop and successfully market innovative products to treat patients, ease suffering and to enhance the quality of life. We also seek to provide a return to shareholders that reflects our performance and to adequately reward those who invest ideas and resources in our company. In 2005, Novartis generated consolidated net sales of $32.2 billion, invested $4.8 billion in research and development and employed approximately 91,000 people worldwide through its activities in more than 140 countries.

        At Novartis, corporate citizenship is a top priority. We aspire to responsible and conscientious global citizenship based on trust, transparency and accountability. The cornerstones of our commitment are active engagement in society in areas where we are competent, helping where most needed while also establishing and implementing transparent, ethical corporate standards and policies.

        Created in 1996 through the merger of Ciba-Geigy and Sandoz, Novartis is currently organized into three divisions:

    Pharmaceuticals, which comprises our activities in innovation-driven prescription medicines.

    Sandoz, which comprises our activities in generic prescription drugs.

    Consumer Health, which comprises activities in OTC, Animal Health, Medical Nutrition, Gerber (formerly Infant & Baby) and CIBA Vision.

        A fourth division—Vaccines & Diagnostics—is planned to be created after the acquisition of Chiron, which is expected in the first half of 2006.

        Our name, derived from the Latin novae artes, means "new skills" and reflects our commitment to focus research and development to bring new health care products to the patients and physicians that we serve.

        Novartis is the only company with leadership positions in both patented and generic pharmaceuticals. We are strengthening our medicine-based portfolio, investing in strategic growth platforms:

    Innovation-driven prescription medicines.

    Cost-effective and high-quality generic medicines.

    Human vaccines that address public health and therapeutic needs.

    Leading self-medication (OTC) brands.

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Pharmaceuticals Division

        Ranked by IMS Health as one of the fastest-growing global pharmaceutical companies worldwide in recent years, we are seeking to further expand our market share by introducing new products and maximizing sales. We have received 14 new pharmaceutical product approvals in the US since 2000. Our current product portfolio includes more than 40 key marketed products, many of which are leaders in their respective therapeutic areas. In addition, the Development portfolio involves more than 75 projects—including potential new products as well as potential new indications or formulations for existing products—in various stages of clinical development.

        Our efforts have been recognized by industry experts, who have ranked Novartis as having one of the best combinations of organic growth, pipeline opportunities and low patent-risk exposure among major companies in the pharmaceuticals industry.

        The Pharmaceuticals Division has the following therapeutic areas:

Cardiovascular & Metabolism

        Our broad portfolio of cardiovascular and metabolic agents offers some of the best tools available today to treat and protect patients along critical points of the cardiovascular continuum. Top products include Diovan, Co-Diovan/Diovan HCT and Lotrel for the treatment of high blood pressure as well as the cholesterol-lowering agent Lescol/Lescol XL.

Oncology & Hematology

        Novartis has a strong oncology portfolio that provides a broad range of innovative therapies and practical solutions for cancer patients. Our efforts to discover and develop innovative approaches for the treatment of cancer have produced breakthrough medicines such as the leukemia therapy Gleevec/Glivec and the breast cancer agent Femara as well as Zometa for the treatment of bone cancers.

Neuroscience

        Novartis has been an innovator in the area of neuroscience for more than 50 years, having pioneered early breakthrough treatments for a series of disorders that include Alzheimer's disease, Parkinson's disease, attention deficit/hyperactivity disorder, epilepsy, depression, schizophrenia and migraine. Leading products include Exelon for the treatment of Alzheimer's disease and Trileptal for the treatment of epilepsy.

Respiratory & Dermatology

        One of our leading products is Xolair for the treatment of severe allergic asthma, and we are making investments in the research of new medicines for respiratory diseases, which also include chronic obstructive pulmonary disease (COPD). Our focus in dermatology is on the treatment of two very common diseases—the inflamed skin condition atopic dermatitis, or eczema, and fungal nail infections. Elidel is a non-steroid cream for eczema, while Lamisil is the most frequently prescribed treatment worldwide for fungal nail infections, with prescriptions written for more than 20 million patients.

Infectious Diseases, Transplantation & Immunology (IDTI)

        An emerging therapeutic area for Novartis is infectious diseases, particularly products used to treat viral infections by inhibiting their replication. Our portfolio consists of three main areas: antiviral medicines such as the herpes treatment Famvir, tropical medicines such as the malaria treatment Riamet/Coartem and antibacterials. We are also a world leader in transplantation and immunology, pioneering and revolutionizing the field of transplantation with the discovery and introduction of cyclosporine more than 20 years ago. We have one of the broadest portfolios of immunosuppressants on the market, which include Neoral, Simulect, Certican and myfortic. As of January 1, 2006, responsibility for our Infectious

17



Diseases franchise was transferred from the ABGU therapeutic area to be joined with the Transplantation and Immunology therapeutic area, to form the new IDTI therapeutic area. See "Item 4. Information on the Company—4.B Business Overview—Pharmaceuticals—Overview."

Ophthalmics

        Our research and development in this disease area is aimed at the discovery and development of innovative treatments for "back of the eye" (macular) diseases as well as on "dry eye" conditions in which the eye does not produce sufficient tears. Both of these conditions are characterized by high growth and significant unmet medical need. Our flagship Ophthalmics product is Visudyne, a treatment for certain forms of age-related macular degeneration (AMD).

Arthritis/Bone/Gastrointestinal/Urology (ABGU)

        This therapeutic area includes a group of internal diseases where there is significant unmet medical need, particularly in the areas of gastrointestinal disorders with medicines such as Zelnorm/Zelmac for irritable bowel syndrome and chronic constipation as well as Enablex/Emselex for the treatment of urinary incontinence. Other products include Miacalcin/Miacalcic for osteoporosis as well as Prexige and Voltaren for the treatment of certain types of pain.

Sandoz Division

        Sandoz is a leading global supplier of generic pharmaceuticals that develops, produces and markets these drugs along with pharmaceutical and biotechnological active substances. Through Sandoz, Novartis is the only major pharmaceutical company to have leadership positions in both patented prescription drugs as well as generic pharmaceuticals.

        Ranked as the second-largest generics company in the world based on sales, Sandoz has made a series of targeted acquisitions to strengthen its product portfolio, technological expertise and geographic presence, led by the acquisitions of Hexal AG and Eon Labs, Inc. in 2005.

        Sandoz offers more than 600 active substances in over 5,000 forms in more than 140 countries. The most important product groups include antibiotics, treatments for central nervous system disorders, gastrointestinal medicines, cardiovascular treatments and hormone therapies.

Consumer Health Division

        Consumer Health focuses on creating, developing and manufacturing a range of competitively differentiated products that restore, maintain or improve the health and well-being of consumers. Giving a voice to the consumer is critical for Consumer Health in its objective to deliver accelerated sales growth and gain leadership in key markets with strategic brands. Consumer Health is comprised of activities in OTC, Animal Health, Medical Nutrition, Gerber (formerly Infant & Baby) and CIBA Vision.

Novartis AG

        Novartis AG, headquartered in Basel, Switzerland, is a public company incorporated under the laws of Switzerland with an indefinite duration. We are domiciled in and governed by the laws of Switzerland. Our registered office is located at the following address:

    Novartis AG
    Lichtstrasse 35
    CH-4056 Basel
    Switzerland
    Telephone: 011-41-61-324-1111
    Web: www.novartis.com

18


        Our registered shares are listed in Switzerland on the SWX Swiss Exchange ("SWX") and traded on the European trading platform virt-x. Our American Depositary Shares are listed on the New York Stock Exchange ("NYSE"). Our shares are also traded on the International Retail Service (IRS) at the London Stock Exchange. In the US, Corporation Service Company (2711 Centerville Road, Suite 400, Wilmington, Delaware 19808, telephone: 1-800-927-9800) acts as our agent solely for the purpose of accepting service of process in respect of registration statements on Forms F-3 under the US Securities Act of 1933, as amended.

Major Corporate Developments 2003-2005

2005

January   The exclusive marketing rights to the antihypertension medicines Cibacen and Cibadrex in most European markets are granted to the Swedish specialty pharmaceuticals company Meda AB in exchange for a cash payment of $135 million.

February

 

Novartis announces the acquisition of two leading generic drug companies—privately-held Hexal AG of Germany and the US quoted company Eon Labs, Inc.—and their integration into its Sandoz division. The two companies are acquired for approximately $8 billion in all-cash transactions that bring together three premier generics companies that combine Sandoz's global geographic presence and expertise in anti-infectives, Hexal's leadership in Germany and strong track record of successful product development, and Eon Labs' strong position in the US for "difficult-to-make" generics. The acquisition of Hexal is completed in June, while the purchase of 100% of Eon Labs is completed in July. Based on these acquisitions, Sandoz had a portfolio of over 600 active ingredients in more than 5,000 dosage forms.

March

 

A new CHF 4.0 billion share repurchase program—the fifth at Novartis since 1999—is approved by our shareholders at the Annual General Meeting (AGM). The program will begin following completion of a prior program initiated in August 2004.

July

 

An agreement is signed for Novartis to acquire the rights to a portfolio of over-the-counter (OTC) products—led by the pain medicine
Excedrin—from Bristol-Myers Squibb Company for approximately $660 million in cash, significantly strengthening the company's OTC business in the US market. The business is consolidated as of September 1.

September

 

Novartis announces its intention to acquire all of the remaining shares of Chiron Corporation in addition to the 42.5% stake that it already owns for $40.00 per share. In October, the independent Directors on the Chiron Board of Directors recommended that shareholders other than Novartis approve an improved offer by Novartis to acquire the remaining shares of Chiron for $45.00 per share. In December, we purchased an additional 6.9 million shares of Chiron common stock for an aggregate price of $300 million. See "Item 18. Financial Statements—Note 29." This additional purchase increased our stake in Chiron to 44.1%.

November

 

Novartis announced an agreement to divest its Nutrition & Santé business to ABN AMRO Capital France for approximately EUR 220 million ($260 million) on a cash and debt free basis. The transaction, which is subject to regulatory approvals, is expected to be completed in the first quarter of 2006.
     

19




2004


 


 

January

 

A CHF 3.0 billion share repurchase program is announced to start following completion of a program initiated in 2002. Shareholders at the Annual General Meeting (AGM) approved the program in February 2004, and it commenced in August 2004.

February

 

The global adult medical nutrition business of Mead Johnson & Company, a Bristol-Myers Squibb Company subsidiary, is acquired for approximately $385 million in cash.

April

 

Novartis studies making a bid for a potential business combination with the French-German pharmaceutical group Aventis SA at the request of the Aventis Supervisory Board, but declines to make a bid.

June

 

Novartis announces plans to acquire two generics companies: the Danish company Durascan A/S from AstraZeneca plc and Sabex Holdings Ltd of Canada. Durascan expands our generics presence in the Nordic region, while Sabex, which was acquired for $565 million in cash, provides strong growth opportunities in injectable generics and new entry into the Canadian generics sector.

July

 

Novartis Institute for Tropical Diseases opens its new facility in Singapore with particular focus on biomedical research for dengue fever and drug-resistant tuberculosis (TB).

October

 

Novartis announces the reorganization of its Sandoz generics business. Effective January 1, 2005, Sandoz ceases to be a Business Unit of our Consumer Health Division, and becomes a separate Division.


2003


 


 

February

 

US rights to market the tension headache products
Fioricet and Fiorinal are sold to Watson Pharmaceuticals, Inc. for $178 million.

April

 

An anti-incontinence product called
Enablex in certain countries and Emselex in other countries is acquired from Pfizer Inc. We paid up to $225 million for the rights to this product. Part of that amount was contingent on obtaining approval in the US (approved in December 2004) and EU (approved in October 2004). In 2005, Novartis and Procter & Gamble enter into a commercialization agreement calling for both companies to market this product in the US.

May

 

A majority ownership interest is acquired in Idenix Pharmaceuticals, Inc., for an initial payment of $255 million in cash, with up to an additional $357 million in future contingent payments to the selling stockholders if Idenix achieves certain future targets. We also obtained options to license future products from Idenix. In each case, we may pay additional amounts to Idenix in the event the applicable drug achieves certain future targets. In July 2004, Idenix completed an initial public offering (IPO) of its shares, and Novartis retained its existing 57% stake.

June

 

Novartis groups all of its generic pharmaceutical companies under the brand name Sandoz as part of a worldwide initiative to unite its generic pharmaceutical operations.

November

 

Novartis confirms its support for the Universal Declaration of Human Rights and announces new corporate human rights guidelines to meet its public commitments under the UN Global Compact.

20


4.B  Business Overview

        Novartis is a world leader in both patent-protected and generic pharmaceuticals as well as targeted consumer health products. Our aim is to seek and maintain leadership positions in these businesses.

        Our company is currently organized into three Divisions: Pharmaceuticals, Sandoz and Consumer Health.

        The Pharmaceuticals Division develops and markets branded pharmaceutical products in seven therapeutic areas. It also includes the Novartis Institutes for BioMedical Research (NIBR), which was established in 2003 with the aim of redefining drug discovery in a new era marked by the completion of the human genome sequence. NIBR is headquartered in Cambridge, Massachusetts, and has subsidiaries worldwide.

        Sandoz, which ranks as the second-largest generics company in the world following the acquisitions of Hexal AG and Eon Labs, Inc. in 2005, is organized as a Retail Generics business that also operates an Anti-Infectives business. The Retail Generics business produces finished dosage forms that are sold to pharmacies, hospitals and other health care outlets. It also includes the company's biopharmaceutical operations, which draw on the company's rich experience in biotechnology to meet the growing demand for generic biologicals, which are often referred to as "follow on proteins." The Anti-Infectives business manufactures active pharmaceutical ingredients and their intermediates for internal requirements and industrial customers.

        The Consumer Health Division has five Business Units, each of which coordinate the worldwide research, development, manufacturing and marketing of their respective products. The Business Units are: OTC self-medication, Animal Health, Medical Nutrition, Gerber and CIBA Vision.

        A fourth Division—Vaccines & Diagnostics—is planned to be created following the successful acquisition of the remaining 56% of the US biopharmaceuticals company Chiron Corporation, which would provide Novartis entry to the dynamic human vaccines business. No guarantee can be made that Novartis will be successful in completing this transaction, which is subject to shareholder and regulatory approval.

Key Figures

        Following the adoption of a number of new IFRS from January 1, 2005, as required by IFRS, the 2004 and 2003 consolidated financial statements have been restated. Not all of the new standards required retrospective application of the new accounting and reporting requirements. See "Item 18. Financial Statements—Note 32" for a more detailed discussion.

        In order to assist our investors and analysts in their understanding of our results by having comparable information, pro forma 2004 and 2003 consolidated income and cash flow statements are provided that include additional adjustments compared to the audited restated 2004 and 2003 consolidated income and cash flow statements. See "Item 5.A Operating Results—2004 and 2003 Pro Forma Consolidated Financial Information" for a more detailed discussion.

21


 
  Year Ended December 31,
 
 
  2005
  2004
Pro Forma

  2003
Pro Forma

 
 
  (in $ millions)

 
Net Sales to third parties              
Pharmaceuticals   20,262   18,497   16,020  
Sandoz   4,694   3,045   2,906  
Consumer Health   7,256   6,705   5,938  
   
 
 
 
Group net sales   32,212   28,247   24,864  
   
 
 
 

Operating income

 

 

 

 

 

 

 
Pharmaceuticals   6,014   5,366   4,517  
Sandoz   342   263   496  
Consumer Health   1,055   1,006   907  
Corporate income, net   (506 ) (346 ) (254 )
   
 
 
 
Group operating income   6,905   6,289   5,666  
   
 
 
 

        The table below sets forth a regional breakdown of certain data for the years ended December 31, 2005, 2004 and 2003.

 
  Americas
  Europe
  Asia/Africa/Australia
 
  2005
  2004 Restated
  2003 Restated
  2005
  2004 Restated
  2003 Restated
  2005
  2004 Restated
  2003 Restated
 
  (in $ millions, except number of employees)

Net sales   15,011   13,285   12,036   12,000   10,289   8,788   5,201   4,673   4,040
Operating income   1,916   1,355   876   4,518   4,301   4,274   471   496   485
Number of employees (at December 31)   32,175   30,186   28,608   43,559   38,229   37,510   15,190   12,977   12,423
Investment in property, plant and equipment   396   340   427   683   787   846   115   142   56
Depreciation of property, plant and equipment   264   229   220   508   510   480   49   41   37
Total assets   17,049   12,166   10,524   37,977   37,897   35,627   2,706   2,425   2,227

   
PHARMACEUTICALS

    Overview

        Our Pharmaceuticals Division is a world leader in offering innovation-driven, patent-protected medicines to patients, physicians and health care payors worldwide. This division is made up of approximately 80 affiliated companies and 49,308 employees, selling products in approximately 140 countries. In 2005, the Division reported consolidated net sales of $20.3 billion, which represented 63% of total Group net sales.

        The Pharmaceuticals Division develops and markets products in the following therapeutic areas:

    Cardiovascular & Metabolism

    Oncology & Hematology

22


    Neuroscience

    Respiratory & Dermatology

    Infectious Diseases, Transplantation & Immunology (IDTI)

    Ophthalmics

    Arthritis/Bone/Gastrointestinal/Urology (ABGU)

        Our Pharmaceuticals Division's current product portfolio includes more than 40 key marketed products, many of which are their respective market leaders. In addition, the Division's portfolio of development projects includes more than 70 potential new products and new indications or formulations for existing products in various stages of clinical development.

        Prior to January 1, 2006, the therapeutic areas of the Pharmaceuticals Division were divided into two marketing segments, General Medicines and Specialty Medicines. In addition, as of January 1, 2006, responsibility for our Infectious Diseases franchise was transferred from the ABGU therapeutic area (formerly known as ABGHI), to be joined with the Transplantation and Immunology therapeutic area, to form the new IDTI therapeutic area. The following tables and product descriptions reflect this new organization. However, certain historical information contained elsewhere in this 20-F may continue to provide information organized by the prior therapeutic areas.

23


Selected Key Marketed Products

        The following table describes selected key marketed pharmaceutical products, in alphabetical order, by therapeutic area. Not all products are registered in all markets for all of the indications described below.


Therapeutic
Area

  Compound

  Generic name

  Indication

  Formulation

Cardiovascular
& Metabolism
  Diovan   valsartan   Hypertension
Heart failure (in
some countries in
patients intolerant of
ACE inhibitors)
Post-myocardial
infarction
  Capsule
Coated tablet
   
    Diovan HCT/
Co-Diovan
  valsartan and
hydrochlorothiazide
  Hypertension   Film-coated tablet
   
    Lescol/
Lescol XL
  fluvastatin sodium   Primary
hypercholesterolemia
and mixed dyslipidemia
Secondary prevention
of adverse cardiac events
after coronary
transcatheter therapy
Slowing the progression
of atherosclerosis
  Capsule
Tablet
   
    Lotensin HCT/
Cibadrex
  benazepril
hydrochloride
  Hypertension   Coated tablet
   
    Lotensin/
Cibacen
  benazepril
hydrochloride
and hydrochlorothiazide
  Hypertension
Adjunct therapy in
heart failure
Progressive chronic
renal insufficiency
  Coated tablet
   
    Lotrel   amlodipine besylate
and benazepril
hydrochloride
  Hypertension   Capsule
   
    Starlix   nateglinide   Type 2 diabetes   Coated tablet

                 

24


Oncology &
Hematology
  Exjade   deferasirox   Chronic iron overload due
to blood transfusion
  Dispersible tablets
   
    Femara   letrozole tablets/
letrozole
  Advanced post-menopausal
breast cancer (worldwide)
Extended adjuvant use in
early breast cancer
following tamoxifen
Early post-menopausal
breast cancer after
surgery (US&UK)
  Coated tablet
   
    Gleevec/
Glivec
  imatinib mesylate/
imatinib
  Certain forms of Chronic
myeloid leukemia (CML)
Certain forms of
gastrointestinal stromal
tumors (GIST)
  Tablet
Capsule
   
    Sandostatin
LAR/
Sandostatin SC
  octreotide acetate for
injectable suspension/
octreotide acetate
  Acromegaly
Symptoms associated
with certain tumors
  Vial
Ampoule
Pre-filled syringe
   
    Zometa   zoledronic acid for
injection/zoledronic acid
  Hypercalcemia of
malignancy
Prevention of
skeletal-related events in
patients with bone metastases
from solid tumors
  Liquid concentrate
Vial

                 

25


Neuroscience   Clozaril/
Leponex
  clozapine   Treatment-resistant
schizophrenia
Prevention and treatment
of recurrent suicidal
behavior in patients with
schizophrenia and
schizoaffective disorder
  Tablet
   
    Comtan   entacapone   Parkinson's disease   Coated tablet
   
    Exelon   rivastigmine tartrate   Alzheimer's disease   Capsule
Oral solution
   
    Focalin   dexmethylphenidate HCl   Attention-deficit
hyperactivity disorder
  Tablet
   
    Ritalin/
Ritalin LA
  methylphenidate HCl   Attention-deficit
hyperactivity disorder
  Tablet
Capsule
   
    Stalevo   carbidopa, levodopa
and entacapone
  Parkinson's disease   Coated tablet
   
    Tegretol   carbamazepine   Epilepsy
Acute mania and bipolar
affective disorders
Treatment of pain
associated with trigeminal
neuralgia
  Tablet
Chewable tablet
Syrup
Suppository
   
    Trileptal   oxcarbazepine   Epilepsy   Tablet
Oral suspension

Respiratory & Dermatology   Elidel   pimecrolimus cream   Atopic dermatitis
(eczema)
  Cream
   
    Foradil   formoterol   Asthma
Chronic obstructive
pulmonary disease
  Aerolizer
(capsules)
Aerosol
   
    Lamisil   terbinafine   Fungal infections of
the skin and nails
  Tablet
Cream
DermGel
Solution
Spray
   
    Xolair   omalizumab   Allergic asthma   Subcutaneous
injection

                 

26


Infectious
Diseases,
Transplantation
& Immunology
(IDTI)
  Certican   everolimus   Prevention of organ
rejection following heart
or kidney transplantation
  Tablet
Tablet for oral
suspension
   
    Coartem/
Riamet
  artemether and
lumefantrine
  Treatment of
Plasmodium falciparum
malaria or mixed infections
that include
Plasmodium falciparum
Standby emergency malaria
treatment
  Tablet
   
    Famvir   famciclovir   Acute herpes zoster
Recurrent genital herpes
in immunocompetent
patients
Suppression of recurrent
genital herpes in
immunocompetent patients
Recurrent mucocutaneous
herpes simplex infections
in HIV-infected patients
  Tablet
   
    Myfortic   mycophenolic acid   Prevention of graft
rejection following
kidney transplantation
  Enteric coated
tablet
   
    Neoral   cyclosporine,
USP modified
  Prevention of rejection
following organ and bone
marrow transplantation
Non-transplantation
autoimmune conditions such
as severe psoriasis,
nephrotic syndrome,
rheumatoid arthritis, atopic
dermatitis or endogenous
uveitis
  Capsule
Oral solution
   
    Simulect   basiliximab   Acute organ rejection
in de novo renal
transplantation
  Vial

Ophthalmics   Visudyne   verteporfin   Age-related macular
degeneration
(all forms of wet AMD)
  Vial, activated
by laser light
   
    Zaditor/
Zaditen
  ketotifen   Allergic conjunctivitis   Eye drops

                 

27


Arthritis/
Bone/
Gastrointestinal/
Urology (ABGU)
  Aclasta   zoledronic acid   Paget's disease   Solution for
infusion
   
    Combipatch/
Estalis
  estradiol norethisterone
acetate
  Treatment of symptoms
of estrogen deficiency
in post-menopausal women
Prevention of osteoporosis
in post-menopausal women
  Transdermal patch
   
    Enablex/
Emselex
  darifenacin
hydrobromide
  Overactive bladder   Tablet
   
    Estraderm TTS/
Estraderm
MX
  estradiol hemihydrate   Treatment of signs and
symptoms of estrogen
deficiency
Prevention of accelerated
post-menopausal bone loss
  Transdermal patch
   
    Estragest
TTS
  estradiol hemihydrate
and norethisterone
acetate
  Treatment of symptoms
of estrogen deficiency
in post-menopausal women
Post-menopausal
osteoporosis
  Transdermal patch
   
    Miacalcin/
Miacalcic
  salmon calcitonin   Osteoporosis
Bone pain associated with
osteolysis and/or osteopenia
Paget's disease
Neurosdystrophic disorders
(synonymous with
algodystrophy or Sudeck's
disease)
Hypercalcemia
  Nasal spray
Ampoule
Vial
Injection
   
    Prexige   lumiracoxib   Osteoarthritis
Acute pain
Primary dysmenorrhea
  Tablet
   
    Vivelle Dot/Estradot   estradiol hemihydrate   Oestrogen replacement
therapy
  Transdermal patch
   
    Voltaren   diclofenac   Inflammatory forms of
rheumatism
Pain management
  Coated tablet
Drop
Ampoule
Suppository
Gel
   
    Zelnorm/Zelmac   tegaserod   Irritable bowel syndrome
with constipation
Chronic idiopathic
constipation
  Tablet

28


Compounds in Development

        The following table describes some of our compounds and new indications for our existing products presently under development. "Submission" means that product registration documents have been submitted to the FDA, to regulatory authorities in the EU (by either the centralized or mutual recognition procedure) and/or to national health authorities in Europe, and/or Japan, but not necessarily in all jurisdictions.


Therapeutic
area

  Project/
Compound

  Generic
name

  Indication

  Mechanism of action

  Formulation

  Planned filing
dates/Current
phase

Cardiovascular
& Metabolism
  Lotrel   amlodipine
besylate and
benazepril
hydrochloride
  Hypertension (5-40 and 10-40)   ACE inhibitor
and calcium
channel blocker
  Oral   US
(submitted)
           
            High-risk hypertension
(ACCOMPLISH)
      Oral   >2008/III
   
    Galvus
(LAF237)
  vildagliptin   Type 2 diabetes   Dipeptidyl-
peptidase 4
(DPP-4) inhibitor
  Oral   2006/III
   
    Rasilez
(SPP100)
  aliskiren   Hypertension   Renin inhibitor   Oral   2006/III
   
    Exforge
(fixed-dose
combination)
  amlodipine
and valsartan
  Hypertension   Dihydropyridine
calcium antagonist
and angiotensin-II
receptor antagonist
  Oral   2006/III
   
    Diovan and
Starlix (free
combination)
  valsartan and
nateglinide
  Prevention of new onset
type 2 diabetes,
cardiovascular morbidity
and mortality
(NAVIGATOR)
  ARB and insulin
secretagogue
  Oral   >2008/III
   
    LBM642   TBD   Dyslipidemia   PPAR alpha and
gamma dual
agonist
  TBD   >2008/II
   
    APP018   TBD   Atherosclerosis   ApoA1 mimetic   Oral   TBD/I
   
    VNP489   TBD   Hypertension   ARB/NEP
inhibitor FDC
  Oral   TBD/I

Oncology &
Hematology
  Femara   letrozole   Breast cancer (early
adjuvant therapy)
  Aromatase inhibitor   Oral   US
(approved)
EU
(submitted)
   
    Exjade   deferasirox   Chronic iron overload
due to blood
transfusion
  Iron chelator   Oral   US
(approved) EU
(submitted)
   
    Zometa   zoledronic acid   Treatment of bone
metastases
  Bisphosphonate   Intravenous   Japan
(submitted)
   
    Gleevec/
Glivec
  imatinib
mesylate/
imatinib
  Ph+ ALL, rare diseases   Signal
transduction
inhibitor
  Oral   US, EU
(submitted)
           
            Glioblastoma
multiforme
          2008/III
           
            Solid tumors           TBD/II
   
                         

29


    PTK787   vatalanib   Colorectal cancer
Solid tumors
  Angiogenesis
inhibitor
  Oral   2007/III
TBD/I
   
    EPO906   patupilone   Solid tumors   Microtubule
depolymerization
inhibitor
  Intravenous   2008/III
   
    AMN107   (nilotinib)   Chronic myeloid
leukemia (CML)
  Signal
transduction
inhibitor
  Oral   2007/II
           
            GIST           TBD/I
   
    RAD001   everolimus   Solid tumors   Growth-factor-
induced cell
proliferation signal
transduction
inhibitor
  Oral   2008/II
   
    SOM230   pasireotide   Acromegaly
GEP
neuroendocrine
Tumors
Cushing's Disease
  Somatostatin (sst)
1/2/3/5 binder
and hormone
inhibitor
  Intramuscular
injection
Subcutaneous
injection
  >2008/II
   
    LBQ707   gimatecan   Solid tumors   Topoisomerase-I
inhibitor
  Oral   >2008/II
   
    PKC412   midostaurin   Acute myeloid
leukemia (AML)
  Signal
transduction
inhibitor
  Oral   TBD/II
   
    LBH589   TBD   Solid and liquid
tumors
  Histone
deacetylase
inhibitor
  Oral   2008/I
   
    AEE788   TBD   Solid tumors   Tyrosine kinase
inhibitor
  Oral   >2008/I
   
    ABJ879   TBD   Solid tumors   Microtubule
stabilizer
  Intravenous
injection
  TBD/I

                         

30


Neuroscience   Comtan   entacapone   Parkinson's disease   Catechol-O-
methyltransferase
inhibitor
  Oral   Japan
(submitted)
   
    Exelon   rivastigmine
tartrate
  Dementia associated with
Parkinson's disease
  Cholinesterase
inhibitor
  Oral   US, EU
(submitted)
   
    Exelon TDS   rivastigmine
tartrate
  Dementia   Cholinesterase
inhibitor
  Transdermal
patch
  2006/III
   
    LIC477   licarbazepine   Bipolar disorder   Voltage sensitive
sodium channel
blocker
  Oral   2007/III
   
    FTY720   fingolimod   Multiple sclerosis   Sphingosine-1-
phosphate receptor
modulator
  Oral   >2008/II
   
    SAB378   TBD   Chronic pain   Cannabinoid-1
receptor agonist
  Oral   >2008/II
   
    XBD173   TBD   Generalized anxiety
disorder
  Mitochondrial
benzodiazepine
receptor agonist
  Oral   >2008/II
   
    AFQ056   TBD   Anxiety   mGlu5 Receptor
Antagonist
  Oral   TBD/I
   
    SAD448   TBD   Chronic pain   Cannabinoid
Receptor
Agonist
  Oral   TBD/I
   
    CAD106   TBD   Alzheimer's disease   Beta-amyloid
vaccine
  Injection   TBD/I
   
    RAD001   everolimus   Tuberous sclerosis   Growth-factor-
induced cell
proliferation signal
transduction
inhibitor
  Oral   TBD/I

                         

31


Respiratory &
Dermatology
  Foradil   formoterol   Asthma
Chronic obstructive
pulmonary disease
  Long-acting
beta-2 agonist
  Dry powder
for inhalation
  US, major
EU markets
(submitted)
Approved in
18 European
countries
   
    Lamisil   terbinafine   Fungal infection of the
scalp in children
  Fungal squalene
epoxidase
inhibitor
  Oral   US (2006/III)
           
            Fungal infection
of the nail
      Nail
Lacquer
  >2008/I
   
    QAB149   indacaterol   Asthma
Chronic obstructive
pulmonary disease
  Once-daily
beta-2 agonist
  Inhalation   2008/II
   
    NVA237   glycopyrronium
bromide
  Chronic obstructive
pulmonary disease
  Long acting
anti-muscarinic
  Inhalation   >2008/II
   
    Xolair   omalizumab   New liquid formulations   Anti-IgE
monoclonal
antibody
  Sub-
cutaneous
injection
  2008/I
           
            Peanut allergy       Sub-
cutaneous
injection
  TBD/I
   
    ACZ885   TBD   Chronic obstructive
pulmonary disease
  Monoclonal
antibody to
IL-1 beta
  Injection   >2008/I
   
    TBD   formoterol/
mometasone
  Asthma
Chronic obstructive
pulmonary disease
  Long-acting
beta-2
agonist/inhaled
corticosteroid
  Inhalation   TBD/I
   
    Elidel   pimecrolimus   Seborrheic
dermatitis
  T-cell and mast
cell inhibitor
  Cream   TBD/I
   
    ABN912   TBD   Asthma
Chronic obstructive
pulmonary disease
  Monoclonal
antibody to
monocyte
chemoattractant
protein-1
  TBD   TBD/I
   
    QAP642   TBD   Asthma   CCR3 antagonist   TBD   TBD/I
   
    QAE397   TBD   Asthma   Glucocortic-
osteroid
  Inhaled   TBD/I
   
    QAT370   TBD   Chronic obstructive
pulmonary disease
  Muscarinic
receptor
antagonist
  Inhaled   TBD/I

                         

32


Infectious
Diseases,
Transplantation
& Immunology
(IDTI)
  Certican   everolimus   Prevention of
organ rejection
  Growth-factor-
induced cell
proliferation
inhibitor
  Oral   EU
(approved)
US
(submitted)
   
    LDT600   telbivudine   Hepatitis B   Viral polymerase
inhibitor
  Oral   US
(submitted)
EU, J
(2006/III)
   
    LDC300   valtorcitabine   Hepatitis B   Viral polymerase
inhibitor
  Oral   >2008/II
   
    NMC283   valopacitabine   Hepatitis C   Viral polymerase
inhibitor
  Oral   >2008/II
   
    RSV604   TBD   Respiratory syncytial
virus
  Inhibition of
viral replication
  Oral   >2008/II
   
    ANA975   TBD   Hepatitis C   Toll-like
receptor 7
agonist
  Oral   TBD/I
   
    AEB071   TBD   Prevention of organ rejection   Innovative
immunosup-
pressant
  TBD   TBD/I
   
    NIM811   TBD   Hepatitis C   Cyclophilin
binding
HCV RdRP
Modulator
  Oral   TBD/I
   
    SBR759   TBD   Hyperphosphatemia   Selective binding
of phosphate
(Fe(III) containing
polymer)
  Oral   TBD/I

                         

33


Ophthalmics   Lucentis   ranibizumab   Age-related macular
degeneration
(AMD)
  VEGF blocker   Intra-vitreal   EU (2006/III)
US
(submitted by
Genentech)
   
    Sandostatin
LAR
  octreotide
acetate
  Diabetic retinopathy   Growth hormone
and IGF-1
inhibitor
  Intra
muscular
  2006/III
   
    OPC759   rebamipide   Dry eye   Mucin
secretagogue
  Eye drops   2008/III
   
    Visudyne   verteporfin   Age-related
macular
degeneration
(AMD)
(predominantly occult)
  Photosensitizer
for photodynamic
therapy
  Intravenous   TBD/III
   
    Elidel   pimecrolimus   Dry eye   T-cell and mast
cell inhibitor
  Eye drops   >2008/II
   
    PTK787   vatalanib   Age-related macular
degeneration
(AMD)
  Angiogenesis
inhibitor
  Oral   TBD/II
   
    RKI983   TBD   Glaucoma   Rho-kinase
inhibitor
  Topical   TBD/I

                         

34


Arthritis/
Bone/
Gastrointestinal/
Urology
(ABGU)
  Aclasta   zoledronic
acid
  Paget's disease
of the bone
  Bisphosphonate,
osteoclast
inhibitor
  Intravenous   US
(submitted)
EU
(approved)
   
    Zelnorm/Zelmac   tegaserod   Irritable bowel
syndrome with
constipation
  5HT4-receptor agonist   Oral   US
(approved)
EU
(submitted)
   
    Prexige   lumiracoxib   Osteoarthritis   Cyclo-oxygenase-2
inhibitor
  Oral   EU (2006/III)
           
            Acute pain
Primary
dysmenorrhea
          US (2007/III)
           
            New formulations   Cyclo-oxygenase-2
inhibitor
  Oral
suspension,
parenteral
  TBD/I
           
            Dyspepsia           2007/III
           
            Different
osteoporosis
indications
          2007/III
           
            Rheumatoid
arthritis
          TBD/II
   
    SMC021   calcitonin   Osteoporosis   Regulator of
calcium
homeostasis
  Oral   >2008/II
   
    AAE581   balicatib   Osteoporosis   Cathepsin K
inhibitor
  Oral   TBD/II
           
            Osteoarthritis       Adenoviral
vector
  2008/I
   
    AIN457   TBD   Rheumatoid arthritis   Monoclonal
antobody to
IL-17A
  Intravenous   >2008/I
   
    ACZ885   TBD   Muckle Wells
Syndrome
  Monoclonal
antibody to
IL-1 beta
  Injection   TBD/I
   
    Phase I: First clinical trial of a new compound, generally performed in a small number of healthy human volunteers, to assess clinical safety, tolerability as well as metabolic and pharmacologic properties.

 

 

Phase II: Clinical studies that test the safety and efficacy of the compound in patients with the targeted disease, with the goal of determining the appropriate doses for further testing and evaluating study design as well as identifying common side effects and risks.

 

 

Phase III: Large-scale clinical studies with several hundred or several thousand patients to establish safety and effectiveness for regulatory approval for indicated uses and to evaluate the overall benefit-risk relationship.

        The tables shown above and the summary that follows describe key marketed products and compounds in development in the Pharmaceuticals Division. Unless otherwise indicated, and subject to required regulatory approvals and, in certain instances, contractual limitations, we intend to sell our marketed products throughout the world. These same compounds are in various stages of development throughout the world. For some compounds, the development process is ahead in the US, for other compounds, development is behind in the US. Due to the uncertainties associated with the development

35



process, and due to regulatory restrictions in some countries, including the US, it may not be possible to obtain regulatory approval for any or all of the new compounds and new indications referred to in this Form 20-F. In addition, for some of our products, we are required to conduct post-approval studies (Phase IV) to evaluate long-term effects or to gather information on the use of the product under special conditions. See "—Regulation" for further information on the approval process.

Cardiovascular & Metabolism

        Novartis is a world leader in offering products to treat cardiovascular and metabolic diseases, particularly high blood pressure (hypertension), elevated cholesterol (hyperlipidemia), heart failure and patients following a heart attack. We believe that our broad portfolio of cardiovascular and metabolic agents offer some of the best tools available today to treat and protect patients along critical points of the cardiovascular continuum—from novel treatments for type 2 diabetes and medicines to manage hypertension and high cholesterol, to life-saving therapies following heart attack and for patients who are suffering from heart failure.

        Our pipeline includes compounds with the potential to change the way cardiovascular and metabolic diseases are treated, in particular the oral DPP-4 inhibitor Galvus (vildagliptin, formerly LAF237) for type 2 diabetes and the oral renin inhibitor Rasilez (aliskiren, formerly SPP100) for hypertension.

    Key Marketed Products

    Diovan (valsartan) and Co-Diovan/Diovan HCT (valsartan and hydrochlorothiazide) are leaders in the angiotensin II receptor blocker (ARBs) class of anti-hypertensive (high-blood pressure) agents. The ARB drug class has been a key growth driver in the global anti-hypertensive market segment, with Diovan consistently ranking as the most prescribed brand in this class, according to IMS Health. Diovan specifically inhibits a hormone, angiotensin II, from binding to a receptor and causing arteries to tighten and narrow, an action that can cause high blood pressure. The fixed combination product Co-Diovan, which includes the diuretic hydrochlorothiazide, provides additional efficacy for patients who require a greater reduction in blood pressure than can be achieved with either agent alone. Diovan is the only agent in its class worldwide indicated to treat high blood pressure, high-risk heart attack survivors (VALIANT trial) and patients with heart failure (Val-HeFT trial). In the US, Diovan is approved for the treatment of hypertension, heart failure and in patients following a heart attack. First launched in 1996, Diovan is available in more than 80 countries worldwide for the treatment of heart failure, in more than 70 countries for the treatment of patients following a heart attack, and in over 100 for the treatment of hypertension.

    Lescol/Lescol XL (fluvastatin sodium) is a statin (lipid-lowering agent) approved as an adjunct to diet for reducing elevated total cholesterol levels (hyperlipidemia) as well as to treat abnormal cholesterol levels (dyslipidemia) and to slow progression of hardening of the arteries (atherosclerosis) in patients with coronary heart disease. It is also indicated for secondary prevention of major adverse cardiac events (cardiac death, non-fatal myocardial infarction and coronary revascularization) in patients with coronary heart disease after coronary transcatheter therapy. Lescol XL is an extended-release formulation launched in 2000 to allow for once-daily dosing. Lescol was first launched in the UK in 1993.

    Lotensin/Cibacen (benazepril) is an ACE inhibitor used to treat high blood pressure that was first launched in 1989 as Cibacen in some areas of the world and then in 1991 in the US as Lotensin. In addition, in certain countries this medicine is approved for use as an adjunct therapy in heart failure and for the treatment of chronic renal insufficiency, a kidney disorder. A fixed-combination product called Lotensin HCT/Cibadrex has been developed as a second-line high blood pressure therapy that combines benazepril hydrochloride with hydrochlorothiazide, a widely-used diuretic. In January 2005, the Swedish specialty medicines company Meda acquired the rights to Cibacen and Cibadrex in most European markets for a cash payment of $135 million.

36


    Lotrel (benazepril and amlodipine) is a fixed combination anti-hypertensive treatment consisting of the ACE inhibitor benazepril used in Lotensin/Cibacen and the leading calcium channel blocker amlodipine. Launched in 1996 and only available in the US, Lotrel has been ranked by IMS Health as the leading prescribed branded combination anti-hypertensive therapy in the US since 2002.

    Starlix (nateglinide) is an oral blood-glucose lowering agent for use in patients with type 2 diabetes. The drug helps to control blood glucose levels at mealtime through a rapid onset of action for a short duration. Launched in both the US and EU in 2001, it is approved in the EU for use in combination therapy with metformin, another type of oral anti-diabetic agent. In the US, Starlix is approved as a monotherapy in patients initiating drug treatment and in combination with the oral anti-diabetic agents metformin or thiazolidinediones.

    New Indications in Development

    Diovan (valsartan) is in further development for prevention of new-onset type 2 diabetes and cardiovascular disease in patients with impaired glucose tolerance (IGT). In the NAVIGATOR study (Nateglinide and Valsartan in Impaired Glucose Tolerance and Outcomes Research), Diovan is being investigated in a factorial design including the oral sensitizer Starlix (nateglinide). At its conclusion, the trial will demonstrate whether Diovan or Starlix can prevent people with IGT from progressing to clinical diabetes and, in particular, whether treatment can reduce the incidence of cardiovascular disease in these patients. Results are expected in 2009.

    Starlix (nateglinide) is currently being investigated in combination with Diovan as part of the NAVIGATOR trial.

    Lotrel (amlodipine besylate and benazepril hydrochloride) has two new dosages being developed for hypertension (Lotrel 5-40 and Lotrel 10-40). We received an "approvable" letter from the FDA for these new dosages, requesting additional data before the dosages can be approved. Additional data was filed with the FDA in November 2005. In addition, more than 12,000 patients are being treated with Lotrel or with a combination of benazepril hydrochloride and the diuretic hydrochlorothiazide in the ACCOMPLISH trial that began in October 2003 to investigate cardiovascular morbidity and mortality in patients with high-risk hypertension.

    Compounds in Development

    Galvus (vildagliptin, formerly LAF237; trade name pending regulatory approval) is an oral dipeptidyl peptidase 4 (DPP-4) inhibitor in Phase III development for the treatment of type 2 diabetes. Unlike other therapies, the mechanism of action of Galvus addresses pancreatic islet dysfunction, a key underlying cause of type 2 diabetes, by inhibiting the degradation of two hormones (glucagon like peptide-1 and gastric inhibitory peptide). New data has confirmed that Galvus reduces HbA1c levels (longer-term measure of average blood sugar levels) in a dose-proportional, clinically meaningful manner, both as a monotherapy and in combination with other anti-diabetic agents. It has demonstrated an additive effect in reducing HbA1c levels in combination trials with metformin and with a sulfonylurea. Galvus, which has showed good tolerability without causing weight gain or edema, has been able to sustain meaningful HbA1c reductions out to one year of treatment. Due to its novel effects on pancreatic islet dysfunction, Galvus could become a significant new treatment for type 2 diabetes. US and EU submissions are planned for 2006.

    Rasilez (aliskiren, formerly SPP100; trade name pending regulatory approval) is the first in a new class of hypertensive agents called renin inhibitors that offers a once-daily treatment with efficacy and safety comparable to angiotensin-receptor blockers (ARBs), another class of high blood pressure treatments. Phase III data has confirmed the efficacy and safety of Rasilez as a once-daily oral treatment with double-digit reductions in blood pressure combined with 24-hour blood pressure control. Rasilez is being developed as a monotherapy and in combination with other

37


      anti-hypertensive agents. Rasilez has shown additional blood pressure lowering effects when combined with hydrochlorothiazide (diuretic), ramipril (ACE inhibitor) or amlodipine (calcium channel blocker). Licensed from Speedel, Rasilez also has the potential to offer improved end-organ protection due to its inhibition of plasma renin activity, an emerging risk factor for cardiovascular disease, and an extensive profiling program is underway. Submissions for US and EU approval are planned for 2006.

    Exforge (amlodipine and valsartan fixed combination; trade name pending regulatory approval) is currently in Phase III development after a successful clinical program involving more than 5,000 patients. Results confirmed the efficacy and safety of Exforge as a once-daily oral treatment with double-digit reductions in blood pressure. In addition, less edema (swelling due to excess fluid, a common side effect of amlodipine) was observed with the combination product compared to amlodipine alone. We plan to submit Exforge to regulatory authorities in 2006. Its approval would mark the first fixed-dose combination of the two most prescribed anti-hypertensives in the marketplace, bringing together all the benefits of these two class-leading agents in one tablet.

    LBM642 is a preoxisome proliferator-activated receptor (PPAR) alpha and gamma dual agonist in Phase II development for the treatment of abnormal cholesterol (dyslipidemia), diabetes and obesity. Triglyceride-lowering effects have been demonstrated in a Phase I trial.

    APP018 is a novel ApoA1 mimetic in Phase I trials for the treatment of atherosclerosis. It was in-licensed from Bruin Pharmaceuticals in October 2004.

    VNP489 is the combination of a novel neutral endopeptidase inhibitor and valsartan, now in Phase I trials for the treatment of hypertension.

    FAD286 and NKS104 have been terminated.

Oncology & Hematology

        Novartis Oncology provides a range of innovative therapies and practical solutions for cancer patients. We market products for the treatment of a number of different cancers and for cancer complications, including advanced malignancies involving bone. Research and development in this disease area is aimed at the discovery and development of innovative approaches to the treatment of cancer.

        Novartis ranks No. 3 worldwide in the global oncology market with a 9.7% market share as of May 2005, according to IMS Health.

        Key products include Gleevec/Glivec, to treat certain forms of life-threatening gastrointestinal stromal tumors (GIST) and chronic myeloid leukemia (CML); Femara, a leading treatment in certain types of breast cancer; and Zometa, a treatment for certain cancers that have spread to the bones. Exjade (deferasirox) received its first approvals in 2005 as an oral treatment for use in patients suffering from chronic iron overload. Important compounds in development include AMN107, a signal transduction inhibitor that is the most selective BCR-ABL inhibitor studied to date and more potent than Gleevec/Glivec; the tubulin polymerizing compound EPO906, which has shown more potency than paclitaxel and more activity in paclitaxel-resistant tumors in pre-clinical trials; and RAD001, a compound that inhibits tumor cell growth and formation of new blood vessels that could potentially be used in combination with other therapies, such as hormonal agents, targeted therapies and cytotoxic drugs.

    Key Marketed Products

    Exjade (deferasirox) is an oral iron chelator that was first approved in the US and Switzerland in November 2005 and is awaiting approval in a number of other countries. It is approved for the treatment of chronic iron overload due to blood transfusions (transfusional haemosiderose) in adults and pediatric patients age two and older. Iron accumulation resulting from repeated blood transfusions can lead to organ damage and death if not properly chelated. Patients with congenital and acquired chronic anemias such as thalassemias, sickle cell disease, and myelodysplastic

38


      syndromes require frequent transfusion as support for their anemia. Exjade has been shown in clinical trials to effectively induce iron removal and represents the first significant breakthrough therapy for this condition in more than 40 years, possibly offering a replacement therapy for patients taking Desferal who currently undergo cumbersome 12-hour infusions for five to seven days per week.

    Femara (letrozole) is a leading once-daily oral aromatase inhibitor for the treatment of certain forms of breast cancer. It works by inhibiting the synthesis of estrogen, a hormone that promotes the growth of some breast cancers. Femara was first launched in 1996 and has since received approval for a number of indications, most recently at the end of 2005 in the US for use in the adjuvant (post surgery) treatment of early breast cancer in post-menopausal women. Femara also received US approval in October 2004 as an extended adjuvant therapy treatment for early breast cancer in post-menopausal women who have received adjuvant tamoxifen therapy for five years. Use in this setting has also been approved in the EU, Switzerland, the UK, Mexico and other countries. Data from the landmark MA-17 study presented at the American Society of Clinical Oncology was the basis for this indication. It is also approved as first-line treatment for post-menopausal women with hormone receptor positive or hormone receptor unknown locally advanced or metastatic breast cancer treatment of advanced breast cancer in post-menopausal women with disease progression following anti-estrogen therapy, and neo-adjuvant (pre-operative) therapy. Femara is currently available in more than 90 countries worldwide, and has been approved for the treatment of post-menopausal women with breast cancer in Japan.

    Gleevec/Glivec (imatinib mesylate/imatinib) is a signal transduction inhibitor approved to treat certain forms of leukemia and gastrointestinal stromal tumors. First launched in 2001 and now available in more than 80 countries, it is one of the first oncology drugs that validates rational drug design based on an understanding of how some cancer cells work. A signal transduction inhibitor interferes with the pathways that stimulate the growth of tumor cells. In the US, Gleevec (known outside the US as Glivec) is indicated for the treatment of newly diagnosed adult and pediatric patients with a form of chronic myeloid leukemia (CML). This condition is a rare form of cancer but one of the most common adult leukemias, and it usually tests positive for the presence of the Philadelphia (Ph) chromosome. Gleevec/Glivec is also indicated for the treatment of patients with certain forms of gastrointestinal stromal tumors (GIST). In 2005, Gleevec/Glivec received EU approval for increasing the average daily dose to 800 mg from 400 mg or 600 mg in newly-diagnosed patients with chronic-phase CML and GIST who are not responding to the lower average doses. The Glivec International Patient Assistance Program (GIPAP) is now available in 76 countries and has provided treatment at no charge to more than 12,000 patients worldwide who otherwise would not have access to this innovative therapy.

    Sandostatin SC/Sandostatin LAR (octreotide acetate) is primarily used for the treatment of patients with acromegaly, a chronic disease in adults caused by over-secretion of pituitary growth hormone. Complications associated with acromegaly include cardiovascular disease, respiratory distress such as upper airways obstruction and malignancies such as colon cancer as well as carbohydrate intolerance, which can lead to diabetes. Sandostatin is a synthetic protein that mimics the action of somatostatin, a naturally occurring hormone. This product is also indicated for the treatment of certain symptoms associated with carcinoid tumors and other types of gastrointestinal neuroendocrine and pancreatic tumors. Sandostatin SC faces generic competition in the US. However, patent protection for Sandostatin LAR, which represents a significant and growing proportion of our octreotide sales, continues in major markets. See "—Intellectual Property" for further information.

    Zometa (zoledronic acid) is a treatment for certain cancers that have spread to the bones and is used most often with other cancer treatments, such as radiation, hormonal therapy or chemotherapy. Zometa, a third-generation bisphosphonate, is approved in most key markets for the treatment of hypercalcemia of malignancy, which means tumor-induced excessive levels of calcium, as well as the treatment of skeletal-related events in patients with cancer types such as

39


      prostate, breast, lung and multiple myeloma that have spread to involve bone. In 2005, we distributed a letter to over 100,000 dentists describing changes to the label for Zometa and Aredia, another intravenous bisphosphonate used to treat metastatic bone disease, relating to osteonecrosis of the jaw.

    New Indications in Development

    Femara (letrozole) is pending approval in the EU and Switzerland for use in the early adjuvant treatment setting based on the interim results of the BIG 1-98 trial, which were published for the first time in the December 29, 2005 issue of The New England Journal of Medicine. The Phase III study involves nearly 8,000 post-menopausal women with early breast cancer and will compare the utility of four different treatment paradigms of Femara compared to the anti-estrogen agent tamoxifen. This trial is ongoing with data from the sequential arms of the study expected in 2008.

    Exjade (deferasirox) is an oral iron chelator that was first approved in the US and Switzerland in November 2005. Approval is pending in a number of other countries, including member countries in the EU; and in Canada, New Zealand and Australia, in which the application for Exjade has received priority review. In addition, Exjade has received Orphan Drug status in many countries. The Exjade filings were based on the results of a clinical trials program that included a Phase III trial which showed that after one year Exjade produced reductions in liver iron concentration (LIC).

    Zometa (zoledronic acid) was filed in Japan for the treatment of bone metastases.

    Gleevec/Glivec (imatinib mesylate/imatinib) is being studied as a potential treatment of solid tumors primarily as part of a combination therapy. Regulatory submissions have been filed in the US, EU and Japan for Gleevec/Glivec as a treatment for Ph+ acute lymphoblastic leukemia (ALL) and other rare diseases: dermato-fibrosarcoma protuberans (malignancy of the skin) and myeloproliferative disorders (a group of conditions that cause an overproduction of blood cells in the bone marrow). A registration program in glioblastoma multiforme, the most common and aggressive of the primary brain tumors, has been initiated. Preclinical data have shown that Gleevec/Glivec enhances the effect of chemotherapy in animal models. Phase III trials are in progress in glioblastoma multiforme and Phase II trials are in progress in the following cancers: hormone-refractory prostate cancer, KIT-positive acute myeloid leukemia (AML) and as an adjuvant use in treating refractory gastrointestinal stromal tumors (GIST).

    Compounds in Development

    PTK787 (vatalanib) is a new molecular entity called an angiogenesis inhibitor that blocks all known vascular endothelial growth factors (VEGF). Two Phase III studies—CONFIRM 1 and CONFIRM 2—are evaluating this compound in patients with colorectal cancer compared to and in combination with the FOLFOX4 chemotherapy regimen, which is the combination of oxaliplatin, fluorouracil and leucovorin. First results from PTK/ZK CONFIRM 1 trial presented at the American Society of Clinical Oncology showed positive drug effects in advanced colorectal cancer. Central review assessment of primary endpoint of progression free survival showed a 12% reduction in risk that did not achieve statistical significance. A pre-planned analysis of the same endpoint, as assessed by investigators, demonstrated a significant 17% reduction in risk of disease progression. Results of a planned interim analysis of CONFIRM 2 trial of PTK/ZK indicated a low probability of demonstrating overall survival benefit in second-line therapy for metastatic colorectal cancer. Based on these results, the filing strategy in metastatic colorectal cancer is being re-evaluated based on analysis of data. The CONFIRM 1 trial in first-line metastatic colorectal cancer is ongoing, with overall survival results expected in second half of 2006. This compound is being developed in collaboration with, and, if approved, will be marketed jointly with Schering AG of Germany.

40


    EPO906 (patupilone), a cytotoxic, is a novel tubulin polymerizing compound known as an epothilone that inhibits cancer cells with a similar mechanism to paclitaxel, a taxane that is a member of one of the most successful classes of anti-cancer treatments. EPO906 has shown more potency than paclitaxel and good activity in paclitaxel-resistant tumors in pre-clinical trials. Responses have been observed in Phase II in several solid tumors. This compound entered Phase III studies in ovarian cancer in 2005.

    AMN107 (nilotinib) is a signal transduction inhibitor with high affinity and specificity to attach itself to Bcr-Abl. AMN107 has been shown in preclinical studies to be the most selective Bcr-Abl inhibitor to date and more potent than Gleevec/Glivec. Phase I data showed hematological responses in Gleevec/Glivec resistant patients ranging from 42% (advanced disease—myeloid blast crisis) to 92% (chronic phase). A pivotal Phase II study began in April 2005. The study evaluates AMN107 in Ph+ CML patients in blast crisis, accelerated or chronic phase who are intolerant to Gleevec/Glivec, or who do not respond or stop responding to Gleevec/Glivec and have no treatment options available. The compound is planned to be submitted for regulatory approval in 2007.

    RAD001 (everolimus) is an mTOR pathway inhibitor in Phase II development for the treatment of solid tumors. RAD001 is orally bioavailable and it acts by directly inhibiting tumor cell growth and by inhibiting the formation of new blood vessels (angiogenesis). Preclinical data suggest that it may be most attractive for use in combination with other therapies, such as hormonal agents, targeted therapies, and cytotoxic drugs. Clinical responses have been observed in several tumor types with RAD001 alone or in combination with other therapies. Phase I/II studies are currently ongoing examining both single agent and combination activity in a variety of cancers.

    SOM230 is a somatostatin analog in Phase II development for the treatment of acromegaly; Cushing's syndrome, a rare disorder in which body tissue is exposed to excess levels of the stress hormone cortisol; and gastro-entero-pancreatic (GEP) tumors.

    LBQ707 (gimatecan) is a cytotoxic in Phase II development for the treatment of solid tumors. This compound, which has been in-licensed from Sigma-Tau, is a novel oral topoisomerase I inhibitor. Preclinical data have shown greater potency than topotecan or irinotecan as well as activity in cell lines resistant to these two anti-cancer agents. Confirmed partial responses have been seen in Phase I studies in non-small cell lung cancer, breast cancer and colorectal cancer. An improved formulation is expected to enter the clinic in early 2006 with subsequent Phase I and II studies.

    PKC412 (midostaurin) is a protein kinase inhibitor (FLT3 inhibitor) in Phase II development for the treatment of acute myeloid leukemia (AML). Studies are investigating PKC412 in combination with chemotherapy to determine if responses of longer duration can be achieved.

    LBH589 is a histone deacetylase inhibitor in Phase I development for the treatment of hematological and solid tumors.

    AEE788 is a tyrosine kinase protein inhibitor that targets EGFR, HER2 and VEGFR2 that is in Phase I development for the treatment of solid tumors.

    ABJ879 is a microtubule stabilizer in Phase I development for the treatment of solid tumors.

    OctreoTher is being evaluated as an outlicense candidate.

Neuroscience

        Novartis has been a leader in the neuroscience area for more than 50 years, having pioneered early breakthrough treatments for a series of disorders that include Alzheimer's disease, Parkinson's disease, attention deficit/hyperactivity disorder, epilepsy, depression, schizophrenia and migraine.

        Among our leading products are the anti-epileptic Trileptal, which since its first approval in 1990 is widely used to treat adults and children suffering from epilepsy, and Exelon, which was first approved in 1997 and is now available for the treatment of mild to moderate Alzheimer's disease in more than

41



70 countries. Another growth driver is Stalevo, an optimized levodopa product for the treatment of Parkinson's disease that has been successfully launched worldwide.

        Novartis continues to be active in the research and development of new compounds and is committed to addressing unmet medical needs as well as supporting patients and their families affected by these disorders. A key project in development is FTY720 (fingolimod), which is planned to start Phase III trials in early 2006 and has the potential to become the first orally efficacious treatment of multiple sclerosis. Ongoing research to extend the current product portfolio in Neuroscience includes projects in psychiatric diseases (bipolar disorder, psychosis, depression and anxiety), neurological disorders (Alzheimer's disease, multiple sclerosis, amyotrophic lateral sclerosis) and chronic pain.

    Key Marketed Products

    Clozaril/Leponex (clozapine) remains a leading anti-psychotic for treatment-resistant schizophrenia. First launched in the 1970s and facing generic competition in the US and many other markets, this product is also indicated for the prevention of suicidal behavior in patients with schizophrenia or schizo-affective disorder.

    Comtan (entacapone) treats Parkinson's disease by enhancing the action of levodopa, the standard therapy for Parkinson's disease. The compound is licensed from Orion Pharma, which retains exclusive rights to market Comtan under a different brand name in certain European countries.

    Exelon (rivastigmine tartrate) is a symptomatic treatment of mild to moderate Alzheimer's disease dementia. It belongs to a class of drugs known as cholinesterase inhibitors (ChEI's) that increase neurotransmitter activity in the brain. First approved for the treatment of Alzheimer's disease in 1997, Exelon is currently used in over 70 countries with over three million patient years of treatment.

    Focalin/Focalin XR (dexmethylphenidate HCl) is the single isomer version of methylphenidate, the active ingredient in Ritalin, and is approved in the US for the treatment of attention deficit hyperactivity disorder (ADHD). Focalin XR, a long-acting formulation, was approved in the US in 2005 for the treatment of pediatric and adult ADHD. This compound is licensed from Celgene Corporation, while Focalin XR uses SODAS™ technology, a proprietary drug delivery technology under license from Elan.

    Ritalin LA (methylphenidate hydrochloride) is a once-daily formulation of Ritalin launched in 2002 for the treatment of ADHD in both children and adults. This product, which removes the need for a midday dose, has been approved in a number of countries, including the US, EU and countries in Latin America. Ritalin LA uses SODAS™ technology, a proprietary drug delivery technology under license from Elan.

    Stalevo (carbidopa, levodopa and entacapone) is an optimized levodopa product indicated for the treatment of Parkinson's disease patients with signs and symptoms of end-of-dose "wearing off." This product combines levodopa, considered the most effective treatment for Parkinson's disease, with the enzyme inhibitors carbidopa and entacapone. It has been shown to significantly improve the ability of patients with Parkinson's disease to perform everyday tasks and to reduce symptoms associated with the disease. Licensed from Orion Pharma, Stalevo was first launched in the US in 2003 and is now available in many countries in Europe, Latin America and Asia-Pacific. Orion retains exclusive rights to this product in certain Scandinavian countries, Germany, the UK and Ireland.

    Tegretol XR/CR (carbamazepine) is the long-acting formulation of Tegretol, which has long been a mainstay for the treatment of epileptic seizures and has faced generic competition for some time. First launched in 1996, Tegretol XR/CR is also indicated in the US for the treatment of pain associated with trigeminal neuralgia, which is characterized by attacks of intense pain affecting the face, as well as for the treatment of acute mania and bipolar affective disorders in the EU.

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    Trileptal (oxcarbazepine) is an anti-epileptic drug for the treatment of partial seizures as adjunctive or monotherapy in both adults and children over age four. In the US, Trileptal has also been approved for adjunctive therapy for children over age two. Trileptal acts by stabilizing neuronal functions, thereby controlling and limiting the spread of seizures. It was first approved in Denmark in 1990, in the rest of Europe in 1999 and the US in 2000.

    New Indications in Development

    Comtan (entacapone) was filed in Japan for the treatment of Parkinson's disease.

    Exelon (rivastigmine tartrate) has been submitted in the EU and US for the treatment of dementia associated with Parkinson's disease. In January 2006, Switzerland approved Exelon as the first treatment for dementia associated with Parkinson's Disease, and the EU's Committee for Medicinal Products for Human Use (CHMP) recommended that the EU grant a marketing authorization for Exelon for the treatment of mild to moderately severe dementia associated with Parkinson's Disease later this year. In addition, a transdermal formulation called Exelon TDS (rivastigmine) is in Phase III development for dementia and aims to increase patient convenience and compliance due to improved tolerability of the therapy.

    Compounds in Development

    LIC477 (licarbazepine) is a sodium channel blocker. Phase III trials were initiated in 2004 for the treatment of acute manic episodes in bipolar disorders.

    FTY720 (fingolimod), an oral immunomodulator with a novel mechanism of action, has the potential to become the first efficacious oral therapy for multiple sclerosis (MS), a condition estimated to affect more than one million people worldwide. Data from a Phase II study showed a significant reduction in the relapse rate and in the number of brain lesions detected by MRI scan as well as a longer time to first relapse, both at a six-month analysis and after 12 months of treatment. Phase III studies are starting in early 2006. FTY720 was in-licensed from Mitsubishi.

    SAB378 is a cannabinoid-(CB)-1 receptor agonist in Phase II development for the treatment of chronic pain.

    XBD173 is a mitochondrial benzodiazepine ligand in Phase II trials for the treatment of anxiety. A Phase II safety trial was initiated in March 2005 in patients with Generalized Anxiety Disorder. Data from this study are expected in the second half of 2006.

    AFQ056 is a novel mGlu5 Receptor Antagonist in Phase I development for anxiety.

    SAD448 is a novel cannabinoid receptor agonist in Phase I development for chronic pain.

    CAD106 is a novel beta-amyloid vaccine in Phase I trials for the treatment of Alzheimer's disease.

    RAD001 (everolimus) is in Phase I development for the treatment of tuberous sclerosis.

    AEP924, AMP397 and the Trileptal development program for neuropathic pain have been terminated.

Respiratory & Dermatology

        Novartis is developing a number of important new medicines in the respiratory field, led by Xolair, a novel biological therapy that targets an underlying cause of allergic asthma and has been approved in Europe and the US. Our leading development compound is QAB149 (indacaterol), a long-acting beta-2 agonist that has completed Phase II development and provides the cornerstone for an ambitious program to develop a range of once-daily inhaled therapies for asthma and chronic obstructive pulmonary disease (COPD). We are also continuing to commercialize the long-acting bronchodilator Foradil for the treatment of asthma and COPD.

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        Our focus in dermatology is on the treatment of two very common diseases—the inflamed skin condition known as atopic dermatitis, or eczema, and fungal nail infections. Novartis offers a series of leading medicines for these conditions. Elidel is the first and only non-steroid cream for eczema, a disease that affects about 10% of children in the US, while Lamisil tablets are the most frequently prescribed treatment worldwide for fungal nail infection.

    Key Marketed Products

    Elidel (pimecrolimus) was the first non-steroid cream approved for the treatment of atopic dermatitis, a skin condition commonly known as eczema, in adults and children. It is one of the first new eczema treatments introduced since the 1950s, when topical corticosteroids—historically the mainstay of therapy—became available. First launched in 2002 in the US, Elidel is now registered in approximately 90 countries, including many EU markets. Following discussions with the FDA, prescribing information for Elidel (dispensed only as a topical cream) will be updated in early 2006. A boxed warning and medication guide make clear that no causal link has been established between the use of Elidel and rare post-marketing reports of malignancy. The concern of the FDA for a potential risk for malignancies exists based on the use of oral calcineurin inhibitors at high doses. A similar change in labeling will be made for other products in this class. While we believe this action in not substantiated by scientific or clinical evidence, we have agreed to make the requested changes and will communicate them to physicians and patients so that they can continue to use Elidel as labeled to effectively manage eczema. We are confident in the safety and efficacy of Elidel, which is one of the most thoroughly researched dermatology products in the world and continues to be supported with significant ongoing clinical trials.

    Foradil (formoterol fumarate) is a long-acting bronchodilator that offers onset of action within five minutes and 12 hour relief of symptoms for patients with asthma and COPD, which includes chronic bronchitis and emphysema. It was first approved and launched in Switzerland in 1994, followed by other key European markets in 1997. US approval was granted in 2001, and in 2002 we licensed Foradil to Schering-Plough in the US. We continue to market and distribute the product in other areas of the world. Foradil Aerolizer is a single-dose dry powder inhaler, while a metered-dose inhaler is available in some countries. This product is licensed from Yamanouchi.

    Lamisil (terbinafine) is a leading therapy for onychomycosis, also known as fungal nail infection. Lamisil tablets kill the fungus that causes the infection at its source, working through the patient's bloodstream. This product was first launched in 1991 and is now available in more than 90 countries, with the US the leading market. Lamisil tablets are also approved for treating athlete's foot (tinea pedis) and fungal infection of the scalp (tinea capitis) in some countries, though not yet in the US. Our Consumer Health Division's OTC Business Unit markets over-the-counter cream formulations of Lamisil for use in treating athlete's foot in many markets, including the US. Generic forms of terbinafine were launched in a number of European markets in 2005, with generic competition expected in the US in 2007 following the expiry of patent protection.

    Xolair (omalizumab) is the first humanized therapeutic antibody for the treatment of allergic asthma and the first approved therapy designed to target the antibody IgE, a key underlying cause of the symptoms of allergic asthma. Xolair is the only asthma treatment dosed every two or four weeks and is administered by subcutaneous injection. In the US, EU and Canada, Xolair is indicated for use in adults and children over age 12 with moderate-to-severe allergic asthma whose symptoms are inadequately controlled with inhaled corticosteroids. Xolair gained US and Australian regulatory approval in 2003, while EU approval was given in October 2005 for treating adults and adolescents with severe persistent allergic asthma that is inadequately controlled by current medication. This product is being jointly developed with Genentech and Tanox, and is co-marketed by Novartis in the US with Genentech.

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    New Indications in Development

    Foradil (formoterol) has received an "approvable letter" in the US for the Certihaler formulation. The Certihaler is a novel, breath-activated multi-dose dry powder inhaler technology developed by SkyePharma, which has a dose counter which is easy to read and also gives patients confirmation that the full dose has been administered. Novartis licensed the exclusive US distribution and marketing rights for this product to Schering-Plough. Product registration files for the ForadilCertihaler have also been submitted in Europe and the rest of the world, and regulatory approvals have been received in 18 countries. Certihaler was launched in Germany and Switzerland in September 2005. This replaces a prior agreement with Ivax to market Foradil with Ivax's Airmax[nc_cad,176] device, which has been discontinued. In 2002, we entered into a co-development and co-commercialization agreement with Schering-Plough to bring to market a fixed-dose combination Foradil product with the inhaled steroid mometasone using a metered dose inhaler. The Phase I/II program for the fixed-dose combination product started in 2005.

    Lamisil (terbinafine) is in Phase III development for ringworm of the scalp (tinea capitis).

    Xolair (omalizumab) is in development for the treatment of patients with peanut allergy. A clinical study of Xolair in patients with peanut allergy was discontinued after pre-study oral food challenges resulted in severe hypersensitivity reactions in two individuals. The decision to discontinue the trial was not related to the safety of Xolair since neither of the patients had yet received Xolair, as they had not yet been enrolled in the study. We are committed to the development of this indication for Xolair, and are evaluating with others a safe path forward for the continuation of the necessary clinical trials. Separately, a liquid formulation of Xolair is also in development to improve patient convenience.

    Compounds in Development

    QAB149 (indacaterol) has the potential to be the first beta-2 agonist that offers true 24-hour control for the treatment of asthma and COPD. This compound, which has completed Phase II, has been shown to have a fast onset of action and proven efficacy for 24 hours with once-daily dosing and a good safety profile. QAB149 is being developed first as a monotherapy for the bronchodilator market. Phase III trials are due to begin in 2006 in both asthma and COPD.

    NVA237 (glycopyrronium bromide) is an inhaled, long-acting muscarinic antagonist with a fast onset of action. It is in Phase II clinical development for the treatment of COPD. Novartis has in-licensed NVA237 from Vectura Group plc and Arakis Ltd.

    ACZ885 is a monoclonal antibody to IL-1 beta in Phase I development for the treatment of COPD.

    ABN912 is a fully human monoclonal antibody to Monocyte Chemoattractant Protein-1 in Phase I development for the treatment of asthma and COPD.

    QAP642 is a novel CCR3 antagonist in Phase I development for the treatment of asthma.

    QAE397 is a novel compound in Phase I development for the treatment of asthma.

    OAT370 is a novel compound in Phase I development for the treatment of COPD.

    ASM981 oral, Elidel ointment, VAG624, QAK423 and QAN747 have been terminated.

Infectious Diseases, Transplantation & Immunology (IDTI)

        Infectious Diseases, Transplantation & Immunology combines the capabilities, expertise and infrastructure of Novartis in transplantation and immunology with the growth potential of our expanding infectious diseases pipeline.

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        The infectious diseases portfolio consists of three main areas: anti-virals, anti-bacterials and tropical medicine. We market Famvir for herpes and Coartem for malaria. Ongoing research and development efforts are focused on new specific anti-virals against Hepatitis B and C. We established Infectious Diseases as a separate franchise following our May 2003 purchase of a majority of the outstanding capital stock of Idenix Pharmaceuticals, Inc. As a result of that transaction, we obtained certain rights to market Idenix products as well as options to license additional Idenix compounds in the future.

        Novartis is a world leader in transplantation and immunology, pioneering and revolutionizing the field of transplantation with the discovery and introduction of cyclosporine more than 20 years ago. We have one of the broadest portfolios of immunosuppressant drugs due to our continued research and strong commitment to provide solutions to unmet medical needs for the transplant recipient. Neoral and Simulect are established products used to protect transplanted organs from rejection. Certican and myfortic, which have now been approved in more than 40 countries, provide additional efficacy and safety benefits to the transplant patient. With a worldwide research program, Transplantation & Immunology is committed to developing a new and innovative range of therapeutic products for the prophylaxis of organ rejection and to maintain our role as a global leader in this field.

    Key Marketed Products

    Certican (everolimus) is a type of immunosuppressant drug called a "proliferation signal inhibitor" (or m-tor inhibitor) that targets the primary causes of allograft dysfunction (also known as chronic rejection) of a transplanted organ, including acute rejection and vascular remodeling. Certican is used in combination with Neoral and corticosteroids. First approved in Europe in 2003, Certican has been launched in over 40 countries, including the majority of the EU members and Switzerland. In the US, the FDA has issued "approvable letters" for Certican. In November 2005, an FDA Advisory Committee recommended that more data be provided to substantiate the safety of Certican with Neoral before US approval can be granted as a prophylaxis against rejection in heart transplant recipients.

    Coartem/Riamet (artemether and lumefantrine) is an effective and well-tolerated anti-malarial treatment for adults and children that achieves cure rates of up to 95%, even in malaria patients living in areas with multi-drug resistance. It is indicated for treatment of falciparum malaria, the most dangerous form of malaria. Coartem is the only fixed-dose combination of the two agents artemether, an artemisinin derivative, and lumefantrine, known as the Artemisinin Combination Therapy (ACT). Coartem, which is marketed commercially as Riamet in some countries, was co-developed by Novartis in collaboration with Chinese partners. The active ingredients (artemether and lumefantrine) are predominantly produced in China by Chinese suppliers and pharmaceutical production is done in China and the US by Novartis. First approved in 1998, Coartem is currently registered in 75 countries. We have provided more than 17 million treatments at cost to public sector agencies of malaria-endemic developing countries as part of the Roll Back Malaria initiative since 2001. The WHO has added Coartem to its List of Essential Medicines, and we have significantly increased production capacity to help meet a significant surge in demand for the ACT therapy.

    Famvir (famciclovir) is an anti-viral agent for the treatment of recurrent genital herpes, a sexually-transmitted, life-long disease, and shingles (herpes zoster), which is caused by the reactivation of the highly contagious variacella-zoster virus, the same virus that causes chickenpox. Other indications include the treatment of recurrent mucocutaneous herpes simplex infections in HIV-infected patients.

    Neoral (cyclosporine, USP modified) is a micro-emulsion formulation of cyclosporine, an immunosuppressant used in both adults and children to prevent organ rejection following a kidney, liver, heart, combined heart-lung, lung or pancreas allogenic transplantation as well as in bone-marrow transplantation. Neoral is one of the world's most commonly used primary immunosuppressants, according to IMS Health, after largely replacing its predecessor Sandimmun/

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      Sandimmune, which was introduced in 1982 and revolutionized organ transplantation. First launched in 1995, Neoral was designed to provide improved and constant absorption of cyclosporine, the active ingredient. It is also indicated for use in treating select autoimmune disorders such as psoriasis, nephrotic syndrome and rheumatoid arthritis. Despite our patent protection for Neoral, generic companies have launched competing products in the US, Europe and elsewhere, and will continue to compete with us vigorously. See "—Intellectual Property" for further information.

    myfortic (mycophenolic acid) is a treatment option approved for use in combination with cyclosporine and corticosteroids to prevent rejection episodes in patients with kidney transplants. Data from PROGIS (Patient Reported Outcomes in renal transplant patients with or without Gastro-Intestinal Symptoms) showed that converting kidney patients who experienced GI problems on MMF to myfortic significantly reduced the patient-reported symptom burden while significantly improving their gastrointestinal and general Health-related Quality of Life. myfortic has been approved in over 50 countries, including Switzerland (the first approval in 2003), the US, Canada, Germany, France, Italy, Spain, the UK, Australia, India, Brazil and a number of Latin American countries.

    Simulect (basiliximab) is a chimeric monoclonal antibody that suppresses interleukin-driven proliferation of T-cells. Simulect is used for induction therapy, and is designed to complement Neoral or other primary immunosuppressants in preventing acute rejection episodes in kidney transplantation.

    Compounds in Development

    LDT600 (telbivudine) and LDC300 (valtorcitabine) are currently in development for the treatment of hepatitis B. We have licensed these compounds from Idenix, a company in which we own a majority of the issued stock. We have the right to co-promote or co-market these compounds with Idenix in the US, the UK, France, Germany, Italy and Spain, and to market these compounds on our own in the rest of the world. LDT600 completed the first year of its pivotal Phase III study showing good efficacy, and meeting the primary endpoint of non-inferiority to lamivudine. The US submission for LDT600 was completed in December 2005 and submissions in the EU and key Asian markets are planned to be completed in the first quarter of 2006. LDC300 is in Phase II clinical trials for hepatitis B. In addition to the license to these hepatitis B compounds, Idenix also granted us an option to license all other compounds developed by Idenix, including Idenix's hepatitis C drug candidate, NMC283, which is currently in Phase II clinical trials.

    RSV604 is a selective inhibitor of viral replication, currently in Phase II studies for the treatment of respiratory syncytial virus infection. RSV604 has been in-licensed from Arrow.

    ANA975 is a novel, oral toll-like receptor 7 agonist now in Phase I studies for the treatment of hepatitis C virus infection. ANA975 has been in-licensed from Anadys.

    AEB071 is an innovative compound in development for the prevention of organ rejection now in Phase I trials.

    NIM811 is a cyclophilin binder inhibiting HVC replication that is in Phase I development for the treatment of chronic hepatitis C.

    SBR759 is a polynuclear iron (III) starch/saccharose complex which binds selectively to phosphate ions through chelation. It is in Phase I development for the treatment of hyperphosphatemia in late- or end-stage renal disease patients. SBR759 was acquired from Sebo GmbH of Germany.

    FTY720 (fingolimod) has been terminated in development for transplantation, but will enter Phase III trials in 2006 for the treatment of multiple sclerosis. It is in-licensed from Mitsubishi.

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Ophthalmics

        We develop and market products for the treatment of a number of different ophthalmic diseases. Our research and development in this disease area is aimed at the discovery and development of innovative treatments for "Back of the Eye" diseases as well as on "Dry Eye" conditions and glaucoma. These areas are characterized by high growth and significant unmet medical needs. The "Back of the Eye" area encompasses several disease areas, such as wet and dry age-related macular degeneration (AMD), diabetic retinopathy, diabetic macular edema and retinitis pigmentosa. The key area of focus within "Back of the Eye" is "wet" AMD, a condition when leaky blood vessels grow across the central portion of the retina, or macula, for unknown reasons and cause bleeding, scar formation and permanent damage, leading to vision loss. Our ophthalmics business has built a leadership position with its flagship product Visudyne. In cooperation with collaborator Genentech, we are also developing Lucentis, a VEGF inhibitor that is currently in Phase III clinical trials for the treatment of "wet" AMD and which will be marketed by Novartis outside of the US and Canada.

    Key Marketed Products

    Visudyne (verteporfin) is a light-activated drug used in a two-step procedure that can be performed in a doctor's office. First, the drug is injected intravenously into the patient's arm. A low-energy laser light is then shone into the patient's eye to activate the drug. First launched in 2000, Visudyne is commercially available in over 75 countries for the treatment of predominantly classic subfoveal choroidal neovascularization (CNV), a major cause of vision loss caused by age-related macular degeneration (AMD). It is also approved in over 40 countries for the treatment of occult subfoveal CNV secondary to AMD (including the EU, where it gained approval in 2002). In addition, Visudyne is approved in over 45 countries, including the EU, US and Canada for the treatment of subfoveal CNV due to pathologic myopia (severe near-sightedness). In Japan, Visudyne is approved for all types of subfoveal CNV secondary to AMD. Further geographic expansion is planned, including China. Visudyne is licensed from QLT.

    Zaditor/Zaditen (ketotifen fumarate) is an eye drop that provides fast and lasting relief of symptoms in patients suffering from ocular allergy. Zaditen works through multiple mechanisms of action to provide relief within minutes and a duration of action of up to 12 hours. Zaditen was first launched in Japan and has been approved in more than 60 countries, including the US, where it is marketed as Zaditor, and the EU.

    New Indications in Development

    Sandostatin LAR (octreotide acetate) is in Phase III development for diabetic retinopathy. This condition affects approximately 25-30% of patients with diabetes and is one of the leading causes of blindness in people of working age. There are currently no pharmacological treatments available to treat diabetic retinopathy.

    Elidel (pimecrolimus), is currently in Phase II development for the treatment of dry eye in a novel drops formulation and for blepharitis in a novel eye ointment formulation.

    Visudyne (verteporfin) is in development for the additional indication of predominantly occult subfoveal choroidal neovascularization (CNV) due to AMD in the US. Preliminary analysis of the intent to treat population of the Visudyne in Occult (VIO) trial demonstrated benefit in these patients, but did not achieve statistical significance at the two-year time point. VIO is part of a broader series of trials conducted with Visudyne in patients with predominantly occult CNV. Further development of this indication is under evaluation.

    Compounds in Development

    Lucentis (ranibizumab) is a recombinant humanized high affinity antibody fragment that binds to VEGF. It is designed to penetrate the retina to decrease permeability and inhibit the formation of

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      choroidal neovascularization, which leads to blindness in AMD patients. The Phase III MARINA and ANCHOR studies demonstrated that Lucentis is highly effective in preventing loss of vision in patients with AMD. In addition, on average, patients' vision actually improved after treatment with Lucentis. Separately, the FOCUS study demonstrated that Lucentis and Visudyne may be usefully combined. Additional data are expected in 2006. US submission was completed in December 2005 by Genentech. Submission for EU approval is planned for early 2006. Lucentis is developed in collaboration with Genentech, which holds the rights to market the product in the US and Canada.

    OPC759 (rebamipide) is a selective mucin secretagogue, currently in Phase III studies for the treatment of dry eye. This compound was in-licensed from Otsuka Pharmaceuticals, Japan.

    PTK787 (vatalanib) is currently in development for the treatment of age-related macular degeneration (all forms of wet AMD) and is in Phase II. We are jointly developing PTK787 with Schering AG for certain oncology indications. We have entered into an agreement with Schering granting us exclusive rights to develop and commercialize PTK787 for the treatment of wet AMD.

    RKI983 is a Rho Kinase inhibitor, currently in Phase I and investigated for topical treatment of glaucoma. This compound was in-licensed from Senju Pharmaceutical Co, Japan, and is under the sub-license rights granted by Mitsubishi Pharma Corporation to Senju.

Arthritis/Bone/Gastrointestinal/Urology (ABGU)

        The primary focus of this therapeutic area is on patients with a variety of internal diseases that have significant unmet medical needs, particularly in the areas of gastrointestinal disorders, urinary incontinence, arthritis, osteoporosis and the treatment of pain.

        We have entered the gastrointestinal market with the launch of Zelnorm/Zelmac for the treatment of irritable bowel syndrome with constipation (IBS-C), a condition where the bowel (large intestine) does not function properly. More than 40 million people in the US are estimated to suffer from IBS-C, and Zelnorm/Zelmac is the first and only medication approved by major health authorities to treat this condition. Zelnorm/Zelmac is also approved for the treatment of chronic idiopathic constipation in the US and several other countries.

        Another important area of focus are bone disorders like osteoporosis, a progressive disease that causes bones to become thin and porous, increasing the risk for fractures. Led by Miacalcin/Miacalcic, Novartis has a number of treatments in development for this disease, which is estimated to affect up to one in three women over age 50 worldwide, according to the International Osteoporosis Foundation. The most advanced compound in development for bone disorders is Aclasta, which was approved in 27 European countries in April 2005 as well as in Canada in June 2005 for the treatment of Paget's disease of the bone, a condition marked by abnormal bone growth. In the US, additional information has been submitted to the FDA in response to an "approvable letter" for this indication issued in March 2005. Aclasta is also being developed for use in treating various forms of osteoporosis. Building on our experience with Voltaren, a leading pain medication in osteoarthritis for over 30 years, we launched the selective COX-2 inhibitor Prexige in Australia, Brazil, New Zealand and the UK in 2005. Launches in other countries where the product is approved are planned for 2006.

    Key Marketed Products

    Aclasta (zoledronic acid 5 mg for infusion) is an intravenous bisphosphonate being developed for the treatment of various metabolic bone diseases including osteoporosis and Paget's disease of the bone. Aclasta was approved in all 27 European countries and in Canada in 2005 for the treatment of Paget's disease. Aclasta was first launched in Germany in May 2005, with additional launches planned for 2006. Given as a single 15-minute infusion, Aclasta was shown in a head-to-head Phase III study published in the New England Journal of Medicine to offer superior efficacy, faster onset of action and a longer period of remission compared to risedronate, the current oral standard treatment in Paget's disease. A decision by the FDA on the US tradename and for the use of

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      zoledronic acid 5 mg for the treatment of Paget's disease of the bone is expected in the first quarter of 2006, after an approvable letter was issued for this indication in March 2005. Zoledronic acid at a different dosing regimen is marketed for oncology indications under the brand name Zometa (zoledronic acid 4 mg for infusion).

    Combipatch/Estalis (estradiol & norethisterone acetate transdermal patch) is a combination estrogen/progestin treatment for symptoms of estrogen deficiency in post-menopausal women, and the prevention of post-menopausal osteoporosis. The product offers a convenient treatment in a single patch for patients with an intact uterus. Combipatch is not approved in the US for the prevention of post-menopausal osteoporosis. This product is sublicensed from Aventis for sale in countries outside the US and Japan under the brand name Estalis. In the US, the product is licensed by Noven Pharmaceuticals to Vivelle Ventures, which is a joint venture between Noven and our US affiliate, for sale under the brand name Combipatch.

    Enablex/Emselex (darifenacin) is a once-daily oral treatment that is part of a new group called M3-selective receptor antagonists for the treatment of overactive bladder. Known as Enablex in the US and Emselex in the EU, this product was approved in the EU in October 2004 and approved in the US in December 2004. It is now available in eight countries: the US (through a co-promotion agreement with Procter & Gamble Pharmaceuticals), Germany (via sole promotion by Bayer) as well as Sweden, Norway, Denmark, Iceland, Slovenia and Switzerland. Enablex/Emselex has been shown to effectively reduce the number of weekly incontinence episodes by up to 77% versus placebo. It was acquired from Pfizer in April 2003.

    Estraderm TTS and Estraderm MX (estradiol transdermal patches) are estrogen-only treatments for symptoms of estrogen deficiency in post-menopausal women as well as for prevention of post-menopausal osteoporosis. These are earlier generations of transdermal patches.

    Estragest TTS (estradiol & norethisterone acetate transdermal patch) is a low-dose combination estrogen/progestin treatment for symptoms of estrogen deficiency in post-menopausal women as well as for prevention of post-menopausal osteoporosis. Estragest TTS offers a high amenorrhea rate in a single patch for patients with an intact uterus. This product is not approved in the US.

    Miacalcin/Miacalcic (salmon calcitonin) is an important treatment for bone metabolic diseases, especially for established post-menopausal osteoporosis in women. Miacalcin/Miacalcic was first launched as an injection in 1974 and as a nasal spray in 1986. It was later launched as an injection in the US in 1989 and then in 1995 in an intra-nasal form. It contains chemically synthesized salmon calcitonin, a thyroid hormone that regulates the calcium content in the blood. Available in the US in both injectable form and as a nasal spray, Miacalcin/Miacalcic is indicated for use in women with low bone mass more than five years after menopause who refuse or cannot tolerate estrogens or in whom estrogens are contraindicated. As injection, it is also indicated for the treatment of symptomatic Paget's disease, a chronic condition that causes the growth of abnormal bone, and for the treatment of hypercalcemia, when a rapid decrease in serum calcium is required. It is also indicated to treat bone pain associated with osteolysis and/or osteopenia, as well as neurodystrophic disorders (synonymous with algodystrophy or Sudeck's disease).

    Prexige (lumiracoxib) is a selective COX-2 inhibitor in development for the treatment of osteoarthritis and acute pain. It has been approved in 24 countries to date. In 2005, Novartis launched Prexige in Brazil (July), New Zealand (October), Australia (November) and the United Kingdom (December). Launches in other countries where the product is approved are planned for 2006.

    Vivelle Dot/Estradot (estradiol transdermal system), licensed from Noven Pharmaceuticals, is an estrogen-only treatment for symptoms of estrogen deficiency in post-menopausal women as well as prevention of post-menopausal osteoporosis. Vivelle Dot/Estradot is the smallest estrogen patch available and offers a thin, flexible and discreet hormone therapy.

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    Voltaren (diclofenac sodium) is a leading non-steroidal anti-inflammatory drug (NSAID) for the treatment of inflammatory and degenerative forms of rheumatism as well as in the treatment of pain and inflammation. This product, which faces generic competition, has a wide variety of ingestible dosage forms marketed by the Pharmaceuticals Division as well as a topical therapy offered as Voltaren Emugel in several markets for the treatment of inflammation of tendons, ligaments, muscles and joints as well as certain localized forms of rheumatism.

    Zelnorm/Zelmac (tegaserod) is the first in a new class of medicines known as serotonin-4 (5-HT4) receptor selective agonists approved for the short-term treatment of the multiple symptoms associated with irritable bowel syndrome with constipation (IBS-C) in women. This product, which is known as Zelnorm in North America and South Africa, and Zelmac in other markets, acts by decreasing the visceral sensitivity of the intestinal tract, increasing intestinal secretion and increasing gastro-intestinal motility. This reduces the impact of symptoms such as abdominal pain, bloating and constipation. In 2004, Zelnorm received US approval to become the first treatment approved for chronic idiopathic constipation in men and women under age 65. First launched in 2002, this product has now been approved in more than 55 countries. Novartis announced in December 2005 that it will appeal an opinion from a European Medicines Agency (EMEA) committee recommending against European approval of Zelnorm for the treatment of women with IBS-C.

    New Indications in Development

    Aclasta (zoledronic acid 5 mg) is a bisphosphonate being developed for the treatment of various metabolic bone diseases, including osteoporosis and Paget's disease. Aclasta was approved in the EU and Canada and is under review in the US for the treatment of Paget's disease of the bone. Phase III trials in osteoporosis (including treatment and prevention of post-menopausal osteoporosis, male osteoporosis, corticosteroid-induced osteoporosis, and prevention of recurrent clinical fracture after acute hip fracture) are currently in progress. Submissions as a once-yearly treatment for osteoporosis are expected in the US and EU in 2007.

    Zelnorm/Zelmac (tegaserod maleate/tegaserod) has been submitted for EU approval for the treatment of irritable bowel syndrome with constipation in women. Novartis will appeal against the negative opinion of the EMEA. In addition, Zelnorm/Zelmac is under development for the treatment of severe stomach discomfort (dyspepsia), which is in Phase III.

    Prexige (lumiracoxib) is a selective COX-2 inhibitor developed for the treatment of osteoarthritis and acute pain. To date, Prexige has been approved in 24 countries. In 2005, Prexige was launched in Australia, Brazil, New Zealand and the United Kingdom. Launches in other countries where the product is approved are planned for 2006. In Europe, a review by the EMEA confirmed a positive benefit/risk ratio for selective COX-2 inhibitors, and the CHMP has confirmed that no additional Prexige cardiovascular safety studies are required for registration. EU re-submission is planned for early 2006. In the US, Prexige received a non-approvable letter in September 2003. The FDA requested the TARGET study as well as additional clinical data for the OA and acute pain indications. In TARGET, when compared with both naproxen (500 mg twice daily) and ibuprofen (800 mg three times daily), Prexige was shown to have superior gastrointestinal safety, a significantly smaller impact on blood pressure, and no significant difference in cardiovascular events, such as heart attack or stroke. The FDA has confirmed that no additional cardiovascular safety data are required before the re-submission, and that it can proceed once data are available from the ongoing studies in hip OA and in effectiveness after 12-months dosing. Re-submission for US approval is planned for 2007 and will include an alternative tradename for FDA approval. Prexige is also being developed as new formulations (oral suspension, parenteral), which are currently in Phase I development.

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    Compounds in Development

    SMC021 (calcitonin) is an oral formulation of salmon calcitonin, the active ingredient in Miacalic/Miacalcin, used in the treatment of osteoporosis. This product, a novel concept in oral peptide delivery, is currently in Phase II development for the treatment of osteoporosis and in Phase I development for osteoarthritis.

    AAE581 is a specific inhibitor of osteoclast-derived cathepsin K currently in Phase II.

    AIN457 is a novel compound currently in Phase I for the treatment of rheumatoid arthritis.

    ACZ885 is a human monoclonal antibody directed against human IL-1-beta that is in Phase I development for the treatment of rheumatoid arthritis.

    Zelnorm for GERD, AKU517, AFG495, and LBM415 have been terminated.

Principal Markets

        The Pharmaceuticals Division has a commercial presence in approximately 140 countries worldwide, but net sales are generally concentrated in the US, Europe and Japan, which together accounted for 85% of 2005 net sales. The following table sets forth certain data relating to our principal markets in the Pharmaceuticals Division.

Pharmaceuticals

  Net Sales 2005
 
  ($ millions)

  (%)

United States   8,085   40
Americas (except the United States)   1,490   7
Europe   6,820   34
Japan   2,212   11
Rest of the World   1,655   8
   
 
Total   20,262   100
   
 

        Many of our Pharmaceuticals Division's products are used for chronic conditions that require patients to consume the product over long periods of time, from months to years. Net sales of the vast majority of our products are not subject to material changes in seasonal demand.

Production

        The primary goal of our manufacturing and supply chain management program is ensuring the uninterrupted, timely and cost-effective supply of products that meet all product specifications. To achieve this objective, we manufacture our products at five bulk chemical and 15 pharmaceutical production facilities as well as two biotechnology sites. Bulk chemical production involves the manufacture of therapeutically active compounds, mainly by chemical synthesis or by a biological process such as fermentation. Pharmaceutical production involves the manufacture of "galenical" forms of pharmaceutical products such as tablets, capsules, liquids, ampoules, vials and creams. Major bulk chemical sites are located in Basel, Switzerland; Grimsby, UK; and Ringaskiddy, Ireland. Significant pharmaceutical production facilities are located in Stein, Switzerland; Wehr, Germany; Torre, Italy; Barbera, Spain; Suffern, New York; Sasayama, Japan, Taboão da Serra, Brazil, and in various other locations in Europe, including France, the UK and Turkey. Our two biotechnology plants are in Switzerland and France.

        During clinical trials, which can last several years, the manufacturing process for a particular product is rationalized and refined. By the time clinical trials are completed and products are launched, the manufacturing processes have been extensively tested and are considered stable. However, improvements to these manufacturing processes may continue throughout a product's life cycle.

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        While we have not experienced material supply interruptions in the past, there can be no assurance that supply will not be interrupted in the future as a result of unforeseen circumstances. The manufacture of our products is heavily regulated, making supply never an absolute certainty. If we or our third party suppliers fail to comply fully with such regulations then there could be a recall or a government-enforced shutdown of production facilities, which in turn could lead to product shortages. We have implemented a global manufacturing strategy to maximize business continuity.

        Raw materials for the manufacturing process are either produced in-house or purchased from a number of third party suppliers. Where possible, our policy is to maintain multiple supply sources so that the business is not dependent on a single or limited number of suppliers. However, our ability to do so may at times be limited by regulatory requirements. We monitor market developments that could have an adverse effect on the supply of essential materials. All raw materials we purchase must comply with our quality standards. Overall, prices are not volatile for materially significant raw materials.

Marketing and Sales

        The Pharmaceuticals Division serves customers with approximately 6,700 field force representatives in the US (including supervisors), and an additional 14,000 in the rest of the world. These trained representatives, where permitted by law, present the economic and therapeutic benefits of our products to physicians, pharmacists, hospitals, insurance groups and managed care organizations.

        Although specific distribution patterns vary by country, Novartis generally sells its prescription drugs primarily to wholesale and retail drug distributors, hospitals, clinics, government agencies and managed care providers.

        In the US, certain products are advertised by way of television, newspaper and magazine advertising. Novartis also pursues co-promotion/co-marketing opportunities as well as licensing and distribution agreements with other companies when economically attractive.

Competition

        The global pharmaceutical market is highly competitive and we compete against other major international corporations with substantial financial and other resources, which sell branded prescription pharmaceutical products. Competition within the industry is intense and extends across a wide range of commercial activities, including pricing, product characteristics, customer service, sales and marketing, and research and development.

        As is the case with other pharmaceutical companies selling patented pharmaceuticals, Novartis faces an increasing challenge from companies selling generic forms of our products following the expiry of patent protection. Generic companies may also gain entry to the market through successfully challenging our patents, but we vigorously defend our intellectual property rights from generic challenges that infringe upon our patents and trademarks. We also face competition from over-the-counter (OTC) products that do not require a prescription from a physician.

        There is no guarantee that any product, even with patent protection, will remain successful if another company develops a new product offering significant improvements over existing therapies.

Research and Development

        We are among the leaders in the pharmaceuticals industry in terms of research and development investment. In 2005, we invested approximately $4.0 billion in Pharmaceuticals Division research and development, which represented 19.6% of the Division's total net sales. Our Pharmaceuticals Division invested $3.5 billion and $3.1 billion on research and development in 2004 and 2003 respectively. There are currently more than 75 projects in clinical development.

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        We have long term research commitments totaling $2.0 billion as of December 31, 2005, including $1.9 billion in milestone payments. We intend to fund these expenditures from internally developed resources.

        The discovery and development of a new drug is a lengthy process, usually requiring 10 to 12 years from the initial research to bringing a drug to market, including six to eight years from Phase I clinical trials to market. At each of these steps, there is a substantial risk that we will not achieve our goals. In such an event, we may be required to abandon a product in which we have made a substantial investment.

Research program

        The discovery of new drugs is the responsibility of our Research program. This is a complex and challenging process which is split into different phases. These phases provide tools that allow our Research team to manage and benchmark their activities. Milestones are established for each phase of the evaluation process. Candidates only advance to the next stage if defined sets of criteria are met. The primary goal of our Research program is to determine that a compound is ready for Proof of Concept in humans. To determine whether a compound may be tested in humans, we must invest significant resources in preclinical activities to satisfy safety requirements, including toxicology studies. Only those compounds that pass this more comprehensive series of preclinical testing (on average, about one in ten candidates) advance to the development stage of a drug's life-cycle. See "—Clinical development program."

        In 2003, we established the Novartis Institutes for BioMedical Research (NIBR), headquartered in Cambridge, Massachusetts, with affiliates worldwide. NIBR is redefining drug discovery in the era which began with the completion of the human genome sequence. Our strategies at NIBR include integrating previously segregated disciplines, fostering interaction among scientists, both within and outside of Novartis and investing and advancing new discovery approaches. Our goal is to produce more relevant, predictable drug discovery and offer new and better medicines for patients worldwide.

        Completed in 2004, our Cambridge facility contains a total of 75,300 square meters of laboratory and office space. The facilities house over 800 scientists and technology experts, and approximately 1,100 employees in total.

        Several of our discovery research platforms, including Functional Genomics, Molecular and Developmental Pathways, Models of Disease, Global Discovery Chemistry, and Epigenetics, are based at our Cambridge headquarters. Disease-area research groups in Cambridge include cardiovascular disease, diabetes and metabolism, infectious disease and oncology.

        Outside of the Cambridge site, an additional 2,000 scientists and technology experts conduct research in Switzerland, Austria, the UK, Japan and various other US sites. Research is conducted in the areas of Neuroscience, Autoimmune Disease (including Dermatology, Transplantation, and Arthritis) and Respiratory Disease at these sites. In addition, research platforms such as Discovery Technologies and Information Knowledge and Management are headquartered in the NIBR site in Basel.

Development program

        The testing of new drugs in humans, to determine whether they are safe and effective, is the focus of our Development program. Clinical trials of drug candidates generally proceed through three phases. In Phase I clinical trials, a drug is usually tested with about 20 to 80 normal, healthy volunteers. The tests study the drug's safety profile, including the safe dosage range. The studies also determine how a drug is absorbed, distributed, metabolized and excreted, and the duration of its action. In Phase II clinical trials, the drug is tested in controlled studies of approximately 100 to 300 volunteer patients (i.e., persons with the targeted disease) to assess the drug's effectiveness and safety, and to establish a proper dose. In Phase III clinical trials, the drug is further tested on larger numbers of volunteer patients (in some cases more than 15,000 patients in total) in clinics and hospitals. In each of these phases, physicians monitor volunteer patients closely to determine the drug's efficacy and to identify possible adverse reactions. The vast amount of data that must be collected and evaluated makes clinical testing the most time-consuming and

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expensive part of new drug development. The next stage in the drug development process is to seek registration for the new drug. See "—Regulation."

Initiatives to optimize the research and development processes

        We are working to be more efficient in selecting candidate drugs for development. For example, we are now better able to select the best compounds for development by having senior management focus on development projects at an early stage. Where possible we run early proof of concept studies in patients which include biomarkers for potential efficacy and which enable us to make an earlier evaluation of the probability that the compound could be successfully developed into a marketable product. Under another initiative, special teams work to develop late stage products more quickly. The goal is to improve the likelihood of therapeutic and commercial success, which should reduce development costs and decrease time to market. In several other initiatives we are improving electronic management of the clinical trial processes, including data capture and transfer, as well as electronic storage and archiving of study data and documents. Most recently we have initiated electronic submissions to health authorities, vastly reducing the quantity of paper documents which need to be submitted and also enabling faster and more efficient review of data by health authorities. Overall, these initiatives have reduced clinical trial outsourcing, have improved data quality and speed of clinical trial reporting, substantially reduced the time between initial research and the introduction of the drug to market, and have provided us with considerable cost savings.

Alliances and acquisitions

        Our Pharmaceuticals Division forms alliances with other pharmaceutical and biotechnology companies, and with academic institutions in order to develop new products, acquire platform technologies and access new markets. We license products that complement our current product line and are appropriate to our business strategy. Therapeutic area strategies have been established to focus on alliances and acquisition activities for key disease areas/indications that are expected to be growth drivers in the future. We review products and compounds we are considering licensing using the same criteria as we use for our own internally discovered drugs.

Regulation

        The international pharmaceutical industry is highly regulated. Regulatory authorities around the world administer numerous laws and regulations regarding the testing, approval, manufacturing, importing, labeling and marketing of drugs, and also review the safety and efficacy of pharmaceutical products. Further controls exist on the non-clinical and clinical development of pharmaceutical products. These regulatory requirements are a major factor in determining whether a substance can be developed into a marketable product, and the amount of time and expense associated with that development.

        World regulatory authorities, especially those in the US, Switzerland, the EU and Japan, have high standards of technical evaluation. The introduction of new pharmaceutical products generally entails a lengthy approval process. Of particular importance is the requirement in all major countries that products be authorized or registered prior to marketing, and that such authorization or registration be subsequently maintained. In recent years, the registration process has required increased testing and documentation for clearance of new drugs, with a corresponding increase in the expense of product introduction.

        To register a pharmaceutical product, a registration dossier containing evidence establishing the quality, safety and efficacy of the product must be submitted to regulatory authorities. Generally, a therapeutic product must be registered in each country in which it will be sold. In every country, the submission of an application to a regulatory authority does not guarantee that approval to market the product will be granted. Although the criteria for the registration of therapeutic drugs are similar in most countries, the formal structure of the necessary registration documents varies significantly from country to country. It is possible that a drug can be registered and marketed in one country while the registration authority in a neighboring country may, prior to registration, request additional information from the

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pharmaceutical company or even reject the product. It is also possible that a drug may be approved for different indications in different countries.

        The registration process generally takes between six months and several years, depending on the country, the quality of the data submitted, the efficiency of the registration authority's procedures and the nature of the product. Many countries provide for accelerated processing of registration applications for innovative products of particular therapeutic interest. In recent years, intensive efforts have been made among the US, the EU and Japan to harmonize registration requirements in order to achieve shorter development and registration times for medical products. However, the requirement in many countries to negotiate selling prices or reimbursement levels with government regulators can substantially extend the time until final marketing approval is granted.

        The following provides a summary of the regulatory process in the principal markets served by Pharmaceuticals Division affiliates:

United States

        In the US, applications for drug registration are submitted to and reviewed by the FDA. The FDA regulates the testing, approval, manufacturing, importing, labeling and marketing of pharmaceutical products intended for commercialization in the US. The FDA also monitors all pharmaceutical products currently on the US market. The pharmaceutical development and registration process is typically intensive, lengthy and rigorous. When a pharmaceutical company has gathered data which it believes sufficiently demonstrates a drug's quality, safety and efficacy, then the company may file a New Drug Application ("NDA") for the drug. The NDA must contain all the scientific information that has been gathered about the drug and typically includes information regarding the clinical experiences of all patients tested in the drug's clinical trials. A supplemental new drug application ("sNDA") must be filed for a line extension of, or new indications for, a previously registered drug.

        Once an NDA is submitted, the FDA assigns reviewers from the fields of biopharmaceuticals, chemistry, medicine, microbiology, pharmacology/toxicology, statistics and labeling. After a complete review, these experts then provide written evaluations of the NDA, including a recommendation. These recommendations are consolidated and are used by the FDA in its evaluation of the NDA. Based on that evaluation, FDA then provides to the NDA's sponsor an approval, or an approvable, or non-approvable letter. The approvable and non-approvable letters will state the specific deficiencies in the NDA which need to be addressed. The sponsor must then submit complete responses to the deficiencies in order to restart the review procedure.

        Once the FDA has approved an NDA or sNDA, the company can make the new drug available for physicians to prescribe. The drug owner must submit periodic reports to the FDA, including any cases of adverse reactions. For some medications, the FDA requires additional post-approval studies (Phase IV) to evaluate long-term effects or to gather information on the use of the product under special conditions. The FDA also requires compliance with standards relating to good laboratory, clinical and manufacturing practices.

European Union

        In the EU, there are two main procedures for application for authorization to market pharmaceutical products in all of the EU Member States, the Centralized Procedure and the Mutual Recognition Procedure. It is also possible to obtain a national authorization for products intended for commercialization in a single EU member-state only, or for line extensions to existing national product licenses.

        Under the Centralized Procedure, applications are made to the European Medicines Agency (EMEA) for an authorization which is valid across all EU member states. The Centralized Procedure is mandatory for all biotechnology products and optional for other new chemical compounds or innovative medicinal products. When a pharmaceutical company has gathered data which it believes sufficiently

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demonstrates a drug's quality, safety and efficacy, then the company may submit an application to the EMEA. The EMEA then receives and validates the application, and appoints a Rapporteur and Co-Rapporteur to review it. The entire review cycle must be completed within 210 days, although there is a "clock stop" at day 120, to allow the company to respond to questions set forth in the Rapporteur/Co-Rapporteur's Assessment Report. When the company's complete response is received by the EMEA, the clock restarts on day 121. If there are further aspects of the dossier requiring clarification, the EMEA will then request an Oral Explanation on day 180, in which the sponsor must appear before the EMEA's Scientific Committee (the CHMP) to provide the requested additional information. On day 210, the CHMP will then take a vote to recommend the approval or non-approval of the application. The final decision under this Centralized Procedure is an EU Community decision which is applicable to all Member States. This decision occurs on average 90 days after a positive CHMP recommendation.

        Under the Mutual Recognition Procedure (MRP), the company first obtains a marketing authorization by a single EU member-state. Subsequently, the company may seek mutual recognition of this first authorization from some or all of the remaining EU Member-States. Then, within 90 days of this initial decision, each Member State reviews the application and can issue objections or requests for additional information. On Day 90, each Member State must be assured that the product is safe and effective, and that it will cause no risks to the public health. Once agreement has been reached, each Member State grants separate marketing authorizations for the product.

        After the Marketing Authorizations have been granted, the company must submit periodic safety reports to the EMEA (Centralized Procedure) or to the National Health Authorities (MRP). These Marketing Authorizations must be renewed on a 5 year basis.

Japan

        In Japan, applications for new products are made through the Pharmaceutical and Medical Devices Agency (PMDA). After a data reliability survey and a Good Clinical Practice inspection are carried out by the PMDA, a team evaluation is carried out by the Pharmaceutical and Medical Devices Evaluation Center (PMDEC) of the PMDA. Its results are passed to PMDA's external experts who then report back to the PMDA. After a further team evaluation, a report is provided to the Ministry of Health, Labor and Welfare (MHLW), which makes a final determination for approval and refers this to the Central Pharmaceuticals Affairs Council (CPAC) which then advises the MHLW on final approvability. Drug manufacturing or import license approval is issued by the local prefecture government. Once the MHLW has approved the application and has listed its national health insurance price, the company can make the new drug available for physicians to prescribe and obtain reimbursement. For some medications, the MHLW requires additional post-approval studies (Phase IV) to evaluate safety, effects and/or to gather information on the use of the product under special conditions. The MHLW also requires the Sponsor to submit safety reports.

Price Controls

        In most of the markets where we operate, the prices of pharmaceutical products are subject to both direct and indirect price controls and to drug reimbursement programs with varying price control mechanisms. Due to increasing political pressure and governmental budget constraints, we expect these mechanisms to remain in place—and to perhaps even be strengthened—and to have a negative influence on the prices we are able to charge for our products.

        In the US, debate over the reform of the health care system has resulted in an increased focus on pricing. Although there are currently no government price controls over private sector purchases in the US, federal legislation requires pharmaceutical manufacturers to pay prescribed rebates on certain drugs to enable them to be eligible for reimbursement under some government health care programs such as Medicaid and health insurance for Department of Defense personnel. In the absence of government pricing regulations, managed care has become a potent force in the US market place that increases downward pressure on the prices of pharmaceutical products. In addition, the recently enacted Medicare

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reform legislation, which has created a prescription drug benefit for Medicare patients, has created additional competitive pressure on prices, and has caused us to provide discounts on business which we have not previously been required to discount. At the same time, we expect this legislation to increase the volume of drugs purchased by Medicare beneficiaries, which would perhaps offset, at least in part, these additional price discounts. It is too soon to predict the full impact of this new legislation with certainty. Another potential influence on pricing in the US is the ongoing efforts by consumers and others to obtain our products from distributors in Canada and other developed nations which have relatively stringent price controls. Such imports to the US are currently illegal. However, there are ongoing political efforts to change their legal status.

        In the EU, governments influence the price of pharmaceutical products through their control of national health care systems that fund a large part of the cost of such products to consumers. The downward pressure on health care costs in general in the EU, particularly with regard to prescription drugs, has become very intense. As a result, increasingly high barriers are being erected to the entry of new products. In addition, in some countries, cross-border imports from low-priced markets exert commercial pressure on pricing within a country. The EU enlargement (with 10 countries having joined the EU in 2004) will probably complicate the environment and have some influence on prices in the region and parallel trade.

        In Japan, the MHLW reviews the National Health Insurance prices of individual pharmaceutical products every two years. In 2005, the NHI price calculation method for new products and price revision rule for existing products were reviewed, and the resulting new drug tariffs are effective beginning April 2006. The Japanese government is currently undertaking a health care reform initiative with a goal of curbing national medical expenditures, and is continuing its review of the pricing methods used.

Intellectual Property

        We attach great importance to patents, trademarks, and know-how in order to protect our investment in research and development, manufacturing and marketing. It is our policy to seek the broadest possible protection for significant product developments in all major markets. Among other things, patents may cover the products themselves, including the product's active substance and its formulation. Patents may also cover the processes for manufacturing a product, including processes for manufacturing intermediate substances used in the manufacture of the products. Patents may also cover particular uses of a product, such as its use to treat a particular disease, or its dosage regimen.

        The protection offered by such patents extends for varying periods depending on the legal life of patents in the various countries. The protection afforded, which may also vary from country to country, depends upon the type of patent and its scope of coverage. We monitor our competitors and vigorously challenge infringements of our intellectual property.

        In general, published pharmaceutical industry benchmarks show that we are at a comparatively low risk of loss of significant amounts of revenue due to patent expirations. As examples, we have basic patent protection (including extensions) on valsartan (the active ingredient used in our best-selling product Diovan) until 2012 in the US, until 2011 in the major countries of the EU, and until 2013 in Japan. We have basic patent protection (including extensions) on imatinib (the active ingredient used in our leading product Gleevec/Glivec) until January 2015 in the US (excluding pediatric extension), until 2016 in the major EU countries, and until 2013 in Japan.

        However, patent protection is no longer available or challenged in several major markets for the active substances used in a number of our Pharmaceuticals Division's leading products:

    Diovan.    The active ingredient in Diovan is covered by a compound patent through 2012 in the US, and through 2011-13 in other markets. In the US additional patents covering the marketed formulation have been challenged. However, we have not filed a suit at this point in time.

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    Neoral.    Patent protection exists for the Neoral micro-emulsion formulation and other cyclosporin formulations through 2009 and beyond in major markets. Despite this protection, generic cyclosporin products competing with Neoral have entered the transplantation market segment in the US, Germany, Japan, Canada and elsewhere. Patent infringement actions are pending against manufacturers of some of these generic products. At present, there are no injunctions in place against any of the manufacturers that we have sued..

    Sandostatin.    Basic patent protection for the active ingredient of Sandostatin SC has expired in the US, Japan, Germany, France and the UK, and it will expire in May 2007 in Italy. Generic versions of Sandostatin SC have been approved in the US and elsewhere. Patent protection for the Sandostatin LAR formulation extending to 2010 (and 2013 and beyond in the US) continues in major markets. Sandostatin LAR is, a long-acting version of Sandostatin which represents a majority of our sales in this product family.

    Lotrel/Cibacen/Lotensin/Cibadrex.    The basic benazepril substance patent protection for Lotrel/Cibacen/Lotensin/Cibadrex expires in 2007 in France and 2008 in Italy and has expired elsewhere. However, Lotrel, which is a combination of benazepril and amlodipine besylate, is patented in the US until 2017. Teva and Dr. Reddy's Laboratories have challenged this patent. Dr. Reddy's is seeking marketing approval for a different benazepril combination, using amlodipine maleate rather than amlodipine besylate. Because of this difference, the Dr. Reddy's product, if brought to market, would not be automatically substitutable in the US for Lotrel. However, Teva is seeking marketing approval for the same benazepril combination as Lotrel, and is thus seeking to bring a fully substitutable product to the US market. We have sued Teva and Dr. Reddy's in the US for patent infringement. The Dr. Reddy's case is currently stayed.

    Lamisil.    The active ingredient in Lamisil is covered by a compound patent family which expires in the US in 2006, in 2007 in France and has expired elsewhere. The US patent had been challenged by Dr. Reddy's Laboratories in the US. Dr. Reddy's has since withdrawn its suit and conceded that this patent is valid and enforceable.

    Miacalcin/Miacalcic.    The specific Novartis formulation of this product is covered by patents which will expire in the US in 2015. However, patents on the Novartis formulation have expired in a number of major countries and will expire in Italy in 2006. Apotex has applied to the FDA for the right to sell a generic version of Miacalcin using the Novartis formulation. We have sued Apotex for patent infringement. Two other companies have applied to the FDA for the right to sell a generic version of Miacalcin based on a different formulation. We have not sued these companies. Unigene's recombinant salmon calcitonin product is approved in the US, but would not be automatically substitutable in the US for Miacalcin.

    Exelon.    The active ingredient in Exelon is covered by a compound patent (granted to Proterra AG), which in the US presently expires in 2007, and has been determined by the FDA to qualify for patent term extension until 2012, and which expires in 2011-13 in the major markets. In addition, we hold an isomer patent on Exelon which expires in 2012-14. Dr. Reddy's, Sun Pharmaceuticals and Watson Pharmaceuticals have filed applications to market a generic version of Exelon in the US. Together with Proterra, we have sued all three parties for patent infringement.

    Focalin.    The drug dosage form of Focalin and its use in attention deficit hyper-activity disorders are covered by patents (granted to Celgene Corporation and licensed to us) through 2015 in the US and 2018 in other markets. Teva has challenged these patents and has filed an application for a generic version of Focalin in the US. Together with Celgene, we have sued Teva for patent infringement under a use patent.

    Trileptal.    Patent protection for Trileptal's active ingredient has expired in major countries. In the US, New Chemical Entity data exclusivity under the Hatch-Waxman Act of 1984 has expired in 2005. We have also pending patent filings relating to our marketed formulations of Trileptal, which,

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      if granted, would expire in 2018 in major countries, including the US. In Europe this formulation patent is being opposed by three generic companies.

    Starlix.    The active ingredient in Starlix is covered by Ajinomoto patents. The basic US patent will expire in 2009. Several parties have informed us that they have filed an ANDA application to market a generic version of Starlix in the US upon expiration of the basic patent in 2009. In Europe basic compound protection exists in Germany, France, the UK and Switzerland and will expire in 2011.

    Foradil.    Patent protection for Foradil's active ingredient has expired in major countries. In the US, Hatch-Waxman data exclusivity is currently scheduled to expire in February 2006.

    Voltaren.    Voltaren is off-patent. As a result, revenue from Voltaren has declined, and may decline significantly further over the next few years.

    Famvir.    The active ingredient in Famvir is covered by a compound patent which expires in 2010 in the US, in 2008 in Europe and 2006 in Canada. Other method of use patents expire in 2014 and 2015. Teva has challenged these patents in the US and has filed an application for a generic version of Famvir in the US. We have sued Teva in the US for infringement of the compound patent.

    Zaditor/Zaditen.    Apotex has filed for approval for a generic version of Zaditor in the US. The Zaditor formulation is covered by a patent in the US. We sued Apotex for patent infringement, however, we subsequently withdrew our suit and there is now no lawsuit pending.

        The loss of patent protection can have a significant impact on our Pharmaceuticals Division. We work to offset these negative effects by developing and patenting inventions that result in process and product enhancements and by positioning many of our products in specific market niches. However, there can be no assurance that this strategy will be effective in the future to extend competitive advantage, or that we will be able to avoid substantial adverse effects from future patent expirations.

SANDOZ

        Our Sandoz Division is a world leader in the development, manufacturing and marketing of pharmaceutical products and substances which are no longer protected by patents. The business of Sandoz is conducted by a number of affiliated companies throughout the world, selling products in approximately 110 countries. Sandoz was a Business Unit of our Consumer Health Division until December 31, 2004, after which it became a separate Division. As of December 31, 2005, the affiliates of the Sandoz Division employed 20,066 associates worldwide. In 2005, the Sandoz Division achieved consolidated net sales of $4.7 billion, which represented 15% of the Group's total net sales.

        In 2005, we acquired two leading generic drug companies—Hexal AG and Eon Labs, Inc., which are both in the process of being integrated into Sandoz. The two companies were acquired for approximately $8 billion in all-cash transactions that bring together three premier generics enterprises that combine Sandoz' global geographic presence and expertise in the retail and anti-infectives business, Hexal's leadership in Germany and strong track record of successful product development, and Eon Labs' strong position in the US for "difficult-to-make" generics. The acquisition of Hexal was completed in June, while the purchase of 100% of Eon Labs was completed in July. With these acquisitions, Sandoz had a portfolio of over 600 active ingredients in more than 5,000 dosage forms. Annual cost synergies totaling $200 million are anticipated within three years from closing, with 50% expected to be achieved in the first 18 months. In July 2005, Sandoz moved its headquarters from Vienna, Austria to Holzkirchen, Germany, where the headquarters of Hexal AG had been based.

        In August 2004, we acquired Sabex Holdings Ltd. (now Sandoz Canada Inc.), a Canadian generics company with a leading position in injectable products. This acquisition provided Sandoz with strong growth opportunities in injectable generics. It also gave Sandoz an operational presence in Canada, the world's sixth largest generics market, and offered the opportunity to increase sales in Canada of our existing portfolio of solid-dosage-form products.

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        In June 2004, we acquired the Danish generics company Durascan A/S (now Sandoz A/S) from AstraZeneca plc. This acquisition provided Sandoz with a leadership position in the Danish market. In addition, Durascan's broad portfolio of generic products offered growth opportunities for Sandoz throughout the Nordic region.

        In 2003, we united 14 of our generics company brands under the single global umbrella name Sandoz, to strengthen recognition and leverage share of voice in the highly competitive marketplace for generic products. This initiative capitalizes on the strong reputation of the Sandoz name, which has a high level of awareness and trust among physicians, pharmacists and patients.

        Sandoz is organized as a Retail Generics business that also operates an Anti-Infectives business. In Retail Generics, we develop and manufacture active ingredients and finished dosage forms that are no longer protected by patents. The Retail Generics business includes the development and manufacture of biopharmaceuticals, which previously had been a separate business within Sandoz. Retail Generics also supplies certain active ingredients to third parties. In the Anti-Infectives business, we develop and manufacture off-patent active pharmaceutical ingredients and intermediates—mainly antibiotics—for internal use in the Retail Generics business and for sale to third-party customers.

        In 2005, Sandoz' total net sales increased by approximately 54% in local currencies over the prior year. The business year was characterized by a sales volume expansion in the US and in the Anti-Infectives business, as well as the acquisitions of Hexal and Eon Labs and their integration into Sandoz.

        In the US, net sales of our Retail Generics business increased by 27%, mainly driven by the sales contribution of Eon Labs and the success of new product launches and authorized generics that were partly off-set by continued price erosion.

        In other key European markets, particularly in France, Poland, Russia, Canada, Italy and Spain, our Retail Generics business achieved double-digit net sales growth, driven by the contribution of the Hexal acquisition and strong volume expansion.

        The Anti-Infectives business increased its internal supply of active pharmaceutical ingredients (i.e. ceftriaxon, cefuroxime axetil, clarythromycin) to the Retail Generics business and strengthened its leading position in the field of cefalosporin intermediates and active pharmaceutical ingredients sold to industrial customers.

        In 2005, we continued our efforts to develop and manufacture follow-on biologics. We are seeking to leverage our technology and more than 20 years of biotech experience to develop, manufacture and market high-quality biopharmaceutical products, such as protein hormones and other human proteins, to be sold as substitutes for branded biopharmaceutical products after their patents have expired. Sandoz also manufactures these products for other industrial customers. With our biopharmaceuticals portfolio, we are at the forefront of emerging regulatory policies for follow-on biologics in Europe and the US. We are determined to contribute to the availability of safe and effective follow-on biologics. Since the first half of 2005, the development and manufacturing of biopharmaceutical products has been managed together with Novartis Pharmaceuticals.

        For the recombinant human growth hormone Omnitrope, a biopharmaceutical product developed by Sandoz, we received our first marketing authorization in Australia in September 2004 and launched the product in November 2005.

        In the US, we received notice from the FDA in September 2004 that the agency was unable to reach a decision on whether to approve an application for the marketing of Omnitrope. The agency did not identify any deficiencies in the application, but was unable to reach a final decision on the application due to uncertainty regarding certain scientific and legal issues. In September 2005, Sandoz filed a lawsuit against the FDA seeking a ruling on this pending application.

        In the EU, Omnitrope received a positive opinion from the CHMP in June 2003. Nevertheless, the European Commission notified us in November 2003 of its intent not to proceed with a decision for a

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marketing authorization for Omnitrope under the regulatory pathway chosen by Sandoz. In January 2004 and March 2005, Sandoz filed complaints against the European Commission to the European Court of First Instance, which are still pending. In July 2004, Sandoz resubmitted its Omnitrope application under a newly established regulatory pathway. We received a positive opinion from the CHMP in January 2006.

Recently Launched Products

        The following is a summary of the most important products launched by Sandoz in 2005:

    Estradiol (a generic version of Climara[nc_cad,176], an Estrogen replacement treatment) was launched in the US in January 2005;

    Fentanyl Patch (a generic version of Duragesic TT[nc_cad,176], a treatment for chronic pain) was launched in the US in January 2005 and in Germany, the UK, and Poland in August 2005;

    Cefixtriaxone (a generic version of Rochephin[nc_cad,176], an antibiotic) was launched in the US in July 2005;

    Octereotide (a generic version of Sandostatin, a treatment to reduce blood levels of growth hormone and IGF-I in acromegaly patients) was launched in the US in April 2005;

    Ketoconazole (a generic version of Nizoral[nc_cad,176], a topical treatment of tinea corporis, cruris, pedis, versicolor, cutaneous candidiasis) was launched in the US in April 2005;

    Cilostazol 50mg (a generic version of Pletal[nc_cad,176], a treatment for the reduction of symptoms of intermediate claudication) was launched in the US in March 2005;

    Glipizide/Metformin (a generic version of MetaGlip[nc_cad,176], a treatment to control hyperglycemia in Type II diabetes patients) was launched in the US in October 2005;

    Terbinafine (a generic version of Lamisil) was launched in Germany by Sandoz in May 2005 and by Hexal in June 2005;

    Leflunomide (a generic version of Arava[nc_cad,176], a treatment of active rheumatoid arthritis) was launched in the US in September 2005;

    Glimeperide (a generic version of Amaryl[nc_cad,176], a treatment to lower blood glucose for Type II diabetes patients) was launched in the US in October 2005;

    Pamidronate Inj. (a generic version of Aredia, a treatment of moderate to severe hypercalcemia) was launched in the US in October 2005;

    Fenoldopam Inj. (a generic version of Corlopam[nc_cad,176], a short term treatment of severe hypertension) was launched in the US in October 2005;

    Flumazenil Inj. (a generic version of Romazicon[nc_cad,176], a treatment to reverse sedatives or anesthesia) was launched in the US in October 2005;

    Azithromycin (a generic version of Zithromax[nc_cad,176], an antibiotic) was launched in US in November 2005;

    Metoprolol (a generic version of Beloc Zok[nc_cad,176], a treatment of hypertension) was launched in Germany, Netherlands, Poland, and the Nordics in March 2005;

    Lamotrigin (a generic version of Lamictal[nc_cad,176], a treatment of anti-epileptic) was launched in Germany, the UK, Poland, and the Nordics in June 2005;

    Sertralin (a generic version of Zoloft[nc_cad,176], an anti-depressant) was launched in Germany, the Netherlands, the UK, Spain, and Italy, in October 2005;

    Lansoprazol (a generic version of Lanzor[nc_cad,176], an anti-ulcer treatment, proton pump inhibitor) was launched in the UK and the Netherlands in December 2005.

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Key Marketed Products

        The following table describes the key marketed products for Sandoz. Not all products are available in all markets.

Retail Generics Business

Product

  Originator Drug

  Description
Amoxicillin/clavulanic acid   Augmentin[nc_cad,176]   anti-infective
Omeprazole   Prilosec[nc_cad,176]   ulcer and heartburn treatment
Citalopram   Celexa[nc_cad,176]   anti-depressant
Loratadine   Claritin[nc_cad,176]   antihistamine
Atenolol   Tenoric[nc_cad,176]   anti-hypertension
Penicillin       anti-infective
Lisinopril   Prinivil[nc_cad,176]   ACE inhibitor
Ranitidine   Zantac[nc_cad,176]   anti-ulcerant
Metformin   Glucophage[nc_cad,176]   anti-diabetic
Terazosin   Hytrin[nc_cad,176]   anti-hypertension and benign prostatic hyperplasia
Enalapril   Lexxel[nc_cad,176]   ACE inhibitor
Metoprolol   Lopressor[nc_cad,176]   Anti-hypertension

Anti-Infectives Business

Active Ingredients

  Description
Oral and sterile penicillins   Anti-infectives
Oral and sterile cefalosporins   Anti-infectives
Clavulanic acid and mixtures with clavulanic acid   ß-lactam inhibitors
Classical and semisynthetic erythromycins   Anti-infectives
Tiamuline   Anti-infectives
Lovastatin, Simvastatin, Pravastatin   Statins
Vancomycin   Anti-infectives
Thyroxine   Hormones

Intermediates


 

Description

Various cephalosporin intermediates   Anti-infectives
Erythromycin base   Anti-infectives
Various crude compounds produced by fermentation   Cyclosporine, ascomysine, rapamycine,
mycophenolic acid, etc.

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Principal Markets

        The principal markets for Sandoz are the two largest generics markets in the world: the US and Europe. The following table sets forth the aggregate 2005 net sales of Sandoz by region:

Sandoz

  Net Sales 2005
 
  ($ millions)

  (%)

United States   1,282   27
Americas (except the United States)   287   6
Europe   2,597   56
Rest of the World   528   11
   
 
Total   4,694   100
   
 

        Many Sandoz products are used for chronic conditions that require patients to consume the product over long periods of time, from months to years. Sales of our anti-infective products are subject to seasonal variation. Sales of the vast majority of our other products are not subject to material changes in seasonal demand.

Production

        We manufacture our Sandoz products at 47 production facilities around the world. Among these, our principal production facilities are located in Barleben and Radebeul, Germany; Kundl, Austria; Menges and Ljubljana, Slovenia; Broomfield, Colorado; Wilson, North Carolina; Stryków, Poland; Kalwe, India; Boucherville, Canada; Cambé, Brazil and Gebze, Turkey. While we have not experienced material supply interruptions in the past, there can be no assurance that supply will not be interrupted in the future as a result of unforeseen circumstances. The manufacture of our products is heavily regulated, making supply never an absolute certainty. If we or our third party suppliers fail to comply fully with such regulations then there could be a recall or a government-enforced shutdown of production facilities, which in turn could lead to product shortages.

        Active pharmaceutical ingredients are manufactured in our facilities or purchased. We purchase active pharmaceuticals ingredients from a number of our affiliates and third-party suppliers. Where possible, our policy is to maintain multiple supply sources so that the business is not dependent on a single or limited number of suppliers and competitive material sourcing can be assured. However, our ability to do so may at times be limited by regulatory requirements. We monitor market developments that could have an adverse effect on the supply of essential active pharmaceutical ingredients. All active pharmaceutical ingredients we purchase must comply with high quality standards. In order to sustain cost competitiveness and reliable quality, we produce some of our active pharmaceutical ingredients, like penicillins, cephalosporins and statins ourselves. These methods include fermentation processes, chemical syntheses and physical production methods, such as sterile processing. We are constantly working to develop other new manufacturing processes.

        We obtain agricultural raw materials such as flours and sugars from multiple suppliers based in the EU. We obtain chemicals and other raw materials from suppliers around the world. The raw materials we purchase are generally subject to market price fluctuations. We seek to avoid these fluctuations, where possible, through the use of long-term supply contracts.

Marketing and Sales

        In our Retail Generics business, we have a broad portfolio of generic medicinal products that we sell to wholesalers, pharmacies, hospitals, and other health care outlets and of active pharmaceutical

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ingredients. Depending on the structure of the local market, customers are supplied with finished dosage forms either by the field service team of the local Sandoz affiliates or by established partners or joint venture associates.

        Our Anti-Infectives business supplies our Retail Generics business and the pharmaceutical industry worldwide with active pharmaceutical ingredients and their intermediates, mainly in the field of antibiotics.

        In response to rising health care costs, many governments and private medical care providers, such as health maintenance organizations (HMOs), have instituted reimbursement schemes that favor the substitution of branded pharmaceuticals. In the US, generic substitution statutes have been enacted by virtually all states and permit or require the dispensing pharmacist to substitute a less expensive generic drug for the brand-name version of the drug. In Europe, the use of generic drugs is growing. But in some EU countries, reimbursement practices do not create an efficient incentive for generic substitution. As a result, generic penetration rates in many European countries are still below those reached in the US.

Competition

        The market for generic products is characterized by increasing demand for high-quality pharmaceuticals which can be produced at lower costs due to minimized initial research and development investments. Increasing pressure on health care expenditures and numerous patent and data exclusivity period expirations have created a favorable market environment for the generics industry. This positive market trend, however, brings increased competition within the generics industry, leading to ongoing price pressure on generic pharmaceuticals.

        In addition, branded pharmaceutical companies have responded to the increased competition from generic products by licensing their branded products to generic companies (the so-called "authorized generic"). By doing so, branded pharmaceutical companies participate in the conversion of their branded product, still protected by patents or data exclusivity, to the generic market. Consequently, generic companies that were not in a position to compete on a specific product are allowed to enter the generic market using the innovator's product. Because, in the US, the authorized generic is not subject to the US Hatch-Waxman Act rules regarding exclusivity (See "—Regulation"), the company that launches an authorized generic typically enters the market at the same time as the generic exclusivity holder. This tends to reduce the value of the exclusivity for the company which invested in creating the first generic.

Research and Development

        Before a generic drug may be marketed, intensive technical and clinical development work must be performed in order to demonstrate in bio-availability studies the bio-equivalency of the generic drug to the reference product. Nevertheless, research and development costs associated with generic drugs are much lower than those of the established counterparts, as no Phase I to Phase III studies must be performed by the generic competitor. As a result, drugs for which the patent and data exclusivity period has expired can be offered for sale at prices much lower than those of drugs protected by patents and data exclusivity, which must recoup substantial basic research and development costs through higher prices over the life of the product's patent and data exclusivity period.

        Currently, the affiliates of the Sandoz Division employ more than 1,000 Research and Development staff who explore alternative routes for the manufacture of known compounds and who aim to develop innovative active pharmaceutical ingredients and dosage forms of generic medicine products. These associates are based worldwide, including facilities in Kundl and Schaftenau, Austria; Menges and Ljubljana, Slovenia; Kolshet, India; Boucherville, Canada; and Dayton, New Jersey.

        In 2005, Sandoz invested $434 million in research and development, which amounted to 9% of net sales. We had long-term research commitments totaling $23 million in the aggregate as of December 31, 2005. We intend to fund these expenditures from internally generated resources.

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Regulation

        The Hatch-Waxman Act in the US (and similar legislation in the EU and in other countries) eliminated the requirement that generic drug manufacturers repeat the extensive clinical trials which are required for originator drugs, so long as the generic version could be shown in bio-availability studies to be of identical quality and purity, and to be biologically equivalent to the reference product.

        In the US, the decision whether a generic drug is bioequivalent to the original branded drug is made by the FDA based on an Abbreviated New Drug Application (ANDA) filed by the generic drug's manufacturer. The process typically takes approximately eighteen months from the filing of the ANDA until FDA approval. However, delays can occur if issues arise regarding the interpretation of bioequivalence study data, labeling requirements for the generic product, or qualifying the supply of active ingredients. In addition, the Hatch-Waxman Act requires a generic manufacturer to certify in certain situations that the generic drug does not infringe any current applicable patents on the drug held by the innovator, or to certify that such patents are invalid. This certification often results in a patent infringement lawsuit being brought by the patent holder against the generic company. In the event of such a lawsuit, the Hatch-Waxman Act imposes an automatic 30-month delay in the approval of the generic drug in order to allow the parties to resolve the intellectual property issues. For generic applicants who are first to file their ANDA containing a certification claiming non-infringement or patent invalidity, the Hatch-Waxman Act provides those applicants with 180-days of marketing exclusivity to recoup the expense of challenging the innovator patents. However, amendments to the Hatch-Waxman Act may affect the availability of generic marketing exclusivity in the future. The amendments now require generic applicants to launch their products within certain time frames or risk losing the marketing exclusivity that they had gained through being a first to file applicant.

        In the EU, decisions on the granting of a marketing authorization are made either by the EMEA under the Centralized Procedure, or by a single Member State, after which the MRP, as a decentralized procedure, may be followed. See "Pharmaceuticals—Regulation—European Union." Companies may submit Abridged Applications for approval of a generic medicinal product, based upon its "essential similarity" to a medicinal product authorized and marketed in the EU seeking to rely upon the innovative data, for not less than six or ten years, depending on the Member States' regulation. According to recent legislation, for all products which received a marketing authorization in the EU after late 2005, the Abridged Application can be submitted throughout the EU. Data submitted by the innovator in support of its application for a marketing authorization for the reference product will be protected for 10 years after the first grant of marketing authorization and can be extended for an additional year if a further innovative indication has been authorized for that product, based on pre-clinical and clinical trials filed by the innovator which show a significant clinical benefit in comparison to the existing therapies. The 10 year protection period is applicable throughout the EU and may lead to an extension of the existing data protection period which may in turn delay future launches.

Intellectual Property

        Wherever possible our products are protected by our own patents. Among other things, patents may cover the products themselves, including the product's active substance and its formulation. Patents may also cover the processes for manufacturing a product, including processes for manufacturing intermediate substances used in the manufacture of the products. Patents may also cover particular uses of a product, such as its use to treat a particular disease, or its dosage regimen. It is our policy to seek the broadest possible protection for significant product developments in all major markets.

        We take all reasonable steps to ensure that our generic products do not infringe valid intellectual property rights held by others. Nevertheless, originating companies commonly assert patent and other intellectual property rights in an effort to delay or prevent the launch of competing generic products. As a result, we can become involved in extensive litigation regarding our generic products. If we are unsuccessful in defending these suits, we could be subject to injunctions preventing us from selling our generic products, or to damages, which may be substantial.

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        In addition, we face the risk that generic competitors may file patents to protect product developments which could block Sandoz' own development projects. If this were to occur we could be forced to terminate a development program, which would require us to write-off any resources invested in that project, and would mean a loss of revenue.

        We are currently involved in litigation in a number of countries with affiliates of AstraZeneca plc regarding omeprazole, our generic version of AstraZeneca's Prilosec[nc_cad,176]. We launched omeprazole in the US in August 2003. While some of the European cases have been decided in our favor, many of the cases, including the cases pending in the US, may continue for some time. We believe that we will be successful in these lawsuits. However, should AstraZeneca succeed in any or all of the lawsuits, then AstraZeneca will likely seek to recover from us its lost profits for sales it would have made had our product not been on the market.

CONSUMER HEALTH

        Our Consumer Health Division is a world leader in the research, development, manufacturing and marketing of a wide range of competitively differentiated products that restore, maintain or improve the health and well being of consumers. The business of Consumer Health is conducted by a number of affiliated companies throughout the world. Created in January 2002, the Consumer Health Division consists of the following five Business Units:

    OTC self-medication

    Animal Health

    Medical Nutrition (including the Nutrition & Santé franchise that is being divested)

    Gerber (formerly Infant & Baby)

    CIBA Vision.

        Sandoz (generics) was a Business Unit of the Consumer Health Division until December 31, 2004, after which time it became a separate Division. The results of the Consumer Health Division do not include Sandoz sales.

        As of December 31, 2005, the affiliates of the Consumer Health Division employed 18,957 associates worldwide. In 2005, the affiliates of the Consumer Health Division achieved consolidated net sales of $7.3 billion, which represented 23% of the Group's total net sales, and invested $291 million in research and development.

        Our Consumer Health Division places considerable emphasis on the development of strong, consumer-oriented and trustworthy brands. In order to deliver accelerated sales growth, and to achieve leadership positions in the fields in which we compete, our Consumer Health Division seeks to give voice to the consumer and to determine the needs and desires of consumers.

        In the dynamic world of consumer health care, aging populations are increasingly affluent and becoming more knowledgeable about their health and the benefits of self-medication. The success of each Business Unit depends upon its ability to anticipate and meet the needs of such consumers and of health professionals worldwide.

        We announced in November 2005 the signing of a definitive agreement to divest the Nutrition & Santé business to ABN AMRO Capital France for approximately EUR 220 million ($260 million) on a cash and debt free basis. The transaction, which requires customary regulatory approvals, is expected to be completed in the first quarter of 2006.

        The Consumer Health division has five Business Units:

    Over-the-Counter (OTC) is a world leader in offering products for the treatment and prevention of common medical conditions and ailments, to enhance people's overall health and well being. The

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      business of OTC is conducted by a number of affiliated companies in more than 50 countries with 4,149 associates as of December 31, 2005. The OTC business focuses on a group of strategic global brands in leading product categories that include cough, cold and allergy treatments (Triaminic and NeoCitran/TheraFlu), headache relief (Excedrin), gastrointestinal treatments (Benefiber/NovaFibra and Ex-Lax), dermatological treatments (LamisilAT), anti-gas treatments (Gas-X), vitamin supplements (sold by OTC under the Sandoz brand name) and smoking cessation treatments (Nictonell/Habitrol). In August 2005, we significantly strengthened our OTC business in the US by acquiring the OTC business of Bristol-Myers Squibb, including Excedrin. In addition, in December 2005, we signed an agreement with TAP Pharmaceutical Products to acquire the right to develop an OTC version of the prescription drug Prevacid®, one of the leading medicines for acid reflux disease and heartburn.

    Animal Health offers products and services to save, prolong and improve animal lives, focusing on both companion and farm animals (including farmed fish). The business of our Animal Health Unit is conducted by affiliated companies in 38 countries with 2,308 associates as of December 31, 2005. Animal Health has a dedicated research and development team, which benefits from synergies with other Novartis businesses, most notably research in the Pharmaceuticals Division. Key products for companion animals include Atopica (atopic dermatitis management), Deramaxx (pain relief) and Milbemax/Interceptor (intestinal and heart worm control), while leading farm animal products include the farm fly control product Agita and the therapeutic anti-infective Tiamutin. In October 2005, Animal Health acquired the North American rights to the Denagard (tiamulin) franchise, an effective broad-spectrum antimicrobial used to treat and control bacteria in swine, from Boehringer Ingelheim Vetmedica, Inc. Novartis already marketed this compound under the Tiamutin brand name in all key swine markets outside North America. Acquaculture products include vaccines and treatments mainly used in salmon farming.

    Medical Nutrition is a global leader in the growing medical nutrition market. Our purpose is to offer to patients and consumers a range of enteral tube feed and oral nutrition brands and devices for use in various health care delivery settings (hospitals, nursing homes and home health care) or for use independently at home. Evidence suggests that adapting and improving the nutritional status of patients in hospitals can accelerate recovery, help prevent future health problems and reduce costs. The business of Medical Nutrition is conducted by affiliated companies in 47 countries with 2,127 employees worldwide as of December 31, 2005. Medical Nutrition offers high-quality medical nutrition products, devices and services ranging from standard to disease-specific products that improve health and quality of life for all age groups. This broad range of supplements, enteral tube feedings and food provides essential nutrients for good nutrition when illness or disabilities limit a person's ability to eat a balanced diet. These products include the oral nutritional liquid supplement Boost as well as Compat, a range of devices to deliver tube feeds to the gastrointestinal tract. In February 2005, we reached a settlement with the US Attorney for the Southern District of Illinois in connection with the federal government's investigation of the enteral nutrition industry. See "Item 8. Financial Information—8.A Consolidated Statements and Other Financial Information—8.A.7 Legal Proceedings." In February 2004, we completed the acquisition of the adult medical nutrition business of the Bristol-Myers Squibb Company subsidiary Mead Johnson & Company for a total cost of $385 million.

    Since 1928, Gerber (formerly Infant & Baby) has been committed to helping parents raise happy, healthy babies. Gerber does extensive scientific research aimed at understanding and improving infant and toddler nutrition and development. It is the leading baby food brand in the US with more than 200 food products. Gerber products are also marketed in several other countries. The business of Gerber is conducted by affiliated companies in more than 50 countries with 4,539 employees as of December 31, 2005. Through its "Start Healthy, Stay Healthy" campaign, Gerber continues to proactively address the obesity epidemic in the US. Together with the American Dietetic Association, Gerber introduced a set of dietary guidelines for babies and toddlers under the age of two years. The aim of Start Healthy, Stay Healthy is to provide parents and nutrition

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      professionals with practical advice about the importance of beginning, and how to instill, healthy eating habits early in life. The product line of Gerber also includes a baby care line featuring nursing and feeding aids, wellness products such as lotions and washes as well as life insurance.

    CIBA Vision is a world leader in the research, development, manufacturing and marketing of optical and ophthalmic products and services, including contact lenses and lens care products. The business of CIBA Vision is conducted by affiliated companies in nearly 40 countries with 5,788 employees as of December 31, 2005. CIBA Vision is committed to the research and development of innovative products, processes and systems. R&D efforts have produced lenses such as O2OPTIX, which are high-oxygen, breathable lenses, and NIGHT&DAY, which are high-oxygen extended wear lenses that can be worn for up to 30 continuous nights and days. We are also the world's leading provider of cosmetic contact lenses to change and enhance eye color through products such as FreshLook ColorBlends lenses. In lens care, CIBA Vision has developed many innovative products, particularly multi-purpose solutions in one bottle such as AQuify/SOLO-care AQUA.

Principal Markets

        The principal markets for the Consumer Health Division are the US and Europe. The following table sets forth the aggregate 2005 net sales of the Consumer Health Division by region:

Consumer Health

 

  Net Sales 2005
 
  ($ millions)

  (%)

United States   3,220   44
Americas (except the United States)   647   9
Europe   2,582   36
Rest of the World   807   11
   
 
Total   7,256   100
   
 

        Sales of our OTC Business Unit are marked by a high degree of seasonality, with our cough, cold and allergy brands significantly impacted by the timing and severity of the annual cold and flu and allergy seasons. Sales of our Animal Health Business Unit also fluctuate seasonally, and can be significantly affected by climatic and economic conditions, and by changing health or reproduction rates of animal populations. Sales of the vast majority of our other products are not subject to material changes in seasonal demand.

Production

        OTC: Our OTC Business Unit has a manufacturing and supply infrastructure comprised of the Business Unit's own plants, strategic third party suppliers and other Novartis Group plants (which are predominantly owned and operated by the Pharmaceuticals Division). The primary OTC plants are located in Lincoln, Nebraska; Nyon, Switzerland; and Humacao, Puerto Rico.

        Animal Health: Approximately 80% of our production volume is manufactured by third parties and Novartis affiliates in other Divisions or Business Units. Animal Health has production facilities of its own located around the world, with main sites in Wusi Farm, China; Dundee and Braintree (UK); Larchwood, Iowa (US); and Huningue, France.

        Medical Nutrition: Our Medical Nutrition Business Unit has a manufacturing and supply infrastructure comprised of the Business Unit's own plants as well as strategic third party suppliers and

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other Novartis Group plants. The most significant of the dedicated Medical Nutrition plants are located in Minneapolis, Minnesota and Osthofen, Germany.

        Gerber: Gerber operates its own production facilities in North America, South America and Eastern Europe for nutrition and Baby Care products. Major production sites are in Fremont, Michigan; Fort Smith, Arkansas; Reedsburg, Wisconsin; Querétaro, Mexico and Rzeszow, Poland. In addition, we contract with 17 companies for the manufacture of our nutrition products, and with 48 companies for our Baby Care products.

        CIBA Vision: CIBA Vision has major production facilities in Batam, Indonesia; Duluth, Georgia; Des Plaines, Illinois; Grosswallstadt, Germany; Cidra, Puerto Rico; Singapore; and Mississauga, Canada.

        The goal of our supply chain strategy is to produce and distribute high quality products efficiently. The manufacture of our products is heavily regulated, making supply never an absolute certainty. If we or our third party suppliers fail to comply fully with such regulations then there could be a government-enforced shutdown of production facilities, which in turn could lead to product shortages. While we have not experienced material supply interruptions in the past, there can be no assurance that supply will not be interrupted in the future as a result of unforeseen circumstances.

        While production practices may vary from Business Unit to Business Unit, we generally obtain our raw materials from sources around the world. We depend to a large extent on suppliers for the raw materials, intermediates and active ingredients. To limit the volatility of prices charged to us for raw materials, where practical and beneficial, we make use of long term supply agreements. We also proactively monitor markets and developments that could have an adverse effect on the supply of essential materials.

Marketing and Sales

        OTC: OTC aims to be a leading global participant in fulfilling the needs of patients and consumers for self-medication health care. Strong, leading brands, science-based products and in-house marketing and sales organizations are key strengths in pursuing this objective. We engage in general public relations activities, including media advertisements, brand websites and other direct advertisements of brands, to the extent permitted by law in each country. We distribute our products through various channels, such as pharmacies, food, drug and mass retail outlets.

        Animal Health: Animal Health's products are mostly prescription-only treatments for both farm and companion animals. The major distribution channel is veterinarians either directly or through wholesalers of veterinary products. Primary marketing efforts are targeted at veterinarians using such marketing tools as targeted personal selling, printed materials, direct mail, advertisements, articles in the veterinary special press, and conferences and educational events for veterinarians. In addition, we engage in general public relations activities, including media advertisements, brand websites and other direct advertisements of brands, to the extent permitted by law in each country.

        Medical Nutrition: The majority of the Medical Nutrition Business Unit's net sales (excluding Nutrition & Santé) are to health care delivery settings such as hospitals and nursing homes as well as home health care and group purchasing organizations. Our products are also used independently by patients at home. As a result of the acquisition of the global adult medical nutrition business of Mead Johnson & Company, we also have a significant level of retail business, principally in the US market. This retail business benefits from a collaboration with the Gerber sales force of our Gerber Business Unit, which markets the Boost brand in the US retail channel. In addition, in the US, outpatient consumers can purchase our products directly through our Walgreens partnership, by means of a toll-free telephone call or the Internet.

        Gerber: The mission for the Gerber Business Unit is to leverage our brand leadership of trust in helping parents nurture happy, healthy babies into the leading infant and baby brand around the world. In 2004, Gerber continued converting glass jars to plastic containers for its nutrition products. This major

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innovation is a result of consumer data, which clearly indicates the preference for plastic as a better fit for today's active parents and families in the US. Gerber will continue to work with the government and experts in the field of nutrition with respect to its "Start Healthy, Stay Healthy" campaign to help parents start their babies off on a lifetime of healthy eating habits. Strong brands, product development based on sound nutrition principles, and in-house marketing and sales organizations are some of our key strengths. Gerber products are distributed through food, drug and mass merchandiser retail outlets.

        CIBA Vision: In most countries, contact lenses are available only by prescription. CIBA Vision lenses can be purchased from eye care professionals and optical chains subject to country regulation. CIBA Vision's lens care products can be found in major drug, food, mass merchandising and optical retail chains in the United States, Europe, Japan and elsewhere. In addition, mail order and Internet sales are becoming increasingly important channels in major markets worldwide. While eye care professionals have traditionally been CIBA Vision's primary marketing focus, that focus has been shifting toward direct-to-consumer initiatives including free trials and coupons, as well as consumer advertising.

Competition

        The global market for products of the type sold by our Consumer Health Division is highly competitive, and we compete against other major international corporations with substantial financial and other resources. Competition within the industry is intense and extends across a wide range of commercial activities, including pricing, product characteristics, customer service, sales and marketing, and research and development.

Research and Development

        OTC: In OTC, the focus of research and development activities is primarily on dermatology, analgesics, cough, cold, allergy, gastrointestinal, minerals, and cardiovascular risk reduction (through smoking cessation programs). OTC also works closely with the Pharmaceuticals Division to evaluate appropriate products that can be switched from prescription to OTC status. The development of line extensions to leverage brand equities is also of high importance. These extensions can take many forms including new flavors, new galenical forms and more consumer-friendly packaging.

        Animal Health: Novartis Animal Health has dedicated research and development facilities in Switzerland, North America and Australia. The main focus for research is identification of potential new parasiticides. In addition, in the US and Canada, we devote resources to the quest for new vaccines for farm animals and farmed fish. In addition, our researchers exploit synergy with other Novartis businesses and also collaborate with external partners to develop veterinary therapeutics. Drug delivery projects, some in collaboration with external partners, concentrate on our key treatment areas and aim to improve efficacy and ease of use.

        Medical Nutrition: The Medical Nutrition research and development function is responsible for generating new products and therapies based on the needs of the market. Concepts are developed into prototypes using new and existing ingredients, processes, and packaging. Prototypes are scaled from bench top to pilot plant to production scale. Product attributes are validated through clinical trials under the direction of our Research and Development team, in order to determine whether the product is safe and well-tolerated. Label claims, label designs, and regulatory compliance issues are also addressed. On-going product quality is monitored and improved through specification development, testing, and corrective and preventative action.

        Gerber: Gerber has a Research and Development department which uses a multi-faceted approach to deliver consumer innovation by developing new processes, products and packaging for the nutrition, Baby Care and Wellness franchises. In addition, Gerber Research and Development oversees research regarding the needs of infants and their development. For example, as a part of the "Start Healthy, Stay Healthy" campaign, Gerber's Feeding Infants and Toddlers Study (FITS) analyzed the feeding habits and nutrient intake of a cross-sectional, random sample of more than 3,000 US children ranging from 4 to

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24 months of age. The results of this Study were published in January 2004, in a special supplement to the Journal of the American Dietetic Association. Gerber commissioned the survey in response to the growing obesity epidemic in the US, in order to better understand eating habits early in life when they are being formed. FITS is the largest scientific study of its kind ever conducted and fills a critical gap in knowledge. The findings have formed the core of the "Start Healthy, Stay Healthy" campaign.

        CIBA Vision: The research results of other Novartis affiliates provide CIBA Vision with new chemical compounds for future products and access to developments in biotechnology. These resources are complemented by CIBA Vision's internal research and development capabilities, licensing agreements and joint research and development partnerships with third parties. For contact lenses our key focus is in three areas: daily disposable contact lenses, silicone hydrogel lenses for continuous or daily wear and an ongoing expansion of our cosmetic and color lenses. In lens care, our development efforts focus on making our lens care solutions more convenient to use, while ensuring that the solutions provide the safety and cleaning power needed to help maintain ocular health.

        In 2005, the Consumer Health Division invested $291 million in research and development, which amounted to 4.0% of net sales. We have long-term research commitments totaling $126 million in the aggregate as of December 31, 2005. We intend to fund these expenditures from internally generated resources.

Regulation

        OTC: For OTC products, the regulatory process for bringing a product to market consists of preparing and filing a detailed dossier with the appropriate national or international registration authority and obtaining approval in the US or registration in the EU and the rest of the world. See "Pharmaceuticals—Regulation." In the US, in addition to the NDA process which is also used to approve prescription pharmaceutical products, an OTC product may be sold if the FDA has determined that the product's active ingredient is generally recognized as safe and effective. FDA makes this determination through a regulatory process known as the OTC Review. In the OTC Review, the FDA establishes, in a series of monographs, the conditions under which particular active ingredients may be recognized as safe and effective for OTC use. Pharmaceutical companies can market products containing these active ingredients without the necessity of filing an NDA and going through its formal approval process, so long as the company complies with the terms of the published monograph. Most countries also have a regulatory process for switching a particular pharmaceutical product from prescription to OTC status. These processes vary from country to country.

        Animal Health: The registration procedures for animal medicines are similar to those for human medicines. An animal drug application for product registration must be accompanied by extensive data on target animal and user safety, environmental fate and toxicology, efficacy in laboratory and clinical studies, information on manufacturing, quality control and labeling as well as on residues and food safety if applied to food producing animals. In the US, animal health products are generally regulated by the FDA's Center for Veterinary Medicine. Certain product categories are regulated by the Environmental Protection Agency (EPA), and vaccines are under the control of the US Department of Agriculture (USDA). In the EU, veterinary medicinal products need marketing authorization from the competent authority of a member-state (national authorization) or from the EU Commission (community authorization) following either the Centralized Procedure, Mutual Recognition Procedure or the new Decentralized Procedure. See "Pharmaceuticals—Regulation." In Japan, veterinary medicinal products are approved by the Ministry of Agriculture, Forestry and Fisheries (MAFF). The application, including supplementary local trial data, is reviewed by the MAFF and a General Investigation Committee, a Special Investigation Committee and a Permanent Investigational Committee before authorization is granted. In addition, any product that is intended for food animals or fish is reviewed by the Food Safety Commission, which was newly established in July 2003, to evaluate the risks to human health of any composition in the products.

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        Medical Nutrition, Gerber: Foodstuffs are highly regulated in order to protect the public health. The following areas are generally subject to international and national food regulations: development, manufacturing, packaging, quality (food standards, ingredients), safety, labeling and advertising of foods. Many countries require food products to be registered in order to document the safety and nutrition of imported food products. These nutritional need standards are determined based on independent, peer-reviewed research, or by studies sanctioned by authorities such as the US Department of Health and Human Services. In the US, agencies such as the FDA, the USDA, and the EPA are responsible for providing safety specifications and otherwise regulating our products and ingredients. The FDA and USDA have issued regulations and standards regarding the use of specific ingredients in certain types of food products, including which ingredients are allowed, and at what level, as well as ingredients that may be required in certain products. In addition, these agencies regulate food product labeling and the claims which can be made regarding food products. In the US, the Medical Nutrition Business Unit's products are covered by FDA regulations covering medical foods, dietary supplements and medical devices. Gerber food products are specifically designed to meet the nutritional needs of infants and toddlers in the regions where they are sold and to meet or exceed requirements of the local regulatory agencies. In addition, in the US, the Consumer Product Safety Commission is responsible for overseeing the safety of Gerber's baby care products.

        CIBA Vision: Contact lenses, surgical devices and lens care products are regulated as medical devices in the US, the EU and Japan. These jurisdictions each have risk-based classification systems that determine the type of information which must be provided to the local regulators in order to obtain the right to market a product. In the US, all devices must receive pre-market approval by the FDA. There are two review procedures to gain this pre-market approval: a pre-market application (PMA) and a 510(k) submission. Under a PMA, the manufacturer must submit to the FDA supporting evidence sufficient to prove the safety and effectiveness of the device. The FDA has 180 days to review a PMA. Certain products, however, may qualify for a submission authorized by Section 510(k) of the US Food, Drug and Cosmetic Act. Under this procedure, the manufacturer gives the FDA a pre-market notification that it intends to commence marketing the product, and that it has established that the product is substantially equivalent to another product already on the market.

        In the EU, the "CE" mark is required for all medical devices sold. CIBA Vision affiliates hold a CE mark for the classes of vision care medical devices that they sell. The CE mark allows CIBA Vision to market products upon signing a declaration of conformity with the EU's Medical Device Directive requirements, which CIBA Vision affiliates do for each product sold. In addition, medical device sales in the EU require auditing by a certified third party (a "Notified Body") to ensure that the manufacturer's quality systems are in compliance with the requirements of the ISO 9000 standards. CIBA Vision has two Notified Bodies which routinely audit the company's quality systems.

        In Japan, contact lenses are categorized as medical devices and are subject to an approval process similar to that in the US. Although there has been an improvement in the willingness to accept foreign data and a movement toward harmonization of requirements, in order to enter the Japanese market, local clinical trials often are required and local protocols must then be observed. Lens care products for soft lenses take several years to gain approval due to the extensive amount of data and clinical testing required. Saline solutions for hard lenses are unregulated.

Intellectual Property

        Our Consumer Health businesses are brand-oriented and, therefore, we consider our trademarks to be of utmost value. Enforceable trademarks protect most of our brands in the majority of the markets where these brands are sold, and we vigorously protect these trademarks from infringement. Our most important trademarks are used in a number of countries. Local variations of these international trademarks are employed where legal or linguistic considerations require the use of an alternative.

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        Wherever possible our products are protected by patents. Among other things, patents may cover the products themselves, including the product's active substance and its formulation. Patents may also cover the processes for manufacturing a product, including processes for manufacturing intermediate substances used in the manufacture of the products. Patents may also cover particular uses of a product, such as its use to treat a particular disease, or its dosage regimen. It is our policy to seek the broadest possible protection for significant product developments in all major markets.

        Our Consumer Health businesses also sell products which are not currently covered by patents. Some of these products have never been patent-protected and others have lost protection due to patent expiry.

        CIBA Vision has settled all patent litigation against Bausch & Lomb regarding patents covering silicone hydrogel long-term wear contact lenses (the "Nicolson" patents). The settlement requires Bausch & Lomb to pay CIBA Vision a royalty on their PureVision™ sales until 2014 in the US and until 2016 in other countries. As part of the settlement, Bausch & Lomb granted a royalty-free license to CIBA Vision for certain of its patents related to silicone hydrogel technology.

        Separately, Johnson & Johnson filed a suit against CIBA Vision in the US in September 2003, claiming that our silicone hydrogel product Focus NIGHT & DAY infringes a Johnson & Johnson packaging patent, and seeking a declaration that the launch of their Acuvue Advance® product does not infringe the Nicolson patents and/or that the patents are invalid. Similar cases filed by Johnson & Johnson in New Zealand and Australia resulted in the surrender of the Nicolson patent in New Zealand and Australia. A continuation application, which was not surrendered, remains pending in Australia. Furthermore, Johnson & Johnson filed another suit against CIBA Vision in the US in February 2005, seeking a declaration that the launch of their Acuvue Oasys® product does not infringe the Nicolson patents and/or that the patents are invalid. CIBA Vision has filed countersuits in both US cases, alleging infringement of the Nicolson patents by both products. These cases are still pending.

4.C  Organizational Structure

        The Novartis Group is a multinational group of companies specializing in the research, development, manufacturing and marketing of innovative health care products. Novartis AG, our Swiss holding company, owns, directly or indirectly, 100% of all significant operating companies. For a list of our significant operating subsidiaries, see note 33 to the consolidated financial statements.

        The Group was divided operationally into three Divisions: Pharmaceuticals, Sandoz and Consumer Health.

        Our Pharmaceuticals Division is organized into five Business Units: Primary Care, Oncology, Transplantation, Mature Products and Ophthalmics. However, because the Business Units of the Pharmaceuticals Division have common long term economic perspectives, common customers, common research, development, production and distribution practices, and a common regulatory environment, their financial data is not required to be separately disclosed.

        As of January 1, 2005, Sandoz became a separate Division organized as a Retail Generics business that also operates an Anti-Infectives business. Prior to January 1, 2005, Sandoz was a Business Unit of the Consumer Health Division.

        The Consumer Health Division is comprised of five Business units: OTC self medication, Animal Health, Medical Nutrition, Gerber and CIBA Vision. Financial data is not required to be disclosed separately since the results of operations of each of these businesses is not considered to be material to the Group.

        We intend to create a fourth Division—Vaccines & Diagnostics—following the anticipated completion of the acquisition of the remaining 56% of the shares in Chiron Corporation by the end of the first half of 2006. No guarantee can be made that Novartis will be successful in completing this transaction, which is subject to shareholder and regulatory approval.

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4.D  Property, Plants and Equipment

        Our principal executive offices are located in Basel, Switzerland. Our Divisions and Business Units operate through a number of affiliates having offices, research facilities and production sites throughout the world.

        It is generally our policy to own our facilities. However, a few sites are leased under long-term leases. Some of our principal facilities are subject to mortgages and other security interests granted to secure indebtedness to certain financial institutions. As of December 31, 2005, the total amount of indebtedness secured by these facilities was not material to the Group. We believe that our production plants and research facilities are well maintained and generally adequate to meet our needs for the foreseeable future.

        The following table sets forth our major production and research facilities.

Location/Division or Business Unit

  Size of Site (in square meters)

  Major Activity


Major Production facilities:        

Pharmaceuticals        

Taboão da Serra, Brazil

 

500,712 square meters

 

Capsules, tablets, syrups, suppositories, suspensions, creams, drop solutions, powders

Ringaskiddy, Ireland   532,000 square meters   Drug substances, intermediates

Basel, Switzerland—Klybeck   254,000 square meters   Drug substances, intermediates

Basel, Switzerland—St. Johann   219,000 square meters   Drug substances, intermediates, biotechnology

Basel, Switzerland—Schweizerhalle   237,000 square meters   Drug substances, intermediates

Stein, Switzerland   460,000 square meters   Steriles, tablets, capsules, transdermals

Grimsby, UK   929,000 square meters   Drug substances, intermediates

Suffern, NY   656,000 square meters   Tablets, capsules, transdermals

Horsham, UK   112,000 square meters   Tablets, capsules

Wehr, Germany   165,000 square meters   Tablets, creams, ointments

Torre, Italy   210,000 square meters   Tablets, biotechnology

Barbera, Spain   51,000 square meters   Tablets, capsules

Huningue, France   250,000 square meters (includes Animal Health facilities)   Suppositories, liquids, solutions, suspensions, biotechnology

Kurtkoy, Turkey   109,000 square meters   Tablets, capsules, effervescents
         

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Sasayama, Japan   104,000 square meters   Capsules, tablets, syrups, suppositories, creams, drop solutions, powders

Sandoz        

Kundl and Schaftenau, Austria

 

320,000 square meters (production and R&D facilities)

 

Biotech products, intermediates, active drug substances, final steps (finished pharmaceuticals)

Menges, Slovenia   131,000 square meters (production and R&D facilities)   Biotech products and active drug substances

Barleben, Germany   95,000 square meters   Broad range of finished dosage forms

Ljubljana, Slovenia   83,000 square meters (production and R&D facilities)   Broad range of finished dosage forms

Broomfield, CO   60,000 square meters   Broad range of finished dosage forms

Radebeul, Germany   40,000 square meters   Broad range of finished dosage forms

Cambé, Brazil   32,000 square meters   Broad range of finished dosage forms

Wilson, NC   23,225 square meters   Broad range of finished dosage forms

Stryków, Poland   20,000 square meters   Broad range of finished dosage forms

Gebze, Turkey   15,000 square meters   Active drug substances

Palafolls, Spain   13,000 square meters   Injectable products

Kalwe, India   10,000 square meters   Broad range of finished dosage forms

Boucherville, Canada   4,600 square meters   Injectable products

Consumer Health        

OTC

 

 

 

 
Lincoln, NE   44,870 square meters   Liquids, creams and tablets

Nyon, Switzerland   14,700 square meters (production and R&D facilities)   Liquids and creams

Humacao, Puerto Rico   8,000 square meters   Sugar coated tablets, small chocolate tablets, packaging of softgels

         

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Animal Health        

Wusi Farm, China

 

42,000 square meters

 

Insecticides, antibacterials, acaricides, powders

Dundee, UK   34,000 square meters   Packaging, formulation liquids, solids, creams, sterile filling

Larchwood, IA   29,700 square meters (production and R&D facilities)   Veterinary immunologicals

Braintree, UK   10,000 square meters   Veterinary immunologicals

Huningue, France   6,000 square meters   Formulation and packaging of tablets, creams, ointments, suspensions and liquids

Medical Nutrition        

Minneapolis, MN

 

33,500 square meters (production and R&D facilities)

 

Medical nutrition products

Osthofen, Germany   17,000 square meters (production and R&D facilities)   Medical nutrition and Nutrition & Santé products

Infant & Baby        

Fremont, MI

 

107,000 square meters (production and R&D facilities)

 

Gerber jarred baby food, fruit and vegetable juices, dry boxed cereal

Fort Smith, AR   80,451 square meters   Gerber jarred baby food, dry cereal

Querétaro, Mexico   205,000 square meters   Gerber jarred baby food, fruit and vegetable juices, dry canned and bagged cereal

Reedsburg, WI   30,000 square meters   Baby Care products; spill-proof cups, bottles, nipples, breast pads, pacifiers, overcaps

Campo Grande, Brazil   89,000 square meters   Baby Care products; spill-proof cups, bottles, nipples, breast pads, pacifiers, overcaps

Rzeszow, Poland   45,000 square meters   Gerber baby food, fruit juice

         

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CIBA Vision        

Gelang Patah Johor, Malaysia

 

Under construction

 

Contact lenses

Singapore   19,200 square meters   Contact lenses

Pulau Batam, Indonesia   19,000 square meters   Contact lenses

Duluth, GA   34,000 square meters   Contact lenses

Des Plaines, IL   27,400 square meters   Freshlook product line

Grosswallstadt, Germany   23,000 square meters   Contact lenses

Cidra, Puerto Rico   6,100 square meters   Contact lenses

Toronto, Canada   14,500 square meters   Lens care products

Major Research and Development Facilities:        

Pharmaceuticals

 

 

 

 

East Hanover, NJ

 

177,398 square meters

 

General pharmaceutical products

Cambridge, MA   75,300 square meters   General pharmaceutical products

Basel, Switzerland—Klybeck   140,000 square meters   General pharmaceutical products

Basel, Switzerland—St. Johann   150,000 square meters   General pharmaceutical products

Vienna, Austria   39,000 square meters   Dermatology

Tsukuba, Japan   20,600 square meters   General pharmaceutical products

Horsham and London, UK   37,700 square meters   Respiratory and nervous system diseases

         

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Sandoz        

Kundl and Schaftenau, Austria

 

320,000 square meters total area (production and R&D facilities)

 

Biotech processes, innovations in antibiotic technologies

Menges, Slovenia   131,000 square meters (production and R&D facilities)   Biotech products and active drug substances

Ljubljana, Slovenia   83,000 square meters (production and R&D facilities)   Broad range of finished dosage forms

Dayton, NJ   29,000 square meters   Broad range of finished dosage forms

Holzkirchen, Germany   17,200 square meters   Broad range of innovative dosage forms, including implants and transdermal therapeutic systems

Kolshet, India   5,000 square meters   Generic pharmaceuticals

Boucherville, Canada   4,377 square meters   Injectable products

Consumer Health
OTC
       

Lincoln, NE

 

44,870 square meters

 

Liquids, creams and tablets

Nyon, Switzerland   14,700 square meters (production and R&D facilities)   Over-the-counter medicine products

Animal Health        

St. Aubin, Switzerland

 

26,000 square meters

 

Parasiticides

Larchwood, IA   29,700 square meters (production and R&D facilities)   Veterinary immunologicals development

Yarandoo, Australia   3,250 square meters   Animal Health products

Medical Nutrition        

Minneapolis, MN

 

33,500 square meters (production and R&D facilities)

 

Medical nutrition products

Osthofen, Germany   17,000 square meters (production and R&D facilities)   Medical nutrition and Nutrition & Santé products

Infant & Baby        

Fremont, MI

 

107,000 square meters (production and R&D facilities)

 

Baby food products

CIBA Vision        

Duluth, GA

 

9,000 square meters

 

Vision-related medical devices

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        Progress is being made in the long-term redevelopment of our St. Johann headquarters site in Basel, Switzerland. This project, called "Campus," was started in 2001 with the aim of transforming the site into a center of knowledge with a primary emphasis on international corporate functions and research activities. Research now accounts for a greater proportion of our activities at the site, and changes need to be made to the Campus, since the site is currently designed primarily for pharmaceuticals production. To date, the total amount paid and committed to be paid on the Campus Project is $328 million. We expect that, through 2011, we will spend more than $1.5 billion at the Campus and to transfer production facilities from the Campus to other sites in the Basel region. We intend to fund these expenditures from internally developed resources.

        Work has begun at our Pharmaceuticals Division's US headquarters in East Hanover, New Jersey to create a world class campus to support our growth. The first phase is planned for completion in 2007 and will create 900 office work stations. Further site development plans covering the next 5 years to create additional office and parking capacity are currently under study. Total capital spending in 2005 reached $70 million with an additional $120 million planned for 2006.

        In January 2005, our Pharmaceuticals Division began construction of a new facility in Stein, Switzerland which will be used to manufacture sterile medication for use in clinical studies. We expect to spend approximately $114 million in the construction of this facility.

        In May 2005, CIBA Vision opened a newly-constructed contact lens manufacturing and distribution facility in Singapore. This facility was constructed at a cost of $83 million.

Environmental Matters

        We integrate core values of environmental protection into our business strategy to add value to the business, manage risk and enhance our reputation.

        We are subject to laws and regulations concerning the environment, safety matters, regulation of chemicals and product safety in the countries where we manufacture and sell our products or otherwise operate our business. These requirements include regulation of the handling, manufacture, transportation, use and disposal of materials, including the discharge of pollutants into the environment. In the normal course of our business, we are exposed to risks relating to possible releases of hazardous substances into the environment which could cause environmental or property damage or personal injuries, and which could require remediation of contaminated soil and groundwater. Under certain laws, we may be required to remediate contamination at certain of our properties regardless of whether the contamination was caused by us, or by previous occupants of the property.

        We believe that we are in substantial compliance with environmental, health and safety requirements applicable to us. We are committed to providing safe and environmentally sound workplaces that will not adversely affect the health or environment of employees or the communities in which we operate. We believe that we have obtained all material environmental permits required for the operation of our facilities as well as all material authorizations required for the products produced by us. We believe that we are not currently subject to liabilities for non-compliance with applicable environmental, health and safety laws that would materially and adversely affect our business, financial condition or results of operations. However, there is a risk that legislation enacted in the future could create liabilities for past activities undertaken in compliance with then-current laws and regulations or that there is environmental or other damage of which we are not aware.

        In recent years, the operations of all companies have become subject to increasingly stringent legislation and regulation related to occupational safety and health, product registration and environmental protection. Such legislation and regulations are complex and constantly changing, and there can be no assurance that future changes in laws or regulations would not require us to install additional controls for certain of our emission sources, to undertake changes in our manufacturing processes or to remediate soil or groundwater contamination at facilities where such clean-up is not currently required. Some of our facilities are over 50 years old, and there may be soil and groundwater

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contamination at such facilities. However, based on current information, we do not believe that expenditures related to such possible contamination, beyond those already accrued, will be significant.

        Our expenditures related to capital investments for environmental, health and safety compliance measures were approximately $57 million in 2005 ($15 million for environment), $79 million in 2004 ($10 million for environment) and $88 million in 2003 ($12 million for environment). In addition, Hexal and Eon Labs reported capital expenditures of $4.2 million for the full year of 2005 ($2.3 million for environment) for environmental, health and safety compliance measures. While we cannot predict with certainty our aggregate capital environmental investments in 2006, based on current information and existing assets, we estimate that such aggregate expenditures will be comparable to the 2005 figure.

        It is difficult to estimate the future costs of environmental protection and remediation because of many uncertainties, including uncertainties about the state of laws, regulations and information related to individual locations and sites. However, given our experience to date regarding environmental matters and the facts currently known, we believe that compliance with existing and known national and local environmental laws and regulations will not have a material effect on our financial condition, but could be material to our results of operations in a given period.


Item 4A.    Unresolved Staff Comments

        Not applicable


Item 5.    Operating and Financial Review and Prospects

5.A  Operating Results

        The following operating and financial review and prospects should be read in conjunction with our consolidated financial statements included in this Form 20-F. The consolidated financial statements and the financial information discussed below have been prepared in accordance with International Financial Reporting Standards (IFRS). Please see "Item 18. Financial Statements—note 34" for a discussion of the significant differences between IFRS and US Generally Accepted Accounting Principles (US GAAP).

        Following the adoption of a number of new International Financial Reporting Standards (IFRS) from January 1, 2005, as required by IFRS, the 2004 and 2003 consolidated financial statements have been restated to account for the new accounting standards that have retrospective application. Not all of the new accounting standards required retrospective application of the new accounting and reporting requirements.

        In order to assist our investors and analysts in their understanding of our results by having comparable information, pro forma 2004 and 2003 consolidated income and cash flow statements are provided that include additional adjustments compared to the audited restated 2004 and 2003 consolidated income and cash flow statements.

Overview

        We are a world leader both in sales and in innovation in our core businesses: pharmaceuticals, generics and consumer health, which includes, OTC self-medication, animal health, medical nutrition, infant and baby foods and products, and eye care products, with global net sales of $32.2 billion in 2005. We aim to hold a leadership position in all of our businesses.

        Novartis AG was formed in 1996 out of a merger of two global participants in the pharmaceutical and agrochemical industries, Sandoz AG and Ciba-Geigy AG. Accounting for the merger under IFRS was based on a uniting of interests and therefore did not result in any goodwill nor in any goodwill amortization. Under US GAAP, the merger is accounted for as a purchase of Ciba-Geigy AG by Sandoz

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AG. For a discussion of the significant differences between IFRS and US GAAP purchase accounting, see "Item 18. Financial Statements—note 34."

        In November 2000, we spun off our Crop Protection and Seeds businesses and merged them with Astra Zeneca plc's Zeneca Agrochemicals to create Syngenta AG, a public company.

Factors affecting results

        The global health care market is growing rapidly due to a number of reasons, particularly the aging population in developed countries, unmet needs in many therapeutic areas (such as cancer and cardiovascular disease), the adoption of more industrialized lifestyles in emerging economies, and increased consumer demand fueled by broad and rapid access to information. At the same time, the health care industry is under increasing pressure to reduce costs as payors in the public and private sectors seek to curb rising health care costs.

        Our revenues are directly related to our ability to identify and develop high-potential products and to bring them to market quickly and effectively. Efficient and productive research and development is crucial in this environment since Novartis, like its competitors, searches for efficacious and cost-efficient pharmaceutical solutions to health problems. The resource requirements to access the full range of new technologies has been one reason for industry consolidation as well as for the increase in collaborations between leading companies and niche players at the forefront of their particular technology areas. The growth in new technology, particularly genomics, is expected to have a fundamental impact on the pharmaceutical industry and upon our future development.

        In addition, competitive conditions have intensified as a result of regulation, price reductions, reference prices, parallel imports, higher patient co-payments and increased pressure on physicians to reduce their prescribing of prescription medicines. Pressure on our Pharmaceuticals Division and other pharmaceutical companies to lower prices is expected to increase primarily due to government initiatives to reduce patient reimbursement, restrict prescribing levels, increase the use of generics and impose overall price cuts. The introduction of technologically innovative products and devices by competitors and growing product distribution and importation anomalies, mainly in the EU, pose additional challenges.

        Competition in the generic pharmaceutical market continues to intensify as the pharmaceutical industry adjusts to increased pressures to contain health care costs. Brand-name pharmaceutical companies have taken aggressive steps to counter the growth of the generics industry. Certain brand-name pharmaceutical companies continue to sell their products to the generic market directly by acquiring or forming strategic alliances with generic pharmaceutical companies. No significant regulatory approvals are required for a brand-name pharmaceutical manufacturer to sell directly or through a third party to the generic market. In addition, certain brand-name pharmaceutical companies continually seek new ways to delay generic introductions and to decrease the impact of generic competition. These efforts by the brand-name pharmaceutical industry have had, and likely will continue to have, a negative effect on the results of operations of our Sandoz Division.

        Under US law, the Food and Drug Administration (FDA) must award 180 days of market exclusivity to the first generic manufacturer who challenges the patent of a branded product. However, recent changes in the Hatch-Waxman Act may affect the availability of this market exclusivity in the future. These amendments now require generic applicants to launch their products within certain time frames or risk losing the marketing exclusivity that they had gained through being a first-to-file applicant.

        At times we seek approval to market generic products before the expiration of patents held by others for those products, based upon our belief that such patents are invalid, unenforceable, or would not be infringed by our products. As a result, our Sandoz Division often faces significant patent litigation. If we are unsuccessful in such litigation, then our ability to launch new products will be substantially limited. In addition, depending upon a complex analysis of a variety of legal and commercial factors, we may, in certain circumstances, elect to market a generic product even though litigation is still pending. This could be before any court decision or while an appeal of a lower court decision is pending. Should we elect to

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proceed in this manner, we could face substantial patent liability damages if the final court decision is adverse to us.

        Exchange rate exposure also affects our results since we have both sales and costs in many currencies other than the US dollar, our reporting currency. This gives rise to both transaction exposure in subsidiary financial statements due to foreign currency denominated transactions and translation exposure from converting non-US dollar subsidiary results and balance sheets into our US dollar consolidated financial statements. Our results have not been significantly affected by inflation.

Critical Accounting Policies and Estimates

        Our principal accounting policies are set out in note 1 of our consolidated financial statements and conform to International Financial Reporting Standards (IFRS). Significant judgments and estimates are used in the preparation of the consolidated financial statements which, to the extent that actual outcomes and results may differ from these assumptions and estimates, could affect the accounting in the areas described in this section.

Revenue

        We recognize revenue for product sales when title and risk of loss for the products are transferred to the customer. At the time of the sale, we also record estimates for a variety of sales deductions, including rebates, discounts and incentives, and product returns. Sales deductions are reported as a reduction of revenue.

        Deductions from Revenues:    As is typical in the pharmaceutical industry, our gross sales are subject to various deductions, primarily comprised of rebates and discounts to retail customers, government agencies, wholesalers and managed health care organizations. These deductions represent estimates of the related obligations, requiring the use of judgment when estimating the impact of these sales deductions on gross sales for a reporting period. We report these adjustments as a reduction of Gross Sales to arrive at Net Sales.

        The following briefly describes the nature of each deduction and how the deduction is estimated. The US market has the most complex arrangements related to revenue deductions. However, in a number of countries outside the US, including major European countries, we provide rebates to government entities. These rebates are often legislatively mandated. The following makes specific references to the US market, and where applicable, to our Pharmaceuticals Division's US subsidiary, Novartis Pharmaceuticals Corporation (NPC).

    The US Medicaid program is a state government-administered program that uses state and federal funds, to provide assistance to certain vulnerable and needy individuals and families. In 1990, the Medicaid Drug Rebate Program was established to reduce state and federal expenditures for prescription drugs. Under the rebate program, we have signed an agreement to provide a rebate on drugs paid for by a state. We calculate provisions for estimating Medicaid rebates using a combination of historical experience, product and population growth, price increases, the impact of contracting strategies and specific terms in the individual state agreements. We adjust these provisions based upon the established processes for re-filing data with the individual states. For Medicaid, the calculation of rebates involves interpretation of relevant regulations, which are subject to challenge or change in interpretative guidance by government authorities. Since Medicaid rebates are typically billed up to six months after the products are dispensed to patients, any rebate adjustments may involve revisions of provisions for several periods.

    Our subsidiaries in the US participate in prescription drug savings programs (industry and government sponsored) that offer savings to eligible patients. These savings vary based on a patient's current drug coverage and personal income levels. Provisions for the subsidiaries' obligations under these programs are based on historical experience, trend analysis and current program terms. On January 1, 2006, an additional prescription drug benefit was added to the US

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      Medicare program. Under that program, individuals that have dual Medicaid/Medicare drug benefit eligibility were to have their Medicaid prescription drug coverage replaced on January 1, 2006 by the new Medicare Part D coverage, provided through private prescription drug plans. The changes will lead to a significant shift of plan participants between programs in which the subsidiaries participate. The estimated impact of this shift that is related to 2005 sales has been reflected in our sales provisions at the end of 2005.

    Wholesaler chargebacks relate to contractual arrangements that certain of our subsidiaries have with several indirect customers in the US to sell products at prices that are lower than the list price charged to wholesalers. A wholesaler chargeback represents the difference between the invoice price to the wholesaler and the indirect customer's contract discount price. We calculate provisions for estimated chargebacks using a combination of factors such as historical experience, product growth rates and the specific terms in each agreement. We then account for wholesalers' chargebacks by reducing accounts receivable. We generally settle wholesaler chargebacks within three months of the date the liability is incurred.

    We offer customer rebates to key managed health care plans, group purchasing organizations and other direct and indirect customers to sustain and increase our product market share. These rebate programs provide that the customer receive a rebate after attaining certain performance parameters relating to product purchases, formulary status and/or pre-established market share milestones relative to competitors. Since rebates are contractually agreed upon, we estimate rebates based on the specific terms in each agreement, historical experience and product growth rates. We consider the sales performance of products subject to managed health care rebates and other contract discounts and levels of inventory in the distribution channel and adjust the provision periodically to reflect actual experience.

    In order to evaluate the adequacy of ending provision balances, we use both internal and external estimates of the level of inventory in the distribution channel and of the rebate claims processing lag time. External data sources include periodic reports of wholesalers and third party market data which we purchase. Management internally estimates the inventory level in the retail channel and in transit.

    When we sell a product which the customer has the right to return, we record a provision for estimated sales returns, which we estimate through a comparison of historical return data to related sales. We also consider other factors such as product recalls and, in the case of NPC, introductions of generic products. In the US, we use historical rates of return and we adjust for known or expected changes in the marketplace when appropriate. Sales returns amount to approximately 1% of gross product sales.

    Our policy relating to supply of pharmaceuticals products is to maintain inventories on a consistent level from year to year based on the pattern of consumption. A process exists at NPC to monitor on a monthly basis inventory levels at wholesalers based on the gross sales volume, prescription volumes based on third party data and information received from the key wholesalers. Based on this information, the inventories on hand at wholesalers and other distribution channels in the US as of December 31, 2005 were estimated to be approximately one month. We believe the third party data sources of information are sufficiently reliable. However their accuracy cannot be verified.

    At the end of 2005, NPC was engaged in negotiations concerning amendments to existing agreements with US pharmaceutical wholesalers. These potential agreements cover items such as product returns, timing of payment, processing of chargebacks, provision of inventory data and the quantity of inventory held by the respective wholesaler. These agreements, if finalized during 2006, would provide a financial disincentive for these wholesalers to purchase quantities of product in excess of what is necessary to meet current demand, and should help to create a more efficient pharmaceutical supply chain.

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    We offer cash discounts to customers in the US and certain other countries to encourage prompt payment. We accrue cash discounts, which in the US are typically 2% of gross sales, at the time of invoicing.

    We generally grant shelf-stock adjustments to customers, based on each customer's existing inventory, following decreases in the invoice or contract price of the related product. Provisions for shelf-stock adjustments, which are primarily relevant within our Sandoz Division, are determined at the time of the price decline or at the point of sale if a price decline is reasonably estimable and are based on estimated inventory levels.

    We also offer other sales discounts, such as consumer coupons and discount cards. We record these discounts at the time of sales, or when the coupon is issued and they are estimated utilizing historical experience and the specific terms for each program.

    We generally record discounts, rebates or other deductions shown on the invoice as a reduction in the gross to net sales value and they do not pass through the provision account.

        The following tables show the worldwide extent of rebates made and payment experiences for Novartis:

Provision for revenue deductions

 
   
   
  Income Statement charge
   
   
 
   
   
  Provisions
offset against
accounts
receivable

   
 
  Provisions at
January 1,
2005

  Payments
  Adjustments of
prior years

  Current year
  Provisions at
December 31,
2005

 
  ($ millions)

  ($ millions)

  ($ millions)

  ($ millions)

  ($ millions)

  ($ millions)

US Medicaid, Medicare and State program rebates & credits including prescription drug saving cards   321   (618 ) (1 ) 795       497
US managed health care rebates   156   (398 ) 28   470       256
Other health care plans & programs (non US) rebates   17   (66 )     84       35
Chargebacks including hospital chargebacks   316 (1) (1,610 ) 1   1,672   (379 )  
Direct discounts, cash discounts & other rebates   170 (1) (646 ) (2 ) 800   (256 ) 66
Sales returns & other deductions   396   (395 ) (9 ) 416       408
   
 
 
 
 
 
Total   1,376   (3,733 ) 17   4,237   (635 ) 1,262
   
 
 
 
 
 

(1)
At January 1, 2005, $350 million of chargebacks and cash discounts were deducted from accounts receivable.

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Gross to Net sales reconciliation

 
  Income Statement charge
   
   
 
 
  Charged
through
revenue
deductions
provisions
2005

  Charged directly
without being
recorded in
revenue
deductions
provisions
2005

  Total
2005

  In % of gross sales
 
 
  ($ millions)

  ($ millions)

  ($ millions)

   
 
Gross sales subject to deductions           38,844   100.0  
US Medicaid & Medicare and State program rebates & credits including prescription drug saving cards   (794 )     (794 ) (2.0 )
US managed health care rebates   (498 )     (498 ) (1.3 )
Other health care plans & programs (non US) rebates   (84 ) (12 ) (96 ) (0.2 )
Chargebacks including hospital chargebacks   (1,673 ) (109 ) (1,782 ) (4.6 )
Direct discounts, cash discounts & other rebates   (798 ) (1,492 ) (2,290 ) (5.9 )
Sales returns & other deductions   (407 ) (765 ) (1,172 ) (3.0 )
   
 
 
 
 
Total gross to net sales adjustments   (4,254 ) (2,378 ) (6,632 ) (17.0 )
   
 
 
 
 
Net sales           32,212   83.0  
           
 
 

Other Revenue

        We also generate revenue from out-licensing and co-promotion arrangements. We record royalty income and revenues from licensing and co-promotion activity as other revenues in our consolidated income statement. We estimate royalty and co-promotion income estimates in advance of their collection using historical and forecasted trends. Royalties tend to be linked to levels of sales by a third party. We record initial payments and other similar non-refundable payments received under licensing and co-promotion agreements as deferred revenue which are recognized over the estimated performance periods established in the agreements. We recognize non-refundable milestone payments in such agreements as revenue upon achievement of specified agreed criteria.

Impairment of long-lived assets

        We regularly review long-lived assets, including identifiable intangible assets and goodwill for impairment, whenever events or changes in circumstance indicate that the balance sheet carrying amount of the asset may not be recoverable. In order to assess if there is any impairment, we make estimates of the future cash flows we expect will result from the use of the asset and its eventual disposal. Goodwill and in-process research and development and acquired development projects not yet ready for use are subject to impairment review at least annually. We review other long-lived assets for impairment when there is an indication that an impairment may have occurred. If the balance sheet carrying amount of the asset exceeds the higher of its value in use to Novartis or its anticipated fair value less cost of sale, we will recognize an impairment loss for the difference. The impairment analysis is principally based upon estimated discounted future cash flows. Actual outcomes could vary significantly from such estimates of discounted future cash flows. In particular, the development of discounted future cash flows for intangible

86



assets under development, involves highly sensitive assumptions specific to the nature of our activities such as:

    Outcome of research and development activities (compound efficacy, results of clinical trials, etc.)

    Probability of obtaining regulatory approval

    Long-term sales forecast period of up to 20 years

    Selling price erosion rates after end of patent protection due to generic competition

    Behavior of competitors (launch of competing products, marketing initiatives, etc.)

        Factors such as lower-than-anticipated sales for acquired products or for sales associated with capitalized patents and trademarks, or lower-than anticipated future sales resulting from acquired research and development, or the closing of facilities or changes in the planned use of buildings, machinery or equipment, could result in shortened useful lives or impairment. Changes in the discount rates used for these calculations also could lead to impairments. Additional information on the US GAAP carrying values of trademarks, product and marketing rights is presented in Note 34.4 to the consolidated financial statements.

Fair value or impairments adjustments on financial instruments

        We have extensive investments in marketable securities and have significant derivative financial instrument positions. These are held mainly, but not exclusively, for hedging underlying positions. Depending on the development of equity and derivative markets, it may be necessary to recognize impairments on the marketable securities or losses on the derivative positions in our consolidated income statement.

Investments in associated companies

        We have investments in associated companies (defined generally as investments of between 20% and 50% of a company's voting shares or in a company over which we otherwise have significant influence) that are accounted for using the equity method. Due to the various estimates that have been made in applying the equity method, the amounts recorded in the consolidated financial statements in respect of Roche Holding AG and Chiron Corporation may require adjustments in the following year after more financial and other information becomes publicly available. We announced in October 2005 that the independent Directors on the Board of Directors of Chiron Corporation have recommended that shareholders approve an offer by Novartis to acquire the remaining 56% of Chiron that we do not own. There can be no guarantee that this acquisition, which requires shareholder and regulatory approvals, can be completed. If the acquisition is successful, Chiron would become a wholly-owned subsidiary of the Novartis Group and would no longer be accounted for as an associated company.

Retirement benefit plans

        We sponsor pension and other retirement plans in various forms covering employees who meet eligibility requirements. These plans cover a significant number of our employees. Several statistical and other factors that attempt to anticipate future events are used in calculating the expense and liability related to the plans. These factors include assumptions about the discount rate, expected return on plan assets and rate of future compensation increases, as determined by our management within certain guidelines. In addition, our actuarial consultants use statistical information such as withdrawal and mortality rates for their estimates. The actuarial assumptions used may differ materially from actual results due to changing market and economic conditions, higher or lower withdrawal rates or longer or shorter life spans of participants. These differences may result in gains or losses in our Statement of Recognized Income and Expense. The differences could have a significant impact on our total equity.

87


Litigation and product liability provisions

        A number of our subsidiaries are subject to litigation and product liability claims arising out of the normal conduct of their businesses. As a result, claims could be made against them that might not be covered by existing provisions or by external insurance coverage. We believe that the outcomes of such actions, if any, would not be material to our financial condition but could be material to future results of operations and cash flows in a given period.

Environmental provisions

        We have provisions for environmental remediation costs. The material components of the environmental provisions consist of estimated costs to fully clean and refurbish contaminated sites and to treat and contain contamination at sites where the environmental exposure is less severe, in each case where it is probable that we are required or obligated to do so. Future remediation expenses are affected by a number of uncertainties that include, but are not limited to, the method and extent of remediation, the percentage of waste material attributable to us at the remediation sites relative to that attributable to other parties, and the financial capabilities of the other potentially responsible parties. We believe that our total provisions for environmental matters are adequate based upon currently available information. However, given the inherent difficulties in estimating liabilities in this area, we cannot guarantee that additional costs will not be incurred beyond the amounts provided. We cannot predict the effect of resolution of environmental matters on results of operations due to uncertainty concerning both the amount and the timing of future expenditures and the results of future operations. We believe that such additional amounts, if any, would not be material to our financial condition but could be material to future results of operations and cash flows in a given period.

Goodwill under US GAAP

        Since 2004, for US GAAP purposes we no longer amortize goodwill in accordance with Statement of Financial Accounting Standards ("SFAS") No. 142 Goodwill and Other Intangible Assets. SFAS 142 requires us to perform an annual review of our US GAAP goodwill for impairment. Based on this annual review, we recognize impairment losses if necessary. In particular, just under US GAAP, we have goodwill relating to Gerber Products with a carrying amount of $2.9 billion at December 31, 2005. As required, we performed our annual impairment test of goodwill in 2005, which did not require us to record an impairment charge. The process of evaluating goodwill involves making adjustments and estimates relating to the projection and discounting of future cash flows. This evaluation is sensitive to changes in the discount rate. An increase to discount rates is likely to result in a significant impairment charge under US GAAP.

Compliance with the Sarbanes-Oxley Act of 2002 on internal control over financial reporting

        In line with domestic US registrants with the Securities and Exchange Commission (SEC), in 2004 we successfully completed our assessment of internal control over financial reporting under Section 404 of the Sarbanes-Oxley Act. In 2005, we repeated this assessment and obtained a report from our independent auditors. No material weaknesses were revealed in either 2004 or 2005 from this review of our internal control over financial reporting. See "Item 15. Controls and Procedures" for a more detailed discussion of our assessment.

2004 and 2003 Pro Forma Consolidated Financial Information

        We adopted a number of new International Financial Reporting Standards (IFRS) as of January 1, 2005. Certain of these new Standards required the retrospective application of new accounting and reporting requirements. As a result, as required by IFRS we have restated our 2004 and 2003 consolidated financial statements to account for the new standards that have retrospective application.

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        In order to assist our investors and analysts in their understanding of our results by having comparable information, we have provided pro forma 2004 and 2003 consolidated income and cash flow statements that include the following additional adjustments compared to the audited restated 2004 and 2003 consolidated income and cash flow statements. The discussions on income statement and cash flow items in this Operating and Financial Review principally compares 2005 with 2004, and 2004 with 2003 pro forma financial information.

        The following describes in detail the 2004 and 2003 pro forma adjustments:

IFRS 2 (Share-based compensation)

        As permitted by IFRS 2, we have restated our 2004 and 2003 audited consolidated financial statements to reflect the cost of grants awarded only since November 7, 2002, whereas the pro forma income statements include prior grants that would have had an impact on our 2004 and 2003 results had there been further retrospective restatements.

IFRS 3 (Business combinations)

        IFRS 3 requires non-amortization of goodwill arising from pre-March 31, 2004 business combinations only from January 1, 2005. The pro forma income statements exclude all goodwill amortization in 2004 and 2003.

IAS 38 (Intangible assets)

        IAS 38 (revised) requires that acquired R&D assets, such as those related to initial and milestone payments, be capitalized as intangible assets from January 1, 2005 even if uncertainties exist as to whether the R&D will ultimately be successful in producing a saleable product. The pro forma income and cash flow statements adopt this policy for all of 2004 and 2003.

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        The following is a summary of the above on our audited 2004 and 2003 restated consolidated income and cash flow statements:

2004 Pro Forma Consolidated Income Statement

 
  Note
  2004
Restated

  Adjustments
  2004
Pro Forma

 
 
   
  ($ millions)

  ($ millions)

  ($ millions)

 
Net sales       28,247       28,247  
Other revenues       154       154  
Cost of goods sold       (7,268 )     (7,268 )
       
     
 
Gross profit       21,133       21,133  
Marketing & sales       (8,873 )     (8,873 )
Research & development   1   (4,171 ) 94   (4,077 )
General & administration       (1,540 )     (1,540 )
Other income & expense   2   (397 ) 43   (354 )
       
 
 
 
Operating income       6,152   137   6,289  
Result from associated companies   3   68   109   177  
Financial income       486   2   488  
Interest expense       (261 )     (261 )
       
 
 
 
Income before taxes       6,445   248   6,693  
Taxes   4   (1,065 ) (27 ) (1,092 )
       
 
 
 
Net income       5,380   221   5,601  
       
 
 
 
Attributable to                  
  Shareholders of Novartis AG       5,365   221   5,586  
  Minority interests       15       15  

EPS (USD)

 

5

 

2.28

 

0.09

 

2.37

 

2004 Pro Forma Consolidated Cash Flow Statement

 
  Note
  2004
Restated

  Adjustments
  2004
Pro Forma

 
 
   
  ($ millions)

  ($ millions)

  ($ millions)

 
Cash flow from operating activities   6   6,595   94   6,689  
Cash flow used for investing activities   6   (3,217 ) (94 ) (3,311 )
Cash flow used for financing activities       (2,997 )     (2,997 )
Translation effect on cash and cash equivalents       56       56  
       
 
 
 
Net change in cash and cash equivalents       437     437  
       
 
 
 

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2003 Pro Forma Consolidated Income Statement

 
  Note
  2003
Restated

  Adjustments
  2003
Pro Forma

 
 
   
  ($ millions)

  ($ millions)

  ($ millions)

 
Net sales       24,864       24,864  
Other revenues       66       66  
Cost of goods sold       (6,457 )     (6,457 )
       
     
 
Gross profit       18,473       18,473  
Marketing & sales       (7,854 )     (7,854 )
Research & development   1   (3,729 ) 74   (3,655 )
General & administration       (1,381 )     (1,381 )
Other income & expense   2   126   (43 ) 83  
       
 
 
 
Operating income       5,635   31   5,666  
Result from associated companies   3   (279 ) 97   (182 )
Financial income       621       621  
Interest expense       (243 )     (243 )
       
 
 
 
Income before taxes       5,734   128   5,862  
Taxes   4   (947 ) (10 ) (957 )
       
 
 
 
Net income       4,787   118   4,905  
       
 
 
 
Attributable to                  
  Shareholders of Novartis AG       4,743   118   4,861  
  Minority interests       44       44  

EPS (USD)

 

5

 

1.99

 

0.05

 

2.04

 

2003 Pro Forma Consolidated Cash Flow Statement

 
  Note
  2003
Restated

  Adjustments
  2003
Pro Forma

 
 
   
  ($ millions)

  ($ millions)

  ($ millions)

 
Cash flow from operating activities   6   6,553   74   6,627  
Cash flow used for investing activities   6   (1,231 ) (74 ) (1,305 )
Cash flow used for financing activities       (5,732 )     (5,732 )
Translation effect on cash and cash equivalents       258       258  
       
 
 
 
Net change in cash and cash equivalents       (152 )   (152 )
       
 
 
 

Notes to 2004 and 2003 Pro Forma Consolidated Financial Information

1.
In 2004, $94 million (2003: $74 million) reduction in expense from capitalization of previously expensed acquired R&D intangible assets in our Pharmaceuticals Division.

2.
In 2004, $95 million (2003: $80 million) reduction in expense from ending goodwill amortization, $1 million (2003: $0) reduction in expense due to consolidation of our employee share participation foundation and a $53 million (2003: $123 million) increase in expense from share-based compensation, resulting in a net $43 million reduction in expense (2003: net increase of $43 million).

3.
Impact of 2 above and 4 below on result from associated companies.

4.
Tax effect of pro forma adjustments.

5.
Impact of pro forma adjustments on EPS.

6.
Under IAS 38 (revised) acquired R&D assets need to be capitalized as intangible assets. The 2004 pro forma consolidated cash flow statements includes the reclassification of $94 million (2003: $74 million) for capitalized R&D payments to cash flow used for investing activities.

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Results of Operations

        The following table sets forth selected income statement data for each of the periods indicated.

 
  2005
  2004
Pro Forma

  2003
Pro Forma

 
 
  ($ millions)

  ($ millions)

  ($ millions)

 
Net sales to third parties              
Pharmaceuticals   20,262   18,497   16,020  
Sandoz   4,694   3,045   2,906  
Consumer Health   7,256   6,705   5,938  
   
 
 
 
Group net sales   32,212   28,247   24,864  

Other revenues

 

314

 

154

 

66

 
Cost of Goods Sold   (8,868 ) (7,268 ) (6,457 )
Marketing & Sales   (9,802 ) (8,873 ) (7,854 )
Research & Development   (4,846 ) (4,077 ) (3,655 )
General & Administration   (1,742 ) (1,540 ) (1,381 )
Other income & expense   (363 ) (354 ) 83  
   
 
 
 
Group Operating income   6,905   6,289   5,666  
   
 
 
 
Operating income by Division              
Pharmaceuticals   6,014   5,366   4,517  
Sandoz   342   263   496  
Consumer Health   1,055   1,006   907  
Corporate income, net   (506 ) (346 ) (254 )
   
 
 
 
Operating income   6,905   6,289   5,666  
Result from associated companies   193   177   (182 )
Financial income   461   488   621  
Interest expense   (294 ) (261 ) (243 )
Taxes   (1,124 ) (1,092 ) (957 )
   
 
 
 
Net income   6,141   5,601   4,905  
   
 
 
 
Attributable to:              
  Shareholders of Novartis AG   6,130   5,586   4,861  
  Minority interests   11   15   44  

2005 Compared to 2004

        The following compares our results in the year ended December 31, 2005 to those of the year ended December 31, 2004. Our analysis, which is primarily based on the pro forma figures, is divided as follows:

    1.
    Overview

    2.
    Net Sales by Division

    3.
    Operating Expenses

    4.
    Operating Income by Division

    5.
    Net Income

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1. Overview

        Our net sales rose 14% (+13% in local currencies, or lc) to $32.2 billion in 2005 based on the dynamic expansion of Pharmaceuticals and Sandoz, which was supported by the acquisitions of Hexal and Eon Labs in 2005, as well as good performances in Consumer Health, particularly OTC. Volume increases were the primary growth driver, contributing 9 percentage points to our net sales growth. Currency benefits added 1 percentage point, while acquisitions added 5 percentage points. Prices across the Group declined 1 percentage point. Pharmaceuticals accounted for 63% of our total net sales, Sandoz for 15% and Consumer Health 22%. The US remained our largest market, accounting for 39% of our total net sales, Europe for 37% and the rest of the world for 24%.

        Operating income advanced 10% (restated: 12%), at a slower rate than sales, as productivity improvements and the strong volume expansion were partially offset by one-time costs, particularly related to acquisitions. Cost of Goods Sold rose 22% and increased as a percentage of net sales by 1.8 percentage points to 27.5%, owing mainly to purchase price accounting impacts and increased amortization of intangible assets in Sandoz related to acquisitions. Marketing & Sales expenses fell 1 percentage point to 30.4% of net sales based primarily on productivity improvements in Pharmaceuticals. Research & Development expenses rose 19% (restated: 16%), which included a $332 million impairment charge for the development compound NKS104, and represented 15% of net sales. General & Administrative expenses as a percentage of net sales declined 0.1 percentage point, accounting for 5.4% of net sales. Our operating margin decreased to 21.4% of net sales from 22.3% (restated: 21.8%) in 2004, based on acquisition-related costs in Sandoz as well as impairment related charges in Pharmaceuticals.

        Our net income advanced 10% (restated: 14%) to $6.1 billion, reflecting the strong organic growth. Earnings per share rose 11% (restated: 15%), slightly faster than net income, due to the impact of the recent share repurchase programs, to $2.63 per share from $2.37 (restated: $2.28) in 2004.

2. Net Sales by Division

        The following table sets forth selected net sales data for each of the periods indicated.

 
  Year ended December 31,
   
   
 
  Change in $
  Change in local
currencies

 
  2005
  2004
 
  ($ millions)

  ($ millions)

  (%)

  (%)

Net sales                
Pharmaceuticals   20,262   18,497   10   9
Sandoz Division   4,694   3,045   54   54
Consumer Health   7,256   6,705   8   8
   
 
 
 
Total   32,212   28,247   14   13
   
 
 
 

        As discussed in the Critical Accounting Policies section, the US market has the most complex arrangements in the area of deductions from gross sales to arrive at net sales, which is the starting point for all our discussions on our sales developments. The following table shows the extent of sales deductions

93



made in the US for our key subsidiaries affected, which are NPC, Sandoz Inc., Eon Labs Inc. and Novartis Consumer Health, Inc. (OTC):

Gross to Net sales reconciliation in the US

 
  2005
  % of
gross sales

  2004
  % of
gross sales

 
 
  ($ millions)

   
  ($ millions)

   
 
Gross Sales subject to deductions   13,266   100   11,028   100  
   
 
 
 
 
Medicaid & Medicare and State program rebates & credits including prescription drug saving cards   (774 ) (6 ) (624 ) (6 )
Managed health care rebates   (499 ) (4 ) (538 ) (5 )
Chargebacks including hospital chargebacks   (1,405 ) (11 ) (800 ) (7 )
Direct discounts, cash discounts & other rebates   (568 ) (4 ) (115 ) (1 )
Sales returns & other deductions   (268 ) (2 ) (355 ) (3 )
   
 
 
 
 
Total Gross to Net sales adjustments   (3,514 ) (27 ) (2,432 ) (22 )
   
 
 
 
 
Net sales   9,752   73   8,596   78  
   
 
 
 
 

        The principal reason for the changes in the percentage deductions from gross sales are the following:

        The 4 percentage points increase of chargebacks including hospital chargebacks in 2005 as compared to 2004 is principally a reflection of the higher gross sales, as well as the mix of end users and the acquisition of Eon Labs.

Pharmaceuticals Division

        Pharmaceuticals net sales were up 10% (9% lc) to $20.3 billion, delivering dynamic growth ahead of the market and in all regions. Our Cardiovascular and Oncology franchises each generated more than $5 billion in annual net sales while also maintaining double-digit growth rates. Many leading products, particularly Diovan, Lotrel and Gleevec/Glivec, were the No. 1 products by sales in their therapeutic categories. New data continued to underpin the strong position of Femara, which delivered sales growth of nearly 40% for the year. Volume and product mix accounted for nine percentage points of net sales growth in US dollars, while currency benefits added one percentage point. Net price changes had no impact.

        General Medicines (excluding Mature Products) delivered a net sales increase of 11% (+10% lc) as strategic cardiovascular brand sales rose 15% (+15% lc). Net sales in Specialty Medicines (Oncology, Transplantation and Ophthalmics) were up 15% (+15% 1c) as Oncology net sales were up 21% (+20% lc) thanks to new data supporting the clinical benefits of many of the "best-in-class" medicines.

        Net sales advanced 10% to $8.1 billion in the US as strong performances by the cardiovascular and oncology franchises as well as Zelnorm/Zelmac more than offset lower sales of the eczema treatment Elidel, which was impacted by an FDA health advisory statement in March 2005 relating to a theoretical risk of lymphoma for this class of medicines. In Europe, net sales rose 7% (+7% lc), supported particularly by Diovan, that was partly offset by launches of generic terbinafine (Lamisil) in key markets, while Japan advanced 6% (+9% lc). Emerging growth markets reported an increase of 19% (+17% lc), thanks to dynamic performances in China, Russia and Turkey.

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General Medicines

    Diovan ($3.7 billion, +19%, +19% lc, +17% US) the leading angiotensin-receptor blocker (ARB) worldwide, continued its strong performance. Key drivers have been recently approved indications and the global rollout of higher strengths of Co-Diovan (a combination of Diovan and a diuretic) as well as disease-awareness and education programs (such as the "BP Success Zone") in the US. Diovan is the only agent in its class worldwide indicated to treat high blood pressure, high-risk heart attack survivors (VALIANT trial) and patients with heart failure (Val-HeFT trial). In the US Diovan is the leading seller in the ARB market segment, with a 38% share (Source: IMS).

    Lotrel ($1.1 billion, +17% US), the No. 1 fixed combination treatment for hypertension in the US since 2002, kept up double-digit growth based on new guidelines recommending more aggressive treatment of elevated blood pressure with multiple medicines and the US disease awareness campaign.

    Lamisil ($1.1 billion, -2%, -2% lc, +2% US), the leading treatment worldwide for fungal nail infections, had lower overall sales as a result of generic competition in most major European markets. In the US, sales were slightly higher, further increasing its leadership despite the launch in 2005 of a generic version of our competitor itraconazole.

    Zelnorm/Zelmac ($418 million, +40%, +39% lc, +43% US), a breakthrough therapy for irritable bowel syndrome (IBS) with constipation (IBS-C) and the first and only prescription medicine for chronic idiopathic constipation, maintained double-digit growth rates in the US and other key markets, reflecting the product's therapeutic benefits and increasing disease awareness. In the US, the performance was driven by the continued strong uptake of Zelnorm/Zelmac in its new chronic constipation indication and also benefited from the normalization of inventories compared to below-average levels in the year-ago period. We will appeal an opinion from a European Medicines Agency (EMEA) committee recommending against EU approval of Zelnorm. This product has been approved in 56 countries for treatment of women with irritable bowel syndrome with constipation (IBS-C).

    Elidel ($270 million, -23%, -23% lc, -31% US), had a decline in sales since a FDA health advisory statement in March 2005 relating to a theoretical risk of lymphoma for this class of medicines. Sales in the rest of the world declined at a more moderate rate. Product labeling discussions are ongoing with the FDA. We remain confident in the safety and efficacy of Elidel in its approved indications.

Specialty Medicines

Oncology

    Gleevec/Glivec ($2.2 billion, +33%, +32% lc, +42% US), indicated for all stages of Philadelphia-chromosome positive (Ph+) chronic myeloid leukemia (CML) and certain forms of gastro-intestinal stromal tumors (GIST), maintained growth rates through further penetration of the CML and GIST markets. Also supporting growth have been an increase in the average daily dose as well as increasing number of patients thanks to improved survival benefits. Data from the IRIS study showed that more than 90% of patients with newly-diagnosed chronic phase CML who are taking Gleevec/Glivec are still alive after 4.5 years. Moreover less than 1% of patients progressed to advanced disease in the fourth year, indicating an overall decreased rate of progression. Gleevec/Glivec received EU approval in 2005 for increasing the average daily dose to 800 mg from 400 mg or 600 mg for patients with chronic phase CML and in GIST patients whose cancer is progressing on the lower dose. Gleevec/Glivec has been submitted in the US, EU and Japan for Ph+ acute lymphoblastic leukemia (ALL).

    Zometa ($1.2 billion, +14%, 13% lc, +12% US), the leading intra-venous bisphosphonate for bone metastases, reached a record 75% market segment share in a maturing US market. Greater use in

95


      prostate and lung cancer was somewhat offset by slowing growth in breast cancer and myeloma due to high penetration rates. In the EU, Zometa is growing market share despite new competition.

    Femara ($536 million, +39%, +38% lc, +46% US), a leading first-line therapy for early and advanced breast cancer in post-menopausal women, benefited from further penetration of the extended adjuvant setting after five years of tamoxifen therapy. Data from the landmark MA-17 trial reported at a major medical meeting found that post-menopausal women with early breast cancer received significant benefit from Femara therapy even after a prolonged period of no anti-cancer treatment. In addition, Femara received US approval in December 2005 for use as an initial treatment immediately after surgery in patients with hormone-sensitive early breast cancer (adjuvant setting), becoming the only medicine in its class approved in the US for use as an initial treatment as well as after completion of five years of tamoxifen therapy. This new US indication was based on results from the BIG 1-98 study, which were published for the first time in the December 2005 issue of The New England Journal of Medicine. Submissions for this new indication have been made in Europe, where it has already been approved in the UK. Femara has also received approval in Japan for use in the treatment of post-menopausal women with breast cancer.

    Sandostatin ($896 million, +8%, +8% lc, +1% US) for patients with the hormone condition acromegaly as well as for symptoms of gastro-entero-pancreatic neuroendocrine tumors, reported a decline in the US, where the subcutaneous formulation faces generic competition. However, sales of the long-acting LAR version expanded at a double-digit rate in the US and the rest of the world.

Ophthalmics

        Net sales increased 8% in US dollars (7% lc), as Visudyne ($484 million, +8%, +7% lc, -12% US), the leading treatment for "wet" AMD (age-related macular degeneration), were higher despite the entry of off-label competition in the US. Visudyne growth was strong in the rest of the world, including the UK, Germany, and France, with sales outside the US up 24% in local currencies.

Transplantation

        Net sales for the year declined 1% in local currencies based on lower sales of Neoral/Sandimmun ($953 million, -6%, -6% lc, -17% US) due to the impact of ongoing generic competition.

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Top 20 Pharmaceutical Division Product Net Sales—2005

Brands

  Therapeutic Area
  United
States

  % change
in local
currencies

  Rest of
the World

  % change
in local
currencies

  Total
  % change
in $

  % change
in local
currencies

 
 
   
  ($ millions)

   
  ($ millions)

   
  ($ millions)

   
   
 
Diovan/Co-Diovan   Hypertension   1,551   17   2,125   20   3,676   19   19  
Gleevec/Glivec   Chronic myeloid leukemia/Gastro-intestinal stromal tumors   524   42   1,646   28   2,170   33   32  
Zometa   Cancer complications   704   12   520   14   1,224   14   13  
Lamisil (group)   Fungal infections   538   2   595   (6 ) 1,133   (2 ) (2 )
Lotrel   Hypertension   1,075   17           1,075   17   17  
Neoral/Sandimmun   Transplantation   150   (17 ) 803   (4 ) 953   (6 ) (6 )
Sandostatin (incl. LAR)   Acromegaly   376   1   520   13   896   8   8  
Lescol   Cholesterol reduction   257   (10 ) 510   7   767   1   1  
Voltaren (group)   Inflammation/pain   5   (44 ) 684   8   689   8   7  
Trileptal   Epilepsy   462   18   153   17   615   19   18  

 
Top ten products       5,642   13   7,556   13   13,198   13   13  
Femara   Breast cancer   242   46   294   33   536   39   38  
Visudyne   Macular degeneration   183   (12 ) 301   24   484   8   7  
Exelon   Alzheimer's disease   172   (4 ) 295   18   467   11   9  
Zelnorm/Zelmac   Irritable bowel syndrome   357   43   61   17   418   40   39  
Tegretol (incl. CR/XR)   Epilepsy   109   6   284   (5 ) 393   (1 ) (2 )
Miacalcic   Osteoporosis   229   (3 ) 136   (5 ) 365   (3 ) (4 )
Foradil   Asthma   14   8   318   2   332   3   2  
Comtan/Stalevo Group   Parkinson's disease   133   24   145   53   278   39   38  
Elidel   Eczema   192   (31 ) 78   8   270   (23 ) (23 )
Famvir   Viral infections   151   (6 ) 103   4   254       (2 )

 
Top twenty products       7,424   11   9,571   13   16,995   13   12  
Rest of portfolio       723   10   2,606   (6 ) 3,329   (2 ) (3 )

 
Total Division sales excluding accounting adjustments       8,147   11   12,177   8   20,324   10   9  
Prior-years' US sales rebate accounting adjustment       (62 )             (62 )        

 
Total       8,085   10   12,177   8   20,262   10   9  

 

Sandoz Division

        Net sales increased 54% (+54% lc) to $4.7 billion, driven by $1.4 billion in sales contributions from Hexal (starting June 6) and Eon Labs (starting July 20). Excluding these acquisitions, sales rose 9% (+8 lc) thanks to strong retail generics sales in Europe and Russia as well as new launches in the US.

Consumer Health Division

        Net sales increased 8% (+8% lc) to $7.3 billion, helped by double-digit growth performance in OTC tied to its focus on strategic brands and the contribution of the North American OTC business of Bristol-

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Myers Squibb (BMS), which we acquired effective September 1, 2005. This acquisition added $100 million in sales to the division.

3. Operating Expenses

 
  Year ended December 31,
   
 
  2005
  2004 Pro forma
  Change in $
 
  ($ millions)

  ($ millions)

  (%)

Net sales   32,212   28,247   14
Other revenues   314   154   104
Cost of Goods Sold   (8,868 ) (7,268 ) 22
Marketing & Sales   (9,802 ) (8,873 ) 10
Research & Development   (4,846 ) (4,077 ) 19
General & Administration   (1,742 ) (1,540 ) 13
Other Income & Expense   (363 ) (354 ) 3
   
 
 
Operating income   6,905   6,289   10
   
 
 
 
  Year ended December 31,
   
 
 
  2005
  2004 Restated
  Change in $
 
 
  ($ millions)

  ($ millions)

  (%)

 
Net sales   32,212   28,247   14  
Other revenues   314   154   104  
Cost of Goods Sold   (8,868 ) (7,268 ) 22  
Marketing & Sales   (9,802 ) (8,873 ) 10  
Research & Development   (4,846 ) (4,171 ) 16  
General & Administration   (1,742 ) (1,540 ) 13  
Other Income & Expense   (363 ) (397 ) (9 )
   
 
 
 
Operating income   6,905   6,152   12  
   
 
 
 

Other revenues

        Other revenues were higher, primarily the result of increased contributions from the sale of the asthma medicine Xolair in the US, where it is co-marketed and co-developed in partnership with Genentech and Tanox, and the result of additional royalty income.

Cost of Goods Sold

        Cost of Goods Sold rose 22% to $8.9 billion in 2005, rising to 27.5% in 2005 as a percentage of our net sales from 25.7% in 2004. Purchase price accounting impacts and increased amortization of intangible assets in Sandoz due to the acquisitions more than offset lower costs in our Pharmaceuticals Division related to productivity gains and product mix improvements.

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Marketing & Sales

        Marketing & Sales expenses increased 10% to $9.8 billion, but declined slightly as a percentage of net sales to 30.4% compared to 31.4% in 2004, mainly reflecting the impact of sustained productivity gains in the Pharmaceuticals Division.

Research & Development

        Research & Development expenses rose 19% in 2005 to $4.8 billion (restated: 16% to $4.8 billion), reflecting investments in the Novartis Institutes for BioMedical Research in the US as well as in late-stage compounds, particularly Rasilez (hypertension), Galvus (type 2 diabetes) and FTY720 (multiple sclerosis). Also affecting Research & Development was an impairment of $332 million for NKS104, a lipid-lowering agent project that has been stopped, and the consolidation of Hexal and Eon Labs in Sandoz. R&D expenses as a percentage of net sales went up to 15.0% compared to 14.4% (restated: 14.8%) in 2004. The 2004 pro forma impact reflects a reduction in expense of $94 million from capitalization of previously expensed Pharmaceuticals Division acquired R&D intangible assets payments.

General & Administration

        General & Administration expenses rose 13% to $1.7 billion in 2005, expanding at a slower pace than net sales, leading to a modest improvement as a percentage of net sales to 5.4% compared to 5.5% in 2004.

Other Income & Expense

        Other Income & Expense was a net charge of $363 million in 2005 compared to a net charge of $354 million (restated: net charge of $397 million) in 2004. The 2004 pro forma impact reflects a reduction in expense of $95 million from ending goodwill amortization and an increase of $52 million in expense from share-based compensation, resulting in a net $43 million reduction in expense.

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4. Operating Income by Division

        Operating income advanced 10% (restated: 12%), at a slightly lower pace than sales, as strong volume expansion and productivity improvements were partially offset by one-time costs related to acquisitions.

 
  Year ended December 31,
   
 
  2005
  2004 Pro forma
  Change in $
 
  ($ millions)

  ($ millions)

  (%)

Pharmaceuticals   6,014   5,366   12
Sandoz Division   342   263   30
Consumer Health   1,055   1,006   5
Corporate income and expense, net   (506 ) (346 ) 46
   
 
 
Total   6,905   6,289   10
   
 
 
 
  Year ended December 31,
   
 
  2005
  2004 Restated
  Change in $
 
  ($ millions)

  ($ millions)

  (%)

Pharmaceuticals   6,014   5,252   15
Sandoz Division   342   240   43
Consumer Health   1,055   954   11
Corporate income and expense, net   (506 ) (294 ) 72
   
 
 
Total   6,905   6,152   12
   
 
 

Pharmaceuticals Division

        Pharmaceuticals operating income expansion outpaced sales growth, rising 12% (restated: 15%) from productivity gains in all areas that led to an operating margin of 29.7%, an increase of 0.7 percentage points (restated: 1.3 percentage points) over 2004. Other revenues contributed 0.5 percentage points to the improved operating margin, reflecting profits from the successful launch of the asthma medicine Xolair. Costs of Goods Sold improved 0.3 percentage points as a percent of sales, thanks to productivity gains and product mix improvements. Marketing & Sales costs rose 6.3% versus 2004, slower than the 2005 sales growth, leading to an improvement of 1.0 percentage point as productivity gains, especially in the US, offset investments in oncology, particularly for Femara, as well as expansion in emerging markets such as China and Turkey. General & Administration costs were reduced to 3.2% of sales adding 0.3 percentage points to the improved operating margin. A slight decline in Other Income & Expenses also contributed to the better performance. Research & Development costs were higher, reflecting investments in late-stage development projects—particularly Rasilez (hypertension), Galvus (type 2 diabetes) and FTY720 (multiple sclerosis). One-time gains of $231 million from the divestment of product rights for Cibadrex/Cibacen in Europe and the sale of license rights for Restasis® recorded in Other Income and Expense partially offset an impairment recorded in Research & Development of $332 million after management decided the profile of the development compound NKS104 (pitavastatin) was no longer competitive from its point of view. Principally as a result of the impairment R&D costs as a percentage of sales rose 1.4 percentage points to 19.6% (restated: 0.9 percentage points to 19.6%) in 2005. The 2004 forma operating income reflects the impact of $94 million reduction in expense from capitalization of

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previously expensed acquired R&D intangible assets, as well as a $20 million reduction in expense from ending goodwill amortization.

Sandoz Division

        Operating income rose 30% to $342 million (restated: 43% to $342 million), benefiting from a good underlying business performance. Also supporting growth was an operating income contribution of $344 million from Hexal and Eon Labs, which more than offset the one-time acquisition and related integration costs of $237 million and the amortization of intangible assets of $100 million. These businesses exceeded expectations and performed well since their acquisition in mid-2005. The 2004 pro forma operating income reflects the impact of $23 million reduction in expense from ending goodwill amortization.

Consumer Health Division

        Consumer Health operating income was up 5% (restated: 11%) over the year-ago period, rising at a slower pace than sales due to investments in strategic brands and acquisition-related costs. The Bristol-Myers Squibb acquisition provided operating income of $17 million, which was more than offset by related one-time charges of $40 million. The 2004 pro forma operating income reflects the impact of $52 million reduction in expense from ending goodwill amortization.

Corporate Income and Expense, net

        Net Corporate expense totaled $506 million in 2005, compared to $346 million (restated: $294 million) in 2004, reflecting several factors including increased product liability risk provisions. The 2004 pro forma amounts reflect an additional expense of $52 million primarily from share-based compensation.

5. Net income

        The following table sets forth selected income statement data for the periods indicated.

 
  Year ended December 31,
   
 
 
  2005
  2004 Pro forma
  Change in $
 
 
  ($ millions)

  ($ millions)

  (%)

 
Operating income   6,905   6,289   10  
Result from associated companies   193   177   9  
Financial income   461   488   (6 )
Interest expense   (294 ) (261 ) 13  
   
 
 
 
Income before taxes   7,265   6,693   9  
Taxes   (1,124 ) (1,092 ) 3  
   
 
 
 
Net Income   6,141   5,601   10  
   
 
 
 
Attributable to              
  Shareholders of Novartis AG   6,130   5,586   10  
  Minority interests   11   15      

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  Year ended December 31,
   
 
 
  2005
  2004 Restated
  Change in $
 
 
  ($ millions)

  ($ millions)

  (%)

 
Operating income   6,905   6,152   12  
Result for associated companies   193   68   184  
Financial income   461   486   (5 )
Interest expense   (294 ) (261 ) 13  
   
 
 
 
Income before taxes   7,265   6,445   13  
Taxes   (1,124 ) (1,065 ) 6  
   
 
 
 
Net income   6,141   5,380   14  
   
 
 
 
Attributable to              
  Shareholders of Novartis AG   6,130   5,365   14  
  Minority interests   11   15      

Result from associated companies

        Associated companies are accounted for using the equity method when we own between 20% and 50% of the voting shares of these companies, or where we otherwise have significant influence over them. Income from associated companies is mainly derived from our investments in Roche Holding AG and Chiron Corporation. Overall, income from associated companies increased to $193 million from $177 million in 2004. Our 44.1% interest in Chiron contributed an income of $19 million compared to an income of $13 million in 2004.

        Our 33.3% interest in Roche voting shares, which represents a 6.3% interest in the total equity of Roche, generated income of $166 million compared to $156 million in 2004. The income for 2005 reflects an estimate of our share of Roche's 2005 income, which is $281 million, including a positive prior year adjustment of $2 million. This income was reduced by an intangible amortization charge of $115 million arising from the allocation of the purchase price to property, plant & equipment and intangible assets.

        The 2004 pro forma adjustment to the restated figures relates to a reduction in expense from ending goodwill amortization of $154 million and an increase in expense from share-based compensation in respect of associated companies of $45 million.

        A survey of analyst estimates is used to predict our share of the net income of both Roche and Chiron. Any differences between these estimates and actual results will be adjusted in 2006.

Financial income and interest expense

        $461 million of financial income was offset by $294 million of interest expense resulting in financial income, net of $167 million in 2005, compared to $227 million in 2004, a reduction of $60 million, as acquisitions led to a decline in average net liquidity. The overall return on net liquidity for the year was 4.2%, up from 3.7% in 2004 principally due to currency gains.

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        The following table provides an analysis of our sources of financial income:

 
  Equity
options

  Bond
options

  Forward
exchange
contracts

  Foreign
exchange
options

  Interest Rate
Swaps/Cross
Currency Swaps/
Forward Rate Agreements

  Total
 
 
  ($ millions)

  ($ millions)

  ($ millions)

  ($ millions)

  ($ millions)

  ($ millions)

 
2005                          
Income on options and forward contracts   21       92   39   (69 ) 83  
Expenses on options and forward contracts   (32 )     (58 ) (53 ) (1 ) (144 )
   
     
 
 
 
 
Options and forward contracts result, net   (11 )     34   (14 ) (70 ) (61 )
   
     
 
 
     
Interest income                       405  
Dividend income                       3  
Net capital gains                       94  
Impairment of marketable securities                       (49 )
Other financial result, net                       (46 )
Currency result, net                       115  
                       
 
Total financial income                       461  
                       
 
2004 Pro Forma                          
Income on options and forward contracts   93   9   59   68   77   306  
Expenses on options and forward contracts   (104 ) (8 ) (162 ) (58 )     (332 )
   
 
 
 
 
 
 
Options and forward contracts result, net   (11 ) 1   (103 ) 10   77   (26 )
   
 
 
 
 
     
Interest income                       388  
Dividend income                       12  
Net capital gains                       123  
Impairment of marketable securities                       (66 )
Other financial result, net                       (38 )
Currency result, net                       95  
                       
 
Total financial income                       488  
                       
 

Taxes

        The amount of taxes expensed rose 3% (restated: rose 6%) to $1.1 billion in 2005. Our effective tax rate (taxes as a percentage of income before tax) was 15.5% in 2005 compared to 16.3% (restated: 16.5%) in 2004.

        Our expected tax rate (weighted average tax rate based on the result before tax of each subsidiary) was 16.2% in 2005 compared to 16.8% (restated: 17.4%) in 2004. Our effective tax rate is different than

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the expected tax rate due to various adjustments to expenditures and income for tax purposes. See note 6 to the consolidated financial statements for details of the main elements contributing to the difference.

        The restated amount of taxes are different from the pro forma amounts due to the tax effect of the various pro forma adjustments. See "Item 5.A Operating Results—2004 and 2003 Pro Forma Consolidated Financial Information" for a more detailed discussion.

Net income

        Net income grew 10% to $6.1 billion from $5.6 billion in 2004 (restated: 14% increase to $6.1 billion from $5.4 billion in 2004), rising at a slower rate than sales based mainly on acquisition-related charges. As a percentage of total net sales, net income decreased to 19.1% in 2005 compared to 19.8% (restated: 19.0%) in 2004.

        Return on average equity was 19.0% in 2005 compared to 18.6% in 2004.

2004 Compared to 2003

        The following compares our results in the year ended December 31, 2004 to those of the year ended December 31, 2003. Our analysis, which is primarily based on the pro forma figures, is divided as follows:

    1.
    Overview

    2.
    Net Sales by Division

    3.
    Operating Expenses

    4.
    Operating Income by Division

    5.
    Net Income

1. Overview

        Our net sales rose 14% (+9% in local currencies, or lc) to $28.2 billion in 2004 as strong results were recorded in both Pharmaceuticals as well as Consumer Health, particularly in the OTC and Medical Nutrition Business Units which offset lower net sales growth in the Sandoz generics business. Volume increases were the primary growth driver contributing 8 percentage points to our net sales growth. Currency benefits added 5 percentage points, while acquisitions added one percentage point and price increases across the Group were insignificant (<1%). Pharmaceuticals accounted for 65% of our total net sales, Sandoz for 11% and Consumer Health 24%, while the US accounted for 40% of our total net sales, Europe for 36% and the rest of the world for 24%.

        Operating income advanced 11% (restated: 9%), supported by strong volume expansion of leading Pharmaceutical products. Most categories of functional expenses had a positive impact on the operating margin. Cost of Goods Sold rose 13% but declined as a percentage of net sales by 0.3 percentage points to 25.7% owing mainly to efficiency gains and better product mix in Pharmaceuticals. Marketing & Sales fell 0.2 percentage points to 31.4% of net sales based primarily on sales-force productivity improvements, while Research & Development declined 0.3 percentage points to 14.4% (restated: declined 0.2 percentage points to 14.8%) of net sales. General & Administrative expenses also rose at a slower pace than net sales, accounting for 5.5% of net sales. Our operating margin, however, fell 0.5 percentage points to 22.3% from 22.8% (restated: fell 0.9 percentage points to 21.8% from 22.7%) in 2003 due mainly to one-time charges in Sandoz and the Consumer Health Business Units: Medical Nutrition and Animal Health that led to higher Other Operating Expenses.

        The main factors contributing to higher Other Operating Expenses were substantially lower Corporate pension income of $102 million; increased restructuring charges and related impairments on property, plant & equipment in the Sandoz generics business of $37 million, a reduction of $171 million in hedging gains on anticipated intragroup sales and lower product divestment gains principally due to the

104



$178 million Fioricet/Fiorinal gain recorded in 2003. Overall, the strong organic growth and positive contribution this year from associated companies resulted in net income expanding 14% to $5.6 billion. Earnings per share rose 16% (restated: 15%), slightly more than net income due to the impact of the share buy-back program, to $2.37 (restated: $2.28) per share in 2004 from $2.04 (restated: $1.99) per share in 2003.

2. Net Sales by Division

        The following table sets forth selected net sales data for each of the periods indicated.

 
  Year ended December 31,
   
   
 
 
  Change in $
  Change in local
currencies

 
 
  2004
  2003
 
 
  ($ millions)

  ($ millions)

  (%)

  (%)

 
Net sales                  
Pharmaceuticals   18,497   16,020   15   10  
Sandoz   3,045   2,906   5   (1 )
Consumer Health   6,705   5,938   13   8  
   
 
 
 
 
Total   28,247   24,864   14   9  
   
 
 
 
 

        As discussed in the Critical Accounting Policies Section, the US market has the most complex arrangements in the area of deductions from gross sales to arrive at net sales, which is the starting point for all our discussions on our sales developments. The following table shows the extent of sales deductions made in the US for our key subsidiaries affected, which are NPC, Sandoz Inc. and Novartis Consumer Health Inc. (OTC):

Gross to Net sales reconciliation in the US

 
  2004
  % of
gross sales

  2003
  % of
gross sales

 
 
  ($ millions)

   
  ($ millions)

   
 
Gross Sales subject to deductions   11,028   100   10,429   100  
Medicaid & Medicare and State program rebates & credits including prescription drug saving cards   (624 ) (6 ) (390 ) (4 )
Managed health care rebates   (538 ) (5 ) (557 ) (5 )
Chargebacks including hospital chargebacks   (800 ) (7 ) (1,008 ) (10 )
Direct discounts, cash discounts & other rebates   (115 ) (1 ) (184 ) (2 )
Sales returns & other deductions   (355 ) (3 ) (411 ) (4 )
   
 
 
 
 
Total Gross to Net sales adjustments   (2,432 ) (22 ) (2,550 ) (25 )
   
 
 
 
 
Net sales   8,596   78   7,879   75  
   
 
 
 
 

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        The principal reason for the changes in the percentage deductions from gross sales are the following:

        The 2 percentage points increase in Medicaid & Medicare rebates and prescription drug saving cards is mainly due to an increase in Consumer Price Index penalties resulting from 2004 pricing actions, additional state supplemental programs and an increase in the growth of the Medicaid population.

        The Consumer Price Index (CPI) penalties represent the increase in Medicaid rebates due to Novartis price increases in a given year exceeding the US inflation rate, which is calculated on a cumulative basis over the life of each product.

        The 3 percentage points decrease of Chargebacks including Hospital chargebacks is principally a reflection of the lower gross sales in 2004 compared to 2003 of Sandoz Inc.

Pharmaceuticals Division

        The Pharmaceuticals Division, bolstered by the five blockbusters Diovan, Gleevec/Glivec, Lamisil, Zometa and Neoral, reported a net sales increase of 15% (+10% lc) amid outstanding performances from top-selling prescription drugs in both the Primary Care and Specialty Medicines portfolios and above-average growth in several key markets. Most therapeutic areas expanded at double-digit rates in US dollars. Volume expansion contributed 10 percentage points, while currency benefits added five percentage points. Price changes had little impact.

        Total net sales of strategic franchise products (Pharmaceutical net sales excluding mature products) rose 21% (+16% lc) to $15.4 billion as seven of the top ten drugs delivered robust double-digit net sales increases. Primary Care (excluding Mature Products) reported a net sales increase of 21% (+17% lc), led by the strong cardiovascular franchise (+21%, +17% lc) with the ongoing growth of the antihypertensive medicines Diovan, the No. 1 angiotensin receptor blocker (ARB) and No. 2 branded antihypertensive worldwide, and Lotrel, the No. 1 branded US combination high blood pressure treatment. Net sales in Specialty Medicines, which includes our activities in Oncology, Transplantation & Immunology, and Ophthalmics, rose 22% (+15% lc) to $6.1 billion and accounted for 33% of Pharmaceuticals net sales versus 31% in 2003. The Oncology franchise reported a 28% (+22% lc) advance, ranking as one of the fastest-growing businesses in its sector. The key oncology drugs Gleevec/Glivec, Zometa and Femara delivered dynamic growth as new data was presented during 2004 that continued to demonstrate benefits to patients. Mature Products reported a 7% decline (-12% lc) in net sales to $3.1 billion.

General Medicines

    Diovan ($3.1 billion, +28%; +22% lc; +20% US) maintained a strong growth rate in 2004 in the US and worldwide with net sales exceeding $3.0 billion, reaffirming its position as the world's leading ARB and one of the fastest-growing branded hypertension medicines. In the US, Diovan reached 2.6% of the US broad antihypertension market segment and 38.5% of the ARB therapeutic category (IMS Health data as of December 2004), which is expected to remain one of the most dynamic pharmaceutical categories in the coming years. Net sales growth has been driven primarily by data from recent successful outcome trials, the global rollout of more effective doses and the recent launch of our sponsored hypertension awareness program in the US. We recently received an approvable letter from the US Food and Drug Administration (FDA) for Diovan to treat high-risk heart attack patients, an indication already approved in 27 countries, including the UK. Approval is pending further discussions with the FDA.

    Lotrel ($920 million, +18% US), the No. 1 US fixed combination treatment for hypertension, delivered double-digit net sales growth in 2004, amid an increased focus on the efficacy of antihypertension agents in the US. Lotrel has expanded its position as the No. 1 branded combination therapy, a position held since 2002, based on greater awareness of the need for patients to achieve lower blood pressure goals set by national guidelines. Lotrel, which is sold only in the US, also benefited from the US hypertension awareness program.

106


    Lamisil ($1.2 billion, +19%; +14% lc; +23% US), the leading treatment worldwide for fungal nail infections, achieved net sales of more than $1 billion for the first time after extending its US market segment leadership position to a high of 72% (IMS Health data as of November 2004). Higher disease awareness in the US and in leading European markets were key growth drivers, with France reporting the highest net sales in Europe.

    Elidel ($349 million, +49%; +47% lc; +36% US), the world's No. 1 branded prescription agent for eczema, outperformed the market segment growth (+54% Elidel vs. 7.8% IMS top 16 countries as of October 2004) to deliver excellent net sales. In 2004, the influential UK National Institute for Clinical Excellence (NICE) recommended the use of Elidel, which is now available in approximately 90 countries worldwide, for treating appropriate cases of eczema.

    Zelnorm/Zelmac ($299 million, +81%; +80% lc +89% US), a breakthrough therapy for irritable bowel syndrome (IBS) with constipation (IBS-C) and the first and only prescription medicine for chronic idiopathic constipation, reached $299 million in net sales. A key driver has been increasing patient and physician awareness of the availability of a medicine to treat these diseases effectively. Results of the ZENSAA study published in 2004 showed the treatment to be highly effective as a repeat treatment for women with IBS and additionally demonstrated dramatic improvements in important quality of life measures. This study was the basis for resubmission in the European Union in October 2004, with a decision expected in 2005. The US Food and Drug Administration (FDA) granted approval in August 2004 for the additional indication of treating chronic idiopathic constipation in both men and women under age 65.

Specialty Medicines

Oncology

        Net sales rose 28% to $4.2 billion driven by growth in the following products:

    Gleevec/Glivec ($1.6 billion, +45%; +36% lc; +23% US), for all stages of Philadelphia-chromosome positive (Ph+) chronic myeloid leukemia (CML) and certain forms of gastro-intestinal stromal tumors (GIST), continued to grow dynamically amid further penetration of both the CML and GIST markets as well as continued increases in the average daily dose. New data presented at the American Society of Hematology meeting in December demonstrated that most newly diagnosed patients with Ph+ CML receiving 400 mg daily maintained their response to therapy long term. A separate study found patients receiving 800 mg daily had better outcomes compared to patients receiving 400 mg daily. In addition, encouraging data on the use of Gleevec/Glivec in the treatment of Ph+ acute lymphoblastic leukemia (ALL) and gliobastoma multiforme (GBM) were presented at major medical meetings in the fourth quarter. The Glivec International Patient Assistance Program is now open in 71 countries, and the combined Gleevec/Glivec patient assistance programs are providing treatments to more than 10,000 patients worldwide who otherwise would not have access to this innovative therapy.

    Zometa ($1.1 billion, +21%; +17% lc; +10% US), the top intravenous bisphosphonate for bone metastases, achieved blockbuster status in 2004 by continuing to post solid growth despite challenges related to US Medicare reimbursement policy and increasing competition as well as high penetration rates in breast cancer and myeloma. Zometa continued to make progress on increasing the use of intravenous (IV) bisphosphonates in the treatment of prostate and lung cancer patients, two of the most common forms of cancer worldwide.

    Femara ($386 million, +70%; +62% lc; +137% US), a leading first-line therapy for early and advanced breast cancer in post-menopausal women, generated high double-digit growth in 2004. Femara has now been approved in 20 countries, including the US, for a new indication as the only post-tamoxifen treatment for early breast cancer based on the landmark MA-17 study, which showed Femara significantly increased a woman's chance of staying cancer-free following five years of adjuvant (post-surgery) tamoxifen therapy.

107


Ophthalmics

        Net sales rose 25% (+19% lc) to $0.8 billion based on a continued strong performance from Visudyne ($448 million, +25%; +20% lc; +15% US), the world's leading treatment for "wet" AMD (age-related macular degeneration), the leading cause of blindness in people over age 50 in developed countries. Improved US Medicare reimbursement for additional lesion types supported US sales growth, while sales in Europe remained strong.

Transplantation

        Net sales rose 1% (-5% lc) to $1.1 billion as the Neoral/Sandimmun franchise ($1.0 billion, -1%; -7% lc; -17% US) experienced slightly decreased net sales worldwide although, market share gains were made in the US liver transplant segment because of an overall slow erosion by generic competition in the US and some other key markets. Myfortic, an immunosuppressant used in kidney transplant patients, was launched in over 40 countries, including the US, and continued to gain market share. Certican, a novel proliferation signal inhibitor, received European Union Mutual Recognition Procedure review from 10 new EU accession countries and was approved in Australia. We celebrated our 20 years of experience in transplantation in 2004 at the International Society of Transplantation meeting in Vienna.

108




Top 20 Pharmaceutical Division Product Net Sales—2004

Brands

  Therapeutic Area
  United
States

  % change
in local
currencies

  Rest of
the World

  % change
in local
currencies

  Total
  % change
in $

  % change
in local
currencies

 
 
   
  ($ millions)

   
  ($ millions)

   
  ($ millions)

   
   
 
Diovan/Co-Diovan   Hypertension   1,323   20   1,770   25   3,093   28   22  
Gleevec/Glivec   Chronic myeloid leukemia/ Gastro-intestinal stromal tumors   368   23   1,266   41   1,634   45   36  
Lamisil (group)   Fungal infections   528   23   634   7   1,162   19   14  
Zometa   Cancer complications   630   10   448   29   1,078   21   17  
Neoral/Sandimmun   Transplantation   180   (17 ) 831   (4 ) 1,011   (1 ) (7 )
Lotrel   Hypertension   920   18           920   18   18  
Sandostatin (group)   Acromegaly   374   18   453   11   827   19   14  
Lescol   Cholesterol reduction   284   (8 ) 474   3   758   3   (2 )
Voltaren (group)   Inflammation/pain   9   13   629   1   638   7   1  
Trileptal   Epilepsy   391   28   127   30   518   30   29  

 
Top ten products       5,007   15   6,632   16   11,639   21   16  
Visudyne   Wet form of age-related macular degeneration   209   15   239   25   448   25   20  
Exelon   Alzheimer's disease   179   (1 ) 243   20   422   15   10  
Tegretol (incl. CR/XR)   Epilepsy   103   (16 ) 293   5   396   3   (2 )
Femara   Breast cancer   166   137   220   29   386   70   62  
Miacalcic   Osteoporosis   236   (1 ) 141   (13 ) 377   (3 ) (6 )
Elidel   Eczema   279   36   70   123   349   49   47  
Foradil   Asthma   13   44   308   1   321   11   2  
Leponex/Clozaril   Schizophrenia   72   (16 ) 236   (3 ) 308   0   (7 )
Zelnorm/Zelmac   Irritable bowel syndrome   249   89   50   45   299   81   80  
Famvir   Viral infections   160   10   95   0   255   9   6  

 
Top twenty products       6,673   17   8,527   15   15,200   21   16  
Rest of portfolio       695   (20 ) 2,602   (5 ) 3,297   (4 ) (9 )

 
Total       7,368   12   11,129   9   18,497   15   10  

 

109


Sandoz Division

        Sandoz net sales rose 5% (–1% lc) to $3.0 billion following an exceptionally strong 2003 performance driven by the launch of the antibiotic AmoxC in the US. Competitive pricing pressures also emerged during 2004 especially in the US and Germany.

Consumer Health Division

        Net sales rose 13% (+8% lc) to $6.7 billion as double-digit net sales expansion, in part due to currency exchange benefits resulting from a weakness of the US dollar, in OTC, Animal Health and Medical Nutrition offset slower growth in Infant & Baby and CIBA Vision. Volume expansion overall in Consumer Health contributed six percentage points to growth, while currencies added five percentage points and acquisitions added two percentage points. Price increases, on average, were insignificant.

3. Operating Expenses

 
  Year ended December 31,
   
 
  2004
Pro Forma

  2003
Pro Forma

  Change in $
 
  ($ millions)

  ($ millions)

  (%)

Net sales   28,247   24,864   14
Other revenues   154   66   133
Cost of Goods Sold   (7,268 ) (6,457 ) 13
Marketing & Sales   (8,873 ) (7,854 ) 13
Research & Development   (4,077 ) (3,655 ) 12
General & Administration   (1,540 ) (1,381 ) 12
Other Income & Expense   (354 ) 83    
   
 
 
Operating income   6,289   5,666   11
   
 
 
 
  Year ended December 31,
   
 
  2004
Restated

  2003
Restated

  Change in $
 
  ($ millions)

  ($ millions)

  (%)

Net sales   28,247   24,864   14
Other revenues   154   66   133
Cost of Goods Sold   (7,268 ) (6,457 ) 13
Marketing & Sales   (8,873 ) (7,854 ) 13
Research & Development   (4,171 ) (3,729 ) 12
General & Administration   (1,540 ) (1,381 ) 12
Other Income & Expense   (397 ) 126    
   
 
 
Operating income   6,152   5,635   9
   
 
 

110


Cost of Goods Sold

        Cost of Goods Sold rose 13% to $7.3 billion in 2004, but slightly decreased as a percentage of net sales to 25.7% in 2004 from 26% in 2003, due mainly to ongoing productivity improvements and a favorable product mix in Pharmaceuticals Division.

Marketing & Sales

        Marketing & Sales expenses increased 13% to $8.9 billion but declined slightly as a percentage of net sales to 31.4% compared to 31.6% in 2003, mainly reflecting the impact of productivity gains in the Pharmaceuticals US sales-force.

Research & Development

        Research & Development expenses rose 12% in 2004 to $4.1 billion (restated: $4.2 billion), reflecting investments in the Novartis Institutes for BioMedical Research in the US, but decreased as a percentage of net sales to 14.4% (restated: 14.8%) compared to 14.7% (restated: 15.0%) in 2003. The pro forma figures reflect a reduction in expense from capitalization of previously expensed Pharmaceuticals Division acquired R&D intangible assets, amounting to $94 million in 2004 and $74 million in 2003.

General & Administration

        General & Administration expenses rose 12% to $1.5 billion in 2004 expanding at a slower pace than net sales, leading to a modest improvement as a percentage of net sales to 5.5% compared to 5.6% in 2003.

Other Income & Expense

        Other Income & Expense was a net charge of $354 million (restated: net charge of $397 million) in 2004 compared to a net income of $83 million (restated: a net income of $126 million) in 2003, reflecting a series of factors that included $102 million less Corporate pension income, $171 million less hedging gains on intragroup sales, as well as lower income from product divestments principally related to the $178 million gain in 2003 from selling the Fioricet/Fiorinal product range and $37 million additional impairment and restructuring charges in Sandoz. The pro forma impact in 2004 reflects a reduction in expense from ending goodwill amortization of $95 million (2003: $80 million) and an increase of $52 million in expense (2003: $123 million) from share-based compensation, resulting in a net $43 million reduction in expense (2003: $43 million increase in expense).

111


4. Operating Income by Division

        Operating income growth advanced 11% (restated: 9%) to $6.3 billion at a slower rate than net sales due to higher Other Operating Expenses in 2004 leading to an operating margin decline of 0.5 (restated: 0.9) percentage points from 22.8% (restated: 22.7%) of net sales in 2003 to 22.3% (restated: 21.8%) in 2004.

 
  Year ended December 31,
   
 
 
  2004
Pro Forma

  2003
Pro Forma

  Change in $
 
 
  ($ millions)

  ($ millions)

  (%)

 
Pharmaceuticals   5,366   4,517   19  
Sandoz   263   496   (47 )
Consumer Health   1,006   907   11  
Corporate income and expense, net   (346 ) (254 ) 36  
   
 
 
 
Total   6,289   5,666   11  
   
 
 
 
 
  Year ended December 31,
   
 
 
  2004
Restated

  2003
Restated

  Change in $
 
 
  ($ millions)

  ($ millions)

  (%)

 
Pharmaceuticals   5,252   4,430   19  
Sandoz   240   473   (49 )
Consumer Health   954   863   11  
Corporate income and expense, net   (294 ) (131 ) 124  
   
 
 
 
Total   6,152   5,635   9  
   
 
 
 

Pharmaceuticals Division

        In Pharmaceuticals, operating income expanded significantly faster than net sales, rising 19% to $5.4 billion (restated: 19% to $5.3 billion). This resulted in a margin expansion of 0.8 percentage points to 29.0% of net sales from 28.2% in 2003 (restated: expansion of 0.7 percentage point to 28.4% of net sales from 27.7% in 2003). An improvement of 0.9 percentage points in Cost of Goods Sold, mainly from productivity gains and improved product mix, was an important contributor. Marketing & Sales expenses fell 0.2 percentage points to 33.0% based in part on sales-force productivity improvements, particularly in the US. Research & Development expenses rose 12.6% on investments in the Novartis Institutes for BioMedical Research (NIBR) and late-stage clinical trial programs. However, R&D expenses declined 0.5 percentage points to 18.2% as of net sales (restated: declined 0.5 percentage points to 18.7%). Other Operating Expenses increased $242 million as a result of several factors, including a decline of $171 million in hedging gains on intragroup sales and lower income from product divestments compared to 2003, which included a one-time gain of $178 million from the sale of the Fioricet/Fiorinal product range. General & Administrative costs fell to 3.5% of net sales from 3.6% in 2003. The 2004 pro forma operating income as compared to 2004 restated reflects the impact of $94 million (2003: $74 million) reduction in expense from capitalization of previously expensed acquired R&D intangible assets, as well as a $20 million (2003: $13 million) reduction in expense from ending goodwill amortization.

112



Sandoz Division

        Sandoz operating income declined to $263 million (restated: $240 million) compared to $496 million (restated: $473 million) in 2003, due primarily to the impact of competitive pressures on pricing, particularly in the US and Germany. As a consequence, a further impairment of our German operation's goodwill of $73 million was required due to the effects that competitive pressures were likely to have on the business outlook. This followed a similar impairment of $72 million recorded in 2003. Other operating expenses also included $37 million of restructuring charges and related impairments of property, plant & equipment related to operations in Germany, Italy, Austria and Slovenia affecting 363 employees in total. The 2004 pro forma operating income as compared to 2004 restated reflects the impact of $23 million (2003: $23 million) reduction in expense from ending goodwill amortization.

Consumer Health Division

        During 2004 operating income increased 11% to $1.0 billion. One-off charges of $83 million were recorded, which included a one-time inventory write-down of $18 million in Animal Health, one-time costs of $14 million associated with the acquisition of Mead Johnson and the creation of a $51 million provision in Medical Nutrition to cover legal liabilities related to an investigation by the US Department of Justice in the US enteral pump market. Novartis Nutrition Corporation is currently in the process of negotiating a possible settlement of that portion of the investigation directed against it which is described in more detail in Item 8.A.7—legal proceedings. Excluding these one-off items, operating income would have increased 20% to $1.1 billion and the operating margin would have been 16.2% compared to 15.3% in 2003. The operating margin fell to 15.0% compared to 15.3% in 2003. The 2004 pro forma operating income as compared to 2004 restated reflects the impact of $52 million (2003: $44 million) reduction in expense from ending goodwill amortization.

Corporate Income and Expense, net

        Net Corporate expense totaled $346 million (restated: $294 million) in 2004, compared to $254 million (restated: $131 million) in 2003. The principal reason for the increase was $102 million less pension income in 2004 compared to 2003.

5. Net income

        The following table sets forth selected income statement data for the periods indicated.

 
  Year ended December 31,
   
 
 
  2004
Pro Forma

  2003
Pro Forma

  Change in $
 
 
  ($ millions)

  ($ millions)

  (%)

 
Operating income   6,289   5,666   11  
Result from associated companies   177   (182 )    
Financial income   488   621   (21 )
Interest expense   (261 ) (243 ) 7  
   
 
 
 
Income before taxes   6,693   5,862   14  
Taxes   (1,092 ) (957 ) 14  
   
 
 
 
Net Income   5,601   4,905   14  
   
 
 
 
Attributable to              
  Shareholders of Novartis AG   5,586   4,861   15  
  Minority interests   15   44      

113


 
  Year ended December 31,
   
 
 
  2004
Restated

  2003
Restated

  Change in $
 
 
  ($ millions)

  ($ millions)

  (%)

 
Operating income   6,152   5,635   9  
Result from associated companies   68   (279 ) (124 )
Financial income   486   621   (22 )
Interest expense   (261 ) (243 ) 7  
   
 
 
 
Income before taxes   6,445   5,734   12  
Taxes   (1,065 ) (947 ) 12  
   
 
 
 
Net Income   5,380   4,787   12  
   
 
 
 
Attributable to              
  Shareholders of Novartis AG   5,365   4,743   13  
  Minority interests   15   44      

Result from associated companies

        Associated companies are accounted for using the equity method when we own between 20% and 50% of the voting shares of these companies or where we have significant influence over them. Income from associated companies is mainly derived from our investments in Roche Holding AG and Chiron Corporation. Overall, income from associated companies increased to $177 million from an expense of $182 million in 2003.

        Our 42.5% interest in Chiron contributed income of $19 million compared to $74 million in 2003. This reduction was mainly due to manufacturing production issues at a Chiron site in the United Kingdom that prevented Chiron from delivering flu vaccines to the US for the 2004/2005 flu season.

        Our 33.3% interest in Roche voting shares, which represents a 6.3% interest in the total equity of Roche, generated income of $156 million compared to a loss of $278 million in 2003. The 2003 performance was due to Roche's unexpected loss of CHF 4.0 billion in 2002 which was reflected by us as a change in estimate in 2003. The income for 2004 reflects an estimate of our share of Roche's 2004 net income, which is $287 million, including a positive prior year adjustment of $30 million. This income was reduced by intangible amortization charge of $131 million arising from the allocation of the purchase price to property, plant & equipment and intangible assets.

        The pro forma adjustment to the restated figures relates to a reduction in expense from ending goodwill amortization of $154 million (2003: $147 million) and an increase in expense from share-based compensation in respect of associated companies of $45 million (2003: $50 million).

        A survey of analyst estimates is used to predict our share of the net income of both Roche and Chiron. Any differences between these estimates and actual results were adjusted in 2005.

Financial income and interest expense

        $488 million of financial income was offset by $261 million of interest expense resulting in financial income, net of $227 million in 2004, compared to $378 in 2003, a decrease of $151 million. The overall return of net liquidity for the year was 3.7%, down from 6.3% in 2003 principally due to the ongoing low-yield environment. See Item 11 for a discussion of our risk management policy, the employment of financial instruments and their accounting.

114



        The following table provides an analysis of our sources of financial income:

 
  Equity
options

  Bond options
  Forward
exchange
contracts

  Foreign
exchange
options

  Interest Rate
Swaps/Cross
Currency
Swaps/Forward
Rate Agreements

  Total
 
 
  ($ millions)

  ($ millions)

  ($ millions)

  ($ millions)

  ($ millions)

  ($ millions)

 
2004 Pro Forma                          
Income on options and forward contracts   93   9   59   68   77   306  
Expenses on options and forward contracts   (104 ) (8 ) (162 ) (58 )     (332 )
   
 
 
 
 
 
 
Options and forward contracts result, net   (11 ) 1   (103 ) 10   77   (26 )
   
 
 
 
 
     
Interest income                       388  
Dividend income                       12  
Net capital gains                       123  
Impairment of marketable securities                       (66 )
Other financial result, net                       (38 )
Currency result, net                       95  
                       
 
Total financial income                       488  
                       
 
2003 Pro Forma                          
Income on options and forward contracts   270       185   331   327   1,113  
Expenses on options and forward contracts   (419 )     (140 ) (250 )     (809 )
   
     
 
 
 
 
Options and forward contracts result, net   (149 )     45   81   327   304  
   
     
 
 
     
Interest income                       323  
Dividend income                       17  
Net capital gains                       11  
Impairment of marketable securities                       (66 )
Other financial result, net                       (32 )
Currency result, net                       64  
                       
 
Total financial income                       621  
                       
 

Taxes

        The tax charge of $1.1 billion increased by 14% (restated: increased by 12%) compared to 2003. Our effective tax rate (taxes as a percentage of income before tax) was 16.3% (restated: 16.5%) in 2004 compared to 16.3% (restated: 16.5%) in 2003.

        Our expected tax rate (weighted average tax rate based on the result before tax of each subsidiary) was 16.8% (restated: 17.4%) in 2004 compared to 16.2% (restated: 16.6%) in 2003. Our effective tax rate is different than the expected tax rate due to various adjustments to expenditures and income for tax purposes. See note 6 to the consolidated financial statements for details of the main elements contributing to the difference.

115



        The restated amount of taxes are different from the pro forma amounts due to the tax effect of the various pro forma adjustments. See "Item 5.A Operating Results—2004 and 2003 Pro Forma Consolidated Financial Information" for a more detailed discussion.

Net income

        Net income grew 14% to $5.6 billion (restated: $5.4 billion) from $4.9 billion (restated: $4.8 billion) in 2003. As a percentage of total net sales, net income rose to 19.8% in 2004 compared to 19.7% in 2003 due mainly to the strong improvement in operating income.

        Return on average equity increased from 17.4% in 2003 to 18.6% in 2004.

Exchange Rate Exposure and Risk Management

        We transact our business in many currencies other than the US dollar, our reporting currency. As a result of our foreign currency exposure, exchange rate fluctuations have a significant impact in the form of both translation risk and transaction risk on our income statement. Translation risk is the risk that our consolidated financial statements for a particular period or as of a certain date may be affected by changes in the prevailing rates of the various currencies of the reporting subsidiaries against the US dollar. Transaction risk is the risk that the value of transactions executed in currencies other than the subsidiary's measurement currency may vary according to currency fluctuations.

        In 2005, 42% of our net sales were generated in US dollars, 27% in euro, 2% in Swiss francs, 8% in yen and 21% in other currencies. In 2004, 43% of net sales were generated in US dollars, 26% in euro, 3% in Swiss francs, 8% in yen and 20% in other currencies. In 2003, 43% of net sales were generated in US dollars, 26% in euro, 4% in Swiss francs, 8% in yen and 19% in other currencies.

        In 2005, 34% of our operating costs were generated in US dollars, 26% in euro, 16% in Swiss francs, 5% in yen, and 19% in other currencies. In 2004, 37% of operating costs were generated in US dollars, 23% in euro, 15% in Swiss francs, 5% in yen, and 20% in other currencies. In 2003, 41% of operating costs were generated in US dollars, 23% in euro, 17% in Swiss francs, 4% in yen, and 15% in other currencies.

New Accounting Pronouncements

        See note 34.11(ii) to the consolidated financial statements for a discussion of the effect of new accounting standards.

116


5.B  Liquidity and Capital Resources

Cash Flow

        The following table sets forth certain information about our cash flow and net liquidity for each of the periods indicated.

 
  Year ended December 31,
   
 
 
  2005
  2004
Pro Forma

  2003
Pro Forma

 
 
  ($ millions)

  ($ millions)

  ($ millions)

 
Cash flow from operating activities   8,080   6,689   6,627  
Cash flow used for investing activities   (7,482 ) (3,311 ) (1,305 )
Cash flow used for financing activities   (266 ) (2,997 ) (5,732 )
Net effect of currency translation on cash and cash equivalents   (94 ) 56   258  
   
 
 
 
Change in cash and cash equivalents   238   437   (152 )
Change in short- and long-term marketable securities   (3,197 ) 834   723  
Change in short- and long-term financial debts   (1,599 ) (885 ) (400 )
   
 
 
 
Change in net liquidity   (4,558 ) 386   171  
Net liquidity at January 1   7,037   6,651   6,480  
   
 
 
 
Net liquidity at December 31   2,479   7,037   6,651  
   
 
 
 
 
  Year ended December 31,
   
 
 
  2005
  2004
Restated

  2003
Restated

 
 
  ($ millions)

  ($ millions)

  ($ millions)

 
Cash flow from operating activities   8,080   6,595   6,553  
Cash flow used for investing activities   (7,482 ) (3,217 ) (1,231 )
Cash flow used for financing activities   (266 ) (2,997 ) (5,732 )
Net effect of currency translation on cash and cash equivalents   (94 ) 56   258  
   
 
 
 
Change in cash and cash equivalents   238   437   (152 )
Change in short- and long-term marketable securities   (3,197 ) 834   723  
Change in short- and long-term financial debts   (1,599 ) (885 ) (400 )
   
 
 
 
Change in net liquidity   (4,558 ) 386   171  
Net liquidity at January 1   7,037   6,651   6,480  
   
 
 
 
Net liquidity at December 31   2,479   7,037   6,651  
   
 
 
 

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        The analysis of our cash flow, which is primarily on a pro forma basis, is divided as follows:

    1.
    Cash flow from Operating Activities and Free Cash Flow

    2.
    Cash flow used for Investing Activities

    3.
    Cash flow used for Financing Activities

    4.
    Net Liquidity

1. Cash Flow From Operating Activities and Free Cash Flow

        Our primary source of liquidity is cash generated from our operations. In 2005, cash flow from operating activities increased by $1.4 billion or 21% (restated: $1.5 billion, or 23%) to $8.1 billion reflecting the strong business expansion and good working capital management of the Divisions.

        In 2004, cash flow from operating activities increased by $62 million or 1% to $6.7 billion (restated: $42 million or 1% to $6.6 billion). Current tax payments rose $241 million compared to the previous year.

        Under IAS 38 (revised) acquired R&D assets need to be capitalized as intangible assets. Accordingly, the 2004 pro forma consolidated cash flow statement includes the reclassification of $94 million (2003: $74 million) for capitalized R&D payments to cash flow used for investing activities.

        Our free cash flow, excluding the impact of the acquisitions or divestments of subsidiaries, associated companies and minority investments increased by 42% to $4.7 billion in 2005 from $3.3 billion in 2004. The free cash flow decreased 8% from $3.6 billion in 2003 to $3.3 billion in 2004.

        Our capital expenditure on property, plant and equipment for 2005 decreased by $0.1 billion to $1.2 billion (3.7% of net sales in 2005 and 4.5% of net sales in 2004) from $1.3 billion in 2004. In 2003 investments in property, plant and equipment amounted to $1.3 billion (5.3% of net sales).

        This level of capital expenditure reflects the continuing investment in Production as well as Research and Development facilities. We expect to increase spending to approximately 5% of net sales in 2006, excluding any impact from the planned Chiron acquisition and to fund these expenditures with internally generated resources.

        We present Free Cash Flow as additional information as it is a useful indicator of our ability to operate without reliance on additional borrowing or usage of existing cash. Free Cash Flow is a measure of the net cash generated which is available for debt repayment and investment in strategic opportunities. We use Free Cash Flow in internal comparisons of our Divisions' and Business Units' results. Free Cash Flow of our Divisions and Business Units uses the same definition as that for our Group, however no dividends, tax or financial receipts or payments are included in the Division and Business Unit calculations. Free Cash Flow is not intended to be a substitute measure for cash flow from operating activities (as determined under IFRS or US GAAP).

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        The following table details the components of these increases.

 
  Year ended December 31,
   
 
 
  2005
  2004
Pro Forma

  2003
Pro Forma

 
 
  ($ millions)

  ($ millions)

  ($ millions)

 
Cash flow from operating activities   8,080   6,689   6,627  
Purchase of property, plant & equipment   (1,188 ) (1,269 ) (1,329 )
Purchase of intangible assets   (360 ) (275 ) (288 )
Purchase of financial assets   (783 ) (747 ) (816 )
Proceeds from sale of property, plant & equipment   73   129   92  
Proceeds from sale of intangible and financial assets   958   670   967  
Dividends paid to third parties   (2,107 ) (1,896 ) (1,659 )
   
 
 
 
Free cash flow   4,673   3,301   3,594  
   
 
 
 
 
  Year ended December 31,
   
 
 
  2005
  2004
Restated

  2003
Restated

 
 
  ($ millions)

  ($ millions)

  ($ millions)

 
Cash flow from operating activities   8,080   6,595   6,553  
Purchase of property, plant & equipment   (1,188 ) (1,269 ) (1,329 )
Purchase of intangible assets   (360 ) (181 ) (214 )
Purchase of financial assets   (783 ) (747 ) (816 )
Proceeds from sale of property, plant & equipment   73   129   92  
Proceeds from sale of intangible and financial assets   958   670   967  
Dividends paid to third parties   (2,107 ) (1,896 ) (1,659 )
   
 
 
 
Free cash flow   4,673   3,301   3,594  
   
 
 
 

2. Cash Flow used for Investing Activities

        In 2005, cash outflow due to investing activities was $7.5 billion. A total of $8.8 billion was spent on acquisitions, including an additional, approximately, 2% stake in newly issued shares of Chiron, which we acquired through an existing agreement for a total amount of $300 million. Investments in property, plant and equipment amounted to $1.2 billion and $0.2 billion was spent on other investing activities. Net proceeds from marketable securities were $2.7 billion.

        In 2004, cash outflow due to investing activities was $3.3 billion (restated: $3.2 billion). A total of $1.0 billion was spent on acquisitions, while investments in property, plant & equipment amounted to $1.3 billion. The net payments for acquiring marketable securities was $0.8 billion and other investments accounted for $0.2 billion.

        In 2003, our cash outflow due to investing activities was $1.3 billion (restated: $1.2 billion). $0.4 billion was spent to increase the strategic investment in Roche and for the acquisition of Idenix. Our investment in property, plant and equipment totaled $1.3 billion. The net proceeds from sales of marketable securities was $0.5 billion and other net investments accounted for $0.1 billion.

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        Under IAS 38 (revised) acquired R&D assets need to be capitalized as intangible assets. Accordingly, the 2004 pro forma consolidated cash flow statement includes the reclassification of $94 million (2003: $74 million) for capitalized R&D payments from cash flow from operating activities.

3. Cash Flow used for Financing Activities

        Cash flow used for financing activities in 2005 was $0.3 billion. $0.2 billion was spent on the acquisition of treasury shares and $2.1 billion on dividend payments. $2.0 billion inflow was due to the increase in short and long-term financial debts.

        Cash flow used for financing activities in 2004 was $3.0 billion, down $2.7 billion from 2003. $1.8 billion was spent on the acquisition of treasury shares and $1.9 billion on dividend payments. $0.7 billion cash inflow was due to the increase in short and long-term financial debt and a capital inflow from the IPO of Idenix Inc.

        In 2003, the cash flow used for financing activities was $5.7 billion. $0.3 billion was spent for the acquisition of treasury shares, $1.7 billion for dividend payments and $3.5 billion for the repayment of equity instruments.

4. Net Liquidity

        Overall liquidity (cash, cash equivalents and marketable securities including financial derivatives) amounted to $10.9 billion at December 31, 2005. Net liquidity fell by $4.5 billion to a total of $2.5 billion at December 31, 2005, compared to $7.0 billion at the start of the year, reflecting the acquisitions made during the year.

        Acquisitions amounted to approximately $8.8 billion to acquire Hexal and Eon Labs, as well as the North American OTC business of BMS and an additional, approximately, 2% stake in newly issued shares of Chiron through an existing agreement for a total cost of $300 million.

        Overall liquidity (cash, cash equivalents and marketable securities including financial derivatives) amounted to $13.9 billion at December 31, 2004. Net liquidity (liquidity less financial debt) at year-end was $7.0 billion, an increase of $0.4 billion from December 31, 2003.

        Our overall liquidity amounted to $12.6 billion at December 31, 2003. Net liquidity at year end was $6.7 billion.

        We present overall liquidity and net liquidity as additional information as they are useful indicators of our ability to meet our financial commitments and to invest in new strategic opportunities, including strengthening our balance sheet. These items should not be interpreted as measures determined under IFRS.

        We use marketable securities and derivative financial instruments to manage the volatility of our exposures to market risk in interest rates and liquid investments. Our objective is to reduce, where appropriate, fluctuations in earnings and cash flows. We manage these risks by selling existing assets or entering into transactions and future transactions (in the case of anticipatory hedges) which we expect we will have in the future, based on past experience. We therefore expect that any loss in value for those securities or derivative financial instruments generally would be offset by increases in the value of those hedged transactions.

        We use the US dollar as our reporting currency and are therefore exposed to foreign exchange movements primarily in European, Japanese and other Asian and Latin American currencies. We manage the risk associated with currency movements by entering into various contracts to preserve the value of assets, commitments and anticipated transactions. In particular, we enter into forward contracts and foreign currency option contracts to hedge certain anticipated foreign currency revenues in foreign subsidiaries. See "Item 11. Quantitative and Qualitative Disclosures About Market Risk," for additional information.

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Share repurchase program

        In August 2004, we announced the completion of the third share-repurchase program and the start of a fourth program to repurchase shares via a second trading line on the SWX Swiss Exchange for approximately $2.4 billion (CHF 3.0 billion). Additionally, a fifth share repurchase program for up to CHF 4.0 billion was approved at the Annual General Meeting on March 1, 2005. In 2004, a total of 22.8 million shares were repurchased for $1.0 billion to complete the third repurchase program. Since the start of the fourth program, a total of 25.4 million shares have been repurchased for $1.2 billion, of which 10.2 million shares amounting to $0.5 billion were bought back in 2005. Overall in 2005, a total of 16 million shares have been repurchased for $0.8 billion and a total of 13 million shares have been sold for $0.6 billion. This includes shares bought through the repurchase programs as well as additional shares bought and sold on the first trading line and transactions with associates.

        A proposal will be made at the Annual General Meeting on February 28, 2006 to reduce share capital by 10.2 million shares bought through the purchase programs on the second trading line in 2005.

        In 2005, our share capital was reduced by 38.0 million shares relating to shares bought on the second trading line in 2004.

        In 2004, our share capital was reduced by 24.3 million shares relating to shares bought on the second trading line in 2003.

        On July 22, 2002, we initiated our third share buy-back program to repurchase shares on the SWX Swiss Exchange for up to a total of CHF 4.0 billion. During 2003, 24.3 million shares were repurchased via a second trading line for a total amount of $939 million. In 2003, the Group's share capital was reduced by 22.7 million shares relating to shares bought on the second trading line in 2002.

        At December 31, 2005, our holding of treasury shares (excluding the amount that we will propose to be cancelled at the February 28, 2006 Annual General Meeting) amounted to 393 million shares or 14% of the total number of issued shares.

Other equity instruments

        During December 2001, through indirectly held affiliates, we sold a total of 55 million ten-year call options (Low Exercise Price Options—"LEPOs") on our shares, with an exercise price of CHF 0.01, for EUR 2.2 billion in proceeds (EUR 40 per LEPO). We accounted for the LEPOs as an increase in share premium at fair value less related issuance costs. Following changes in US GAAP and expected changes in IFRS, on June 26, 2003 we redeemed these equity instruments in advance of their exercise date.

        We had previously also sold a total of 55 million nine and ten-year put options on our shares to a third party with an exercise price of EUR 51 receiving EUR 0.6 billion in proceeds (EUR 11 per put option). We accounted for the option premium associated with the put options as an increase in share premium less related issuance costs. Following changes in US GAAP and expected changes in IFRS, on June 26, 2003 we redeemed these equity instruments in advance of their exercise date.

Straight Bonds

        On November 14, 2002, our affiliate, Novartis Securities Investment Ltd, Bermuda, issued a 3.75% bond, guaranteed by Novartis AG and due in 2007, in the amount of EUR 1 billion.

        On October 17, 2001, our affiliate, Novartis Securities Investment Ltd, Bermuda issued a 4% bond, guaranteed by Novartis AG and due in 2006, in the amount of EUR 900 million.

Direct Share Purchase Plans

        Since 2001 we have been offering US investors the ADS Direct Plan, which provides investors in the US an easy and inexpensive way of directly purchasing Novartis shares and of reinvesting dividends. This

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plan holds Novartis ADSs which are listed on the NYSE under the trading symbol NVS. At the end of 2005, the US Direct Share Purchase Plan had 453 participants. Since September 1, 2004 we have also offered a Direct Share Purchase Program to investors residing in Switzerland, Liechtenstein, France and the UK, which was the first of its kind in Europe. With this plan we offer an easy and inexpensive way of directly purchasing our registered shares and of depositing them free of charge with SAS SIS Aktienregister AG. As of December 31, 2005, a total of 9,163 shareholders were or had been enrolled in this program.

5.C  Research & Development, Patents and Licenses

        Our Research &a