Novartis AG Annual Report 2018

Plain-text annual report

Annual Report 2018 Annual Report 2018 Table of contents Table of contents * Item 4. Introduction and use of certain terms .................................................................................................................................................................4 Forward-looking statements ...................................................................................................................................................................................5 PART I 7 Item 1. Identity of Directors, Senior Management and Advisers ...................................................................................................7 Item 2. Offer Statistics and Expected Timetable ...................................................................................................................................8 Key Information ........................................................................................................................................................................................9 Item 3. 3.A Selected financial data .........................................................................................................................................................................9 3.B Capitalization and indebtedness ..................................................................................................................................................10 3.C Reasons for the offer and use of proceeds ...........................................................................................................................10 3.D Risk factors ............................................................................................................................................................................................. 11 Information on the Company ..........................................................................................................................................................24 4.A History and development of Novartis ........................................................................................................................................24 4.B Business overview ...............................................................................................................................................................................29 Innovative Medicines ..........................................................................................................................................................................32 Sandoz ...................................................................................................................................................................................................... 63 Alcon ...........................................................................................................................................................................................................68 4.C Organizational structure ................................................................................................................................................................... 74 4.D Property, plants and equipment ................................................................................................................................................... 74 Item 4A. Unresolved Staff Comments ..........................................................................................................................................................78 * Item 5. Operating and Financial Review and Prospects ..................................................................................................................79 5.A Operating results..................................................................................................................................................................................79 5.B Liquidity and capital resources ..................................................................................................................................................122 5.C Research and development, patents and licenses ..........................................................................................................132 5.D Trend information ..............................................................................................................................................................................132 5.E Off-balance sheet arrangements .............................................................................................................................................132 5.F Tabular disclosure of contractual obligations ....................................................................................................................133 Item 6. Directors, Senior Management and Employees ...............................................................................................................134 6.A Directors and senior management ..........................................................................................................................................134 6.B Compensation ....................................................................................................................................................................................135 6.C Board practices.................................................................................................................................................................................. 172 6.D Employees ............................................................................................................................................................................................201 6.E Share ownership................................................................................................................................................................................201 Item 7. Major Shareholders and Related Party Transactions ....................................................................................................202 7.A Major shareholders ..........................................................................................................................................................................202 7.B Related party transactions ...........................................................................................................................................................203 Interests of experts and counsel ..............................................................................................................................................203 7.C Financial Information .......................................................................................................................................................................204 8.A Consolidated statements and other financial information ...........................................................................................204 8.B Significant changes .........................................................................................................................................................................205 The Offer and Listing ......................................................................................................................................................................206 9.A Offer and listing details ..................................................................................................................................................................206 9.B Plan of distribution ............................................................................................................................................................................206 9.C Markets ...................................................................................................................................................................................................206 9.D Selling shareholders ........................................................................................................................................................................206 9.E Dilution ....................................................................................................................................................................................................206 9.F Expenses of the issue ....................................................................................................................................................................206 Item 10. Additional Information .....................................................................................................................................................................207 10.A Share capital ........................................................................................................................................................................................207 10.B Memorandum and articles of association ............................................................................................................................207 10.C Material contracts .............................................................................................................................................................................210 10.D Exchange controls............................................................................................................................................................................ 211 10.E Taxation .................................................................................................................................................................................................. 211 Item 8. Item 9. * “Item 5. Operating and Financial Review and Prospects” together with the sections on compounds in development and key development projects of our divisions (see “Item 4. Information on the Company—Item 4.B Business overview”) constitute the Operating and Financial Review (“Lagebericht”), as defined by the Swiss Code of Obligations. 2 Table of contents 10.F Dividends and paying agents ...................................................................................................................................................... 214 10.G Statement by experts ..................................................................................................................................................................... 214 10.H Documents on display ....................................................................................................................................................................215 10.I Subsidiary information ....................................................................................................................................................................215 Item 11. Quantitative and Qualitative Disclosures About Market Risk ....................................................................................216 Item 12. Description of Securities Other Than Equity Securities............................................................................................... 217 12.A Debt securities ................................................................................................................................................................................... 217 12.B Warrants and rights.......................................................................................................................................................................... 217 12.C Other securities ................................................................................................................................................................................. 217 12.D American Depositary Shares ...................................................................................................................................................... 217 PART II 219 Item 13. Defaults, Dividend Arrearages and Delinquencies ..........................................................................................................219 Item 14. Material Modifications to the Rights of Security Holders and Use of Proceeds .............................................220 Item 15. Controls and Procedures ..............................................................................................................................................................221 Item 16A. Audit Committee Financial Expert ...........................................................................................................................................222 Item 16B. Code of Ethics ....................................................................................................................................................................................223 Item 16C. Principal Accountant Fees and Services ..............................................................................................................................224 Item 16D. Exemptions from the Listing Standards for Audit Committees ................................................................................225 Item 16E. Purchases of Equity Securities by the Issuer and Affiliated Purchasers .............................................................226 Item 16F. Change in Registrant’s Certifying Accountant ..................................................................................................................227 Item 16G. Corporate Governance ..................................................................................................................................................................228 Item 16H. Mine Safety Disclosure ..................................................................................................................................................................229 PART III 230 Item 17. Financial Statements.......................................................................................................................................................................230 Item 18. Financial Statements.......................................................................................................................................................................231 Item 19. Exhibits ...................................................................................................................................................................................................232 3 Introduction and use of certain terms Introduction and use of certain terms Novartis AG and its consolidated affiliates publish consolidated financial statements expressed in US dollars. Our consolidated financial statements responsive to Item 18 of this Annual Report on Form 20-F (Annual Report) are prepared in accordance with International Financial Reporting Standards (IFRS) as issued by the International Accounting Standards Board (IASB). “Item 5. Operating and Financial Review and Prospects,” together with the sections on products in development and key development projects of our businesses (see “Item 4. Information on the Company—Item 4.B. Business overview”), constitute the Operating and Financial Review (“Lagebericht”), as defined by the Swiss Code of Obligations. Unless the context requires otherwise, the words “we,” “our,” “us,” “Novartis,” “Group,” “Company,” and similar words or phrases in this Annual Report refer to Novartis AG and its consolidated affiliates. However, each Group company is legally separate from all other Group companies and manages its business independently through its respective board of directors or similar supervisory body or other top local management body, if applicable. Each executive identified in this Annual Report reports directly to other executives of the Group company that employs the executive, or to that Group company’s board of directors. In this Annual Report, 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; references to the “United States” or to “US” are to the United States of America, references to the “European Union” or to “EU” are to the European Union and its 28 member states, references to “Latin America” are to Central and South America, including the Caribbean, and references to “Australasia” are to Australia, New Zealand, Melanesia, Micronesia and Polynesia, unless the context otherwise requires; references to the “EC” are to the European Commission; references to “associates” are to employees of our affiliates; references to the “SEC” are to the US Securities and Exchange Commission; references to the “FDA” are to the US Food and Drug Administration, references to “EMA” are to the European Medicines Agency, an agency of the EU, and references to the “CHMP” are to the Committee for Medicinal Products for Human Use of the EMA; references to “ADR” or “ADRs” are to Novartis American Depositary Receipts, and references to “ADS” or “ADSs” are to Novartis American Depositary Shares; references to the “NYSE” are to the New York Stock Exchange, and references to “SIX” are to the SIX Swiss Exchange; references to “ECN” are to the Executive Committee of Novartis; references to “GSK” are to GlaxoSmithKline plc, references to “AAA” are to Advanced Accelerator Applications S.A., references to “AveXis” are to AveXis, Inc., and references to “Endocyte” are to Endocyte, Inc. All product names appearing in italics are trademarks owned by or licensed to Group companies. Product names identified by a “®” or a “™” are trademarks that are not owned by or licensed to Group companies and are the prop- erty of their respective owners. 4 Forward-looking statements Forward-looking statements This Annual Report contains certain forward-looking statements within the meaning of Section 27A of the Securi- ties Act of 1933, Section 21E of the Securities Exchange Act of 1934, and the United States Private Securities Litigation Reform Act of 1995, each as amended from time to time. Other written materials filed with or furnished to the SEC by Novartis, as well as other written and oral statements made to the public, may also contain for- ward-looking statements. Forward-looking statements can be identified by words such as “potential,” “expected,” “will,” “planned,” “pipeline,” “outlook,” or similar terms, or by express or implied discussions regarding potential new products, potential new indications for existing products, or regarding potential future revenues from any such prod- ucts; or regarding the potential outcome, or financial or other impact on Novartis, of the proposed spin-off of our Alcon Division, or of the proposed divestiture of certain portions of our Sandoz Division business in the US; or regarding the potential impact of the share buyback plan; or regarding potential future sales or earnings of the Group or any of its divisions or potential shareholder returns; or regarding potential future credit ratings of the Group; or by discussions of strategy, plans, expectations or intentions. Such forward-looking statements are based on the current beliefs and expectations of management regarding future events, and are subject to significant known and unknown risks and uncertainties. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those set forth in the forward-looking statements. You should not place undue reliance on these statements. In particular, our expectations could be affected by, among other things: • Global trends toward healthcare cost containment, including ongoing government, payer and general public pric- ing and reimbursement pressures and requirements for increased pricing transparency; • Regulatory actions or delays or government regulation generally, including potential regulatory actions or delays with respect to the proposed transactions or the development of the products described in this Annual Report; • The potential that the strategic benefits, synergies or opportunities expected from the proposed transactions may not be realized or may take longer to realize than expected; • The inherent uncertainties involved in predicting shareholder returns; • The uncertainties inherent in the research and development of new healthcare products, including clinical trial results and additional analysis of existing clinical data; • Our ability to obtain or maintain proprietary intellectual property protection, including the ultimate extent of the impact on Novartis of the loss of patent protection and exclusivity on key products that commenced in prior years and will continue this year; • Safety, quality or manufacturing issues; • Uncertainties regarding actual or potential legal proceedings, including, among others, actual or potential litiga- tion with respect to the proposed transactions, product liability litigation, litigation and investigations regarding sales and marketing practices, intellectual property disputes and government investigations generally; • Uncertainties involved in the development or adoption of potentially transformational technologies and business models; • Our performance on environmental, social and governance measures; • General political, economic and trade conditions, including uncertainties regarding the effects of ongoing insta- bility in various parts of the world; • Uncertainties regarding future global exchange rates; • Uncertainties regarding future demand for our products; and • Uncertainties regarding potential significant breaches of data security or data privacy, or disruptions of our infor- mation technology systems. 5 Forward-looking statements Some of these factors are discussed in more detail in this Annual Report, including under “Item 3. Key Information— Item 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 Annual Report as anticipated, believed, estimated or expected. We provide the information in this Annual Report 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 Annual Report as a result of new information, future events or otherwise. 6 Item 1. Identity of Directors, Senior Management and Advisers PART I Item 1. Identity of Directors, Senior Management and Advisers Not applicable. 7 Item 2. Offer Statistics and Expected Timetable Item 2. Offer Statistics and Expected Timetable Not applicable. 8 Item 3. Key Information Item 3. Key Information 3.A Selected financial data The selected financial information set out below has been extracted from our consolidated financial state- ments prepared in accordance with IFRS as issued by the IASB. Our consolidated financial statements for the years ended December 31, 2018, 2017 and 2016, are included in “Item 18. Financial Statements” in this Form 20-F. 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 quali- fied in their entirety by reference to the consolidated financial statements and their notes. (USD millions, except per share information) INCOME STATEMENT DATA Year ended December 31, 2018 2017 2016 2015 2014 Net sales to third parties from continuing operations 51 900 49 109 48 518 49 414 52 180 Operating income from continuing operations Income from associated companies Interest expense Other financial income and expense 8 169 6 438 – 957 185 8 629 1 108 – 777 39 Income before taxes from continuing operations 13 835 8 999 8 268 8 977 11 089 703 – 707 – 447 7 817 266 – 655 – 454 1 918 – 704 – 31 8 134 12 272 Taxes Net income from continuing operations Net income/(loss) from discontinued operations1 Group net income Attributable to: Shareholders of Novartis AG Non-controlling interests Basic earnings per share (USD) Continuing operations Discontinued operations Total Diluted earnings per share (USD) Continuing operations Discontinued operations Total Cash dividends2 Cash dividends per share in CHF3 Personnel cost4, 5 – 1 221 – 1 296 – 1 119 – 1 106 – 1 545 12 614 7 703 6 698 7 028 10 727 10 766 – 447 12 614 7 703 6 698 17 794 10 280 12 611 7 703 6 712 17 783 10 210 3 0 – 14 11 70 5.44 3.28 2.82 5.44 3.28 2.82 5.38 3.25 2.80 5.38 3.25 2.80 2.92 4.48 7.40 2.88 4.41 7.29 6 966 6 495 6 475 6 643 2.85 2.80 2.75 2.70 4.39 – 0.18 4.21 4.31 – 0.18 4.13 6 810 2.60 15 651 13 932 13 681 13 540 14 569 Full-time equivalent associates at year-end5 125 161 121 597 118 393 118 700 117 809 1 In 2015, Novartis completed a series of portfolio transformation transactions, including the divestments of its Animal Health and Vaccines business. In addition, a combined consumer healthcare business was created through the combination of the Novartis OTC and GlaxoSmithKline (GSK) Consumer Healthcare businesses. On March 2, 2015 a new entity, GlaxoSmithKline Consumer Healthcare Holdings Ltd. (GSK Consumer Healthcare) was formed via contribution of businesses from both Novartis and GSK. Novartis had a 36.5% interest in the newly created entity. To reflect these transactions, Novartis reported the Group’s financial results for 2015 and 2014 as “continuing operations” and “discontinued operations”, as required by IFRS. 2 Cash dividends represent cash payments in the applicable year that generally relates to earnings of the previous year. 3 Cash dividends per share represent dividends proposed that relate to earnings of the current year. Dividends for 2014 through 2017 were approved at the respective AGMs and dividends for 2018 will be proposed to the Annual General Meeting on February 28, 2019 for approval. 4 Personnel cost include wages, salaries, allowances, commissions and bonuses to staff, overtime, awards, holiday pay, severance payments and social welfare expenses. 5 Own employees 9 Item 3. Key Information (USD millions) BALANCE SHEET DATA Cash, cash equivalents and marketable securities & derivative financial instruments Inventories Other current assets Non-current assets Assets of disposal group held for sale1 Assets related to discontinued operations2 Total assets Trade accounts payable Other current liabilities Non-current liabilities Liabilities of disposal group held for sale1 Liabilities related to discontinued operations2 Total liabilities Issued share capital and reserves attributable to shareholders of Novartis AG Non-controlling interests Total equity Total liabilities and equity Net assets Outstanding share capital Total outstanding shares (millions) Year ended December 31, 2018 2017 2016 2015 2014 15 964 6 956 9 485 6 867 7 777 6 255 5 447 13 862 6 226 6 093 11 836 11 856 10 899 11 172 10 805 110 000 104 871 105 193 108 711 87 826 807 6 801 145 563 133 079 130 124 131 556 125 387 5 556 5 169 4 873 5 668 5 419 24 000 18 234 17 336 18 040 19 136 37 264 35 449 33 024 30 726 27 570 51 66 871 58 852 55 233 54 434 54 543 2 418 78 614 74 168 74 832 77 046 70 766 78 59 59 76 78 78 692 74 227 74 891 77 122 70 844 145 563 133 079 130 124 131 556 125 387 78 692 74 227 74 891 77 122 70 844 875 869 896 890 898 2 311 2 317 2 374 2 374 2 399 1 The disposal group held for sale relate to the assets and liabilities of the pending divestment of the Sandoz US dermatology business and generic US oral solids portfolio to Aurobindo Pharma USA Inc., as announced on September 6, 2018 (see “item 18. Financial Statements – Note 2 Significant pending transactions). 2 A description of discontined operations can be found in footnote 1 of the table above. Cash dividends per share Cash dividends are translated into US dollars at the Bloomberg 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 ADRs. Year earned 2014 2015 2016 2017 2018 1 Month and year paid Total dividend Total dividend per share (USD) per share (CHF) March 2015 March 2016 March 2017 March 2018 March 2019 2.60 2.70 2.75 2.80 2.85 2.67 2.70 2.72 2.94 2.89 2 1 Dividend to be proposed at the Annual General Meeting on February 28, 2019 and to be distributed March 6, 2019 2 Translated into US dollars at the December 31, 2018 rate of USD 1.014 to the Swiss franc. 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. 3.B Capitalization and indebtedness Not applicable. 3.C Reasons for the offer and use of proceeds Not applicable. 10 Item 3. Key Information 3.D Risk factors Our businesses face significant risks and uncertainties. You should carefully consider all of the information set forth in this Annual Report and in other documents we file with or furnish to the SEC, including the Form 20-F filed with the SEC by our subsidiary Alcon Inc. in con- nection with our planned spin-off of the Alcon business, as well as the following risk factors, before deciding to invest in or to maintain an investment in any Novartis securities. Our business, as well as our financial condi- tion or results of operations, could be materially adversely affected by any of these risks, as well as other risks and uncertainties not currently known to us or not currently considered material. Risks facing our business Our products face losses of intellectual property protection. Major products of our Innovative Medicines Division, as well as certain products of our Sandoz and Alcon Divi- sions, are protected by patent and other intellectual property rights, which provide us with exclusive rights to market the products, and give us an opportunity to recoup our investments in research and development. However, the strength and duration of those intellectual property rights can vary significantly from product to product and country to country, and they may be suc- cessfully challenged by third parties or governmental authorities. Loss of market exclusivity for one or more important products has had, and can be expected to continue to have, a material adverse effect on our results of operations. The introduction of generic competition for a pat- ented branded medicine typically results in a significant and rapid reduction in net sales and operating income for the branded product because generic manufactur- ers typically offer their unpatented versions at sharply lower prices. Such competition can occur after success- ful challenges to intellectual property rights or the reg- ular expiration of the term of the patent or other intellec- tual property rights. Such competition can also result from the entry of generic versions of another medicine in the same therapeutic class as one of our drugs or in another competing therapeutic class, from a Declaration of Public Interest or the compulsory licensing of our drugs by governments, or from a general weakening of intellectual property laws in certain countries around the world. In addition, generic manufacturers sometimes take an aggressive approach to challenging intellectual property rights, including conducting so-called “launches at risk” of products that are still under legal challenge for infringement, before final resolution of legal proceed- ings. We also rely in all aspects of our businesses on unpat- ented proprietary technology, know how, trade secrets and other confidential information, which we seek to pro- tect through various measures, including confidentiality agreements with licensees, employees, third-party col- laborators, and consultants who may have access to such information. If these agreements are breached or our other protective measures should fail, then our con- tractual or other remedies may not be adequate to cover our losses. Some of our best-selling products have begun or are about to face significant competition due to the end of market exclusivity resulting from the expiry of patent or other intellectual property protection. • Our former top-selling products Gleevec/Glivec, Diovan and Exforge all face continued and increasing generic competition in major markets. • Patent protection for the marketed forms of our Sandostatin products has expired. Generic versions of Sandostatin SC are available in the US, the EU and Japan. While there is currently no generic competition in the US, the EU or Japan for Sandostatin LAR, the long-acting version of Sandostatin that represents the majority of our Sandostatin sales, such generic com- petition may arise in the future. • Intellectual property protecting a number of additional major products is either being challenged or will expire at various times in the coming years, raising the possi- bility of generic competition. Among these products that may begin to face generic competition in one or more major markets during the next three years are Gilenya, our everolimus products (Afinitor/Votubia and Zortress/Certican), Exjade and Jadenu, and Lucentis. For more information on the patent and generic compe- tition status of our Innovative Medicines Division’s prod- ucts, see “Item 4. Information on the Company—Item 4.B Business overview—Innovative Medicines—Intellectual property.” In 2019, we expect a potentially significant impact on our net sales from products that have already lost intel- lectual property protection, as well as products that will lose protection during the year. Because we typically have substantially reduced marketing and research and development expenses related to products that are in their final years of exclusivity, the initial loss of intellec- tual property protection for a product during the year could also have an impact on our 2019 operating income in an amount corresponding to a significant portion of the product’s lost sales. The magnitude of the impact of generic competition on our income could depend on a number of factors, including the time of year at which the generic competitor is launched; the ease or difficulty of manufacturing a competitor product and obtaining regulatory approval to market it; the number of generic competitor products approved, including whether, in the US, a single competitor is granted an exclusive market- ing period; whether an authorized generic is launched; the geographies in which generic competitor products are approved, including the strength of the market for generic pharmaceutical products in such geographies the comparative profitability of branded and 11 Item 3. Key Information pharmaceutical products in such geographies; and our ability to successfully develop and launch profitable new products to replace the income lost to generic compe- tition. See also “—Our research and development efforts may not succeed,” below, with respect to the develop- ment and launch of new products. Clearly, with respect to major products for which the patent terms are expiring, the loss of exclusivity of these products could have a material adverse effect on our business, financial condition, or results of operations. In addition, should we unexpectedly lose exclusivity on additional products as a result of patent litigation or other reasons, this could also have a material adverse effect on our business, financial condition, or results of opera- tions, both due to the loss of revenue and earnings, and the difficulties in planning for such losses. Our financial performance depends on the commercial success of key products. Our financial performance, including our ability to replace revenue and income lost to generic and other competi- tion and to grow our business, depends heavily on the commercial success of our products. If any of our major products were to become subject to problems such as changes in prescription growth rates, unexpected side effects, loss of intellectual property protection, supply chain issues or other product shortages, regulatory pro- ceedings, changes in labeling, publicity affecting doctor or patient confidence in the product, material product liability litigation, or pressure from new or existing com- petitive products, the adverse impact on our revenue and profit could be significant. In addition, our revenue and profit could be significantly impacted by the timing and rate of commercial acceptance of key new products. See also “—Our business is affected by pressures on pricing and reimbursement for our products,” below, with regard to the impact of pricing and reimbursement issues on the commercial success of our products. All of our businesses face intense competition from new products and technological advances from compet- itors, and physicians, patients and third-party payers may choose our competitors’ products instead of ours if they perceive them to be safer, more effective, easier to administer, less expensive, more convenient or more cost-effective. Products that compete with ours are launched from time to time. We cannot predict with accu- racy the timing of the introduction of such competitive products or their possible effect on our sales. However, products significantly competitive to our major products – including Cosentyx, Lucentis, Gilenya, Sandostatin, Tasigna, Afinitor, Kisqali and Kymriah – are on the mar- ket, and others are in development. In addition, numer- ous companies from around the world are seeking to enter the healthcare field to take advantage of their expertise in digital and other new technologies. See “—We may fail to develop or take advantage of transformational technologies and business models,” below. Such competitive products could significantly affect the revenue from our products and our results of oper- ations. This impact could also be compounded to the extent such competition results in us making significant additional investments in marketing and sales, or in research and development. For example, our US Sandoz business has suffered significant declines in sales and profits in recent years due, at least in part, to increased competition in its prod- uct segments. There can be no certainty that Sandoz US sales will recover in the coming years. In any event, such competition and the costs of our efforts to improve the business’s performance, as well as other factors, can be expected to affect the business, financial condition, or results of operations of this organization, at least in the near term. In addition, despite the devotion of significant resources to our efforts to improve the performance of Sandoz US, those efforts may ultimately prove insuffi- cient. Should our efforts fail to accomplish their goals, or fail to do so in a timely manner, it could have a mate- rial adverse impact on our business, financial condition, or results of operations beyond the near term, as well. See also “—Our research and development efforts may not succeed,” and “—Competition and failure to suc- cessfully develop biosimilars and other differentiated products may impact the success of our Sandoz Divi- sion,” below. Our research and development efforts may not succeed. We engage in extensive and costly research and devel- opment activities, both through our own dedicated resources and through collaborations with third parties, in an effort to identify and successfully and cost-effec- tively develop new products that address unmet and changing medical needs, are accepted by patients and physicians, are reimbursed by payers, and are commer- cially successful. Our ability to continue to maintain and grow our business; to replace sales lost due to compe- tition, entry of generics or other reasons; and to bring to market products and medical advances that take advan- tage of new and potentially disruptive technologies, depends in significant part upon the success of these efforts. However, developing new healthcare products and bringing them to market is a highly costly, lengthy and uncertain process. In spite of our significant invest- ments, there can be no guarantee that our research and development activities will produce commercially suc- cessful new products that will enable us to replace rev- enue and income lost to generic and other competition and to grow our business. See also “—We may not suc- cessfully achieve our goals in transactions or reorgani- zations,” below, with regard to our efforts to reorganize our Innovative Medicines product development organi- zation. Using the products of our Innovative Medicines Divi- sion as an example, the research and development pro- cess for a new product can take up to 15 years, or even longer, from discovery to commercial product launch – and with limited available intellectual property protec- tions, the longer it takes to develop a product, the less time there may be for us to recoup our research and development costs. New products must undergo inten- sive preclinical and clinical testing, and must be approved by means of highly complex, lengthy and expensive approval processes that can vary from country to coun- try. During each stage, there is a substantial risk that we will encounter serious obstacles that will further delay us and add substantial expense, that we will develop a 12 Item 3. Key Information product with limited potential for commercial success, or that we will be forced to abandon a product in which we have invested substantial amounts of time and money. These risks may include failure of the product candidate in preclinical studies, difficulty enrolling patients in clin- ical trials, clinical trial holds or other delays in complet- ing clinical trials, insufficient clinical trial data to support the safety or efficacy of the product candidate or to dif- ferentiate our product candidate from competitors, delays in completing formulation and other testing and work necessary to support an application for regulatory approval, adverse reactions to the product candidate or other safety concerns, an inability to manufacture suffi- cient quantities of the product candidate for develop- ment or commercialization activities in a timely and cost-effective manner, and failure to obtain, or delays in obtaining, the required regulatory approvals for the prod- uct candidate or the facilities in which it is manufactured. In addition, following the “Brexit” vote in the UK, the EU decided to move the headquarters of the EU’s health authority, the EMA, from the UK to the Netherlands by March 2019. It is expected that a significant percentage of the current employees of the EMA will decide not to make the move to the Netherlands. This raises the pos- sibility that new drug approvals in the EU could be delayed as a result. Further, in recent years, in order to achieve approv- als of new products and new indications, governmental authorities around the world have increasingly required more clinical trial data than they had in the past, the inclu- sion of significantly higher numbers of patients in clini- cal trials, and more detailed analyses of the trials. In addi- tion, in order for a product to be reimbursed and to be commercially successful, payers and prescribers have increasingly required additional data that differentiates the product from other drugs on the market. As a result, despite significant efforts by health authorities such as the FDA to accelerate the development of new drugs, the already lengthy and expensive process of obtaining regulatory approvals and reimbursement for pharmaceu- tical products has in many cases become even more challenging. Similarly, the post-approval regulatory burden has also increased. Approved drugs are subject to various requirements such as risk evaluation and mitigation strat- egies (REMS), risk management plans, comparative effectiveness studies, health technology assessments, and requirements to conduct post-approval Phase IV clinical trials to gather additional safety and other data on products. These requirements have the effect of mak- ing the maintenance of regulatory approvals for our prod- ucts increasingly expensive, and further heightening the risk of recalls, product withdrawals, loss of market share, and loss of revenue and profitability. There is also the risk that we may fail to identify sig- nificant new product candidates for development or potentially disruptive new technologies, and so may fail to take advantage of a potential new wave of innovation. Our Alcon Division faces similar challenges in bring- ing new products to market, including both the products and components that have been developed in house, as well as those that have been acquired from third parties. Alcon’s Surgical and Vision Care products face medical device development and approval processes that are often similarly as difficult as those faced by our Innovative Medicines Division. For example, in 2017 the EU pub- lished a new EU Medical Devices Regulation, which has introduced substantial changes to the requirements for medical device manufacturers bringing new products to the EU market, including with respect to clinical devel- opment, labeling, technical documentation and quality management systems. The regulation has a three-year implementation period. Further, the FDA is also pursuing various efforts to modernize its regulation of devices, including potential changes to existing regulatory approval pathways that could impact our device approval efforts. Alcon has taken steps to increase its innovation power and the success of its research and development efforts. But these efforts are costly and require exten- sive efforts over time. There can be no certainty that Alcon will be successful in these efforts, in either the short term or the long term, and if Alcon is not success- ful, there could be a material adverse effect on the suc- cess of the Alcon Division. In addition, our Sandoz Division has made, and expects to continue to make, significant investments in the development of biotechnology-based, “biologic” medicines intended for sale as bioequivalent or “biosim- ilar” versions of currently marketed biotechnology prod- ucts, as well as other differentiated, “difficult-to-make” generic products. While the development of such prod- ucts typically is significantly less costly and complex than the development of the equivalent originator medicines, it is nonetheless often significantly more costly and com- plex than that for non-differentiated generic products. In addition, many countries do not yet have fully devel- oped legislative or regulatory pathways to facilitate the development of biosimilars and permit biosimilars to be sold in a manner in which the biosimilar product would be readily substitutable for the originator product. Fur- ther delays in the development and completion of such regulatory pathways, or any significant impediments that may ultimately be built into such pathways, or any other significant difficulties that may arise in the development or marketing of biosimilars or other differentiated prod- ucts, could put at risk the significant investments that Sandoz has made, and will continue to make, in the devel- opment of differentiated products in general, and in its Biopharmaceuticals business in particular. Sandoz also achieves significant revenue opportunities when it secures and maintains exclusivity periods granted for generic products in certain markets – particularly the 180-day exclusivity period granted in the US by the Hatch Waxman Act for first-to-file generics. Failure to obtain and maintain such exclusivity periods or to successfully develop and market biosimilars and differentiated generic products could have a material adverse effect on the success of the Sandoz Division and the Group as a whole. See also “—Competition and failure to successfully develop biosimilars and other differentiated products may impact the success of our Sandoz Division,” below. Further, in all of our divisions, our research and devel- opment activities must be conducted in an ethical and compliant manner. Among other things, we must be con- cerned with patient safety, data privacy, Good Clinical Practices requirements, data integrity requirements, the fair treatment of patients in developing countries, and animal welfare requirements. Should we fail to properly 13 Item 3. Key Information manage such issues, we risk injury to third parties, dam- age to our reputation, negative financial consequences as a result of potential claims for damages, sanctions and fines, and the potential that our investments in research and development activities could have no ben- efit to the Group. If we are unable to maintain a flow of successful, cost-effective new products and new indications for existing products that will sustain and grow our business, cover our substantial research and development costs and the decline in sales of older products that become subject to generic or other competition, and take advan- tage of technological and medical advances, then this could have a material adverse effect on our business, financial condition, or results of operations. For a further description of the approval processes that must be followed to market our products, see the sections headed “Regulation” included in the descrip- tions of our operating divisions under “Item 4. Informa- tion on the Company—Item 4.B Business overview.” Our business is affected by pressures on pricing and reimbursement for our products. Our businesses are operating in an ever more challeng- ing environment, with significant pressures on the pric- ing of our products and on our ability to obtain and main- tain satisfactory rates of reimbursement for our products by governments, insurers and other payers. The growth of overall healthcare costs as a percentage of gross domestic product in many countries means that govern- ments and payers are under intense pressure to control healthcare spending even more tightly than in the past. These pressures are particularly strong given the increasing demand for healthcare resulting from the aging of the global population and associated increases in noncommunicable diseases, and the resulting impact on healthcare budgets. These pressures are further compounded by significant controversies and intense political debate and publicity about prices for pharmaceuticals that some consider excessive, includ- ing government regulatory efforts, funding restrictions, legislative proposals, policy interpretations, investiga- tions and legal proceedings regarding pharmaceutical pricing practices. See also “—Ongoing consolidation among our dis- tributors and retailers is increasing both the purchasing leverage of key customers and the concentration of credit risk,” below, with regard to the impact of the con- solidation among our customers on our pricing; “—Our products face losses of intellectual property protection,” above, with regard to the impact of the loss or risk of loss of intellectual property protections on our pricing; and “—Political and economic instability may impact our results,” below, with regard to the impact of economic conditions on our pricing. As a result, in addition to ongoing public and political pressures to limit the prices we charge for our products, we face numerous cost-containment measures imposed by governments and other payers, including govern- ment-imposed industrywide price reductions, mandatory pricing systems, reference pricing systems, payers lim- iting access to treatments based on cost-benefit analyses, imports of drugs from lower-cost countries to higher-cost countries, shifting of the payment burden to patients through higher co-payments, limiting physicians’ ability to choose among competing medicines, manda- tory substitution of generic drugs for the patented equiv- alent, growing pressure on physicians to reduce the pre- scribing of patented prescription medicines, increasing pressure on intellectual property protections, and requirements for increased transparency on pricing. For more information on such price controls, see “Item 4. Information on the Company—Item 4.B Business over- view—Innovative Medicines—Price controls.” We expect these challenges to continue and to increase in 2019 and following years as political pres- sures mount, and healthcare payers around the globe, including government-controlled health authorities, insurance companies and managed care organizations, step up initiatives to reduce the overall cost of health- care, restrict access to higher-priced new medicines, increase the use of generics and impose overall price cuts. These factors may materially affect our ability to achieve an acceptable return on our investments in the research and development of our products, may impact our ability to invest in the research and development of new products, and could have a material adverse impact on our business, financial condition, or results of opera- tions, as well as on our reputation. We could be impacted by new laws and regulations, and by failures to comply with law, legal proceedings and government investigations. We are obligated to comply with the laws of all of the countries around the world in which we operate and sell products with respect to an extremely wide and grow- ing range of activities. Such legal requirements can vary from country to country, and new requirements may be imposed on us from time to time as a result of changing government and public expectations regarding the healthcare industry, and acceptable corporate behavior generally. For example, we are faced with increasing pressures, including new laws and regulations from around the world, to be more transparent with respect to how we do business, including with respect to our interactions with healthcare professionals and organizations. These laws and regulations include requirements that we dis- close payments or other transfers of value made to healthcare professionals and organizations, as well as information relating to the prices for our products. Such measures, including any additional such measures that may be put in place, could have a material adverse impact on our business, financial condition, or results of opera- tions. In addition, companies and executives in our indus- try continue to face significant government investiga- tions, legal proceedings and law enforcement activities, both in the US and in countries around the world. Increas- ingly, such activities can involve criminal proceedings, and can retroactively challenge practices previously con- sidered to be legal. A number of our subsidiaries across each of our divisions are, or may in the future be, subject to various investigations and legal proceedings, 14 Item 3. Key Information including proceedings regarding sales and marketing practices, pricing, corruption, trade regulation and embargo legislation, product liability, commercial dis- putes, employment and wrongful discharge, antitrust matters, securities, insider trading, occupational health and safety, environmental matters, tax, cybersecurity, data privacy and intellectual property. Our Sandoz Division may from time to time seek approval to market a generic version of a product before the expiration of patents claimed by the marketer of the patented product. We do this in cases where we believe that the relevant patents are invalid or unenforceable, or would not be infringed by our generic product. As a result, affiliates of our Sandoz Division frequently face patent litigation, and in certain circumstances, we may elect to market a generic product even though patent infringe- ment actions are still pending. Should we elect to pro- ceed in this manner and conduct a “launch at risk,” we could face substantial damages if the final court deci- sion is adverse to us. For information on significant legal matters pending against us, see “Item 18. Financial Statements—Note 19. Provisions and other non-current liabilities” and “Item 18. Financial Statements—Note 27. Commitments and con- tingencies.” See also “—Our reliance on outsourcing key business functions to third parties heightens the risks faced by our businesses,” below. To help us in our efforts to comply with the many requirements that impact us, we have a significant global ethics and compliance program in place, and we devote substantial time and resources to efforts to ensure that our business is conducted in a lawful and publicly accept- able manner. Nonetheless, despite our efforts, any actual or alleged failure to comply with law or with heightened public expectations could lead to substantial liabilities that may not be covered by insurance, or to other signif- icant losses, and could affect our business, financial position and reputation. Such proceedings are inherently unpredictable, and large judgments sometimes occur. As a consequence, we may in the future incur judgments that could involve large cash payments, including the potential repayment of amounts allegedly obtained improperly, and other pen- alties, including treble damages. In addition, such legal proceedings and investigations, even if meritless, may affect our reputation, may create a risk of potential exclu- sion from government reimbursement programs in the US and other countries, and may lead to civil litigation. As a result, having taken into account all relevant factors, we have in the past and may again in the future enter into major settlements of such claims without bringing them to final legal adjudication by courts or other such bod- ies, despite having potentially significant defenses against them, in order to limit the risks they pose to our business and reputation. Such settlements may require us to pay significant sums of money and to enter into corporate integrity or similar agreements, which are intended to regulate company behavior for extended periods. Any such judgments or settlements, and any accru- als that we may take with respect to potential judgments or settlements, could have a material adverse impact on our business, financial condition, or results of operations, as well as on our reputation. The manufacture of our products is highly regulated and complex. The manufacture of our products is complex and heav- ily regulated by governmental health authorities around the world, including the FDA. Whether our products and the related raw materials are manufactured at our own dedicated manufacturing facilities or by third parties, we must ensure that all manufacturing processes comply with our own quality standards, as well as with current Good Manufacturing Practices (cGMP) and other appli- cable regulations. The technically complex manufacturing processes required to manufacture many of our products increase the risk of production failures and product recalls, and can increase the cost of producing our goods. Many of our products require a supply of highly specialized raw materials. For some of our products and raw materials, we may rely on a single source of supply. In addition, we manufacture and sell a number of sterile products, bio- logic products and products involving advanced therapy platforms, such as CAR-T therapies, gene therapy and radioligand therapy products, all of which are particu- larly complex and involve highly specialized manufactur- ing technologies. As a result, even slight deviations at any point in their production process or in material used may lead to production failures or recalls. For example, for our new CAR-T therapy product Kymriah, manufac- turing-related issues have impacted the product’s sales. In sum, because the production process for some of our products is complex and sensitive, the cost of produc- tion of these products can be high, and the chance of production failures, lengthy supply interruptions, prod- uct recalls or voluntary market withdrawals is increased. In addition, due to the inherent complexities of our production processes, we are required to plan our pro- duction activities well in advance. If we should suffer from raw material shortages, or if we should underestimate market demand for a product, or should fail to accurately predict when the product would be approved for sale, then we may not be able to produce sufficient product to meet demand. Alternatively, if we overestimate the quantity or timing of product to be produced, then we may be required to dispose of excess product, which would result not only in the loss of the product but also in the resources spent to produce it. These complex production processes are also heav- ily regulated by health authorities around the world. And in recent years, these health authorities have substan- tially intensified their scrutiny of manufacturers’ compli- ance with such requirements. Any significant failure by us or our third-party suppliers to comply with these requirements, or with the health authorities’ expecta- tions, may cause us to shut down the production facili- ties or production lines and recall previously shipped products. Alternatively, we may be forced to do so by a government health authority, or could be prevented from importing our products from one country to another. In addition, health authorities have in some cases imposed significant penalties for such failures to comply with cGMP. A failure to comply fully with cGMP could also lead to a delay in the approval of new products to be manufactured at the impacted site. Further, because our products are intended to pro- mote the health of patients, for some of our products, a 15 Item 3. Key Information supply disruption or other production issue could endan- ger our reputation and subject us to lawsuits or to alle- gations that the public health, or the health of individu- als, has been harmed. In sum, complex production processes and compli- ance with regulatory requirements can increase our cost of producing our products, and any significant disruption in the supply of our products could impact patient health and our sales, which could have a material adverse effect on our business, financial condition, or results of opera- tions, as well as our reputation. See also “—We may not successfully achieve our goals in transactions or reorganizations,” below, with regard to our efforts to reorganize our product manufac- turing organization, and “—Climate change, extreme weather events, earthquakes and other natural disasters could adversely affect our business,” below. We devote substantial time and resources to meet- ing these challenges. However, there can be no guaran- tee as to the success of our efforts, or that we or our third-party suppliers will not face significant manufac- turing issues, or that we will successfully manage such issues when they arise. Such issues could lead to shut- downs, to product shortages, or to our being entirely unable to supply products to patients for an extended period of time. Such shortages or shutdowns have led to, and could continue to lead to, significant losses of sales revenue and to potential third-party litigation. We may not successfully achieve our goals in transactions or reorganizations. As part of our strategy, from time to time we acquire and divest products or entire businesses in order to expand or complement our existing businesses, or to enable us to focus more sharply on our strategic businesses. For example, we recently completed the acquisitions of AveXis, Inc., a gene therapy company, and Endocyte, Inc., a radioligand therapy company, as well as the divestment of our stake in the GSK consumer healthcare joint ven- ture. We also announced plans to spin off our Alcon Divi- sion and to divest the Sandoz US dermatology business and US oral solids portfolio. Despite expending significant efforts and resources in this area, we cannot ensure that we will identify prod- ucts or businesses that are suitable for acquisition. In addition, acquisition activities can be thwarted by gov- ernmental regulation, including market concentration limitations, political interference, overtures from compet- itors for the targeted assets, potentially increasing prices demanded by sellers, and other issues. Once an acqui- sition is agreed upon with a third party, we may not be able to complete the acquisition in the expected form or within the expected timeframe, or at all, due to a failure to obtain required regulatory approvals or a failure to achieve contractual or other required closing conditions. Further, after an acquisition, efforts to develop and mar- ket acquired products or to integrate the acquired busi- ness may not meet expectations, or may otherwise not be successful, as a result of difficulties in retaining key personnel, customers and suppliers; difference in cor- porate culture, standards, controls, processes and pol- icies; the price at which we acquired the business; or other reasons. Acquisitions and divestments can also divert management’s attention from our existing businesses, and could result in the existing businesses failing to achieve expected results, or in liabilities being incurred that were not known at the time of acquisition, or the creation of tax or accounting issues. Similarly, we cannot ensure that we will be able to successfully divest or spin off businesses or other assets that we have identified for this purpose. Neither can we ensure that we will correctly select businesses or assets as candidates for divestment or spin-off, that we will be able to successfully complete any planned divestments or spin-offs, or that any completed divestment or spin- off will achieve the expected strategic benefits, syner- gies or opportunities, or that the divestment or spin-off will ultimately maximize shareholder value. In addition, as part of our strategy, from time to time we reassess the optimal organization of our business, such as our ongoing efforts to centralize and optimize our manufacturing and business services organizations, in order to better align our organization with the capa- bilities and expertise required for competitive advantage. But the expected benefits of such reorganizations may never be fully realized or may take longer to realize than expected. There can be no certainty that the businesses and functions involved will be successfully integrated into the new organizations or that key personnel will be retained. Disruption from the reorganizations may make it more difficult to maintain relationships with customers, employees or suppliers; could result in shortfalls in pro- gram oversight; and may result in the Group not achiev- ing the expected productivity and financial benefits. Both with respect to the transactions and reorgani- zations previously announced, and to potential future transactions and reorganizations, if we fail to success- fully address these risks, or to devote adequate resources to them, we may fail to achieve our strategic objectives, including our growth strategy, or otherwise may not real- ize the intended benefits of the acquisition, divestiture, spin-off or reorganization. Significant breaches of information security and the use of electronic communications technologies could adversely affect our business and expose people’s personal information. We are heavily dependent on critical, complex and inter- dependent information technology systems, including internet-based systems, to support our business pro- cesses. In addition, we rely on internet and social media tools and mobile technologies as a means of communi- cations and to gather information, which can include peo- ple’s personal data. We also increasingly seek to develop technology-based products such as mobile applications and other digital health products that go “beyond the pill” to improve patient welfare in a variety of ways, which could also result in us collecting personal information about individual patients and others. The size, age and complexity of our information tech- nology systems make them potentially vulnerable to external and internal security threats; outages; malicious intrusions and attacks; cybercrimes, including state-spon- sored cybercrimes; malware; misplaced or lost data; pro- gramming or human errors; or other similar events. Although we have devoted and continue to devote sig- nificant resources and management attention to cyber- information management and business security, 16 Item 3. Key Information continuity efforts, like many companies, we have expe- rienced certain of these events and expect to continue to experience them in the future, as the external and internal information security threat continues to grow. We believe that the information security incidents we have experienced to date have yet to result in significant disruptions to our operations, and have not had a signif- icant adverse effect on our results of operations, or on third parties. However, we may not be able to prevent future outages, security incidents or other breaches in our systems from having a material adverse effect on our business, financial condition, results of operations, or reputation. A significant information security or other such event could negatively impact important business processes, such as the conduct of scientific research and clinical trials, the submission of the results of such efforts to health authorities in support of requests for product approvals, the functioning of our manufacturing and sup- ply chain processes, our compliance with legal obliga- tions, communication between employees and with third parties, and other key business activities. Information technology issues could also lead to the compromise of trade secrets or other intellectual property that could be sold and used by competitors to accelerate the devel- opment or manufacturing of competing products; to the compromise of personal financial and health information that could be misused for fraud and identity theft; and to the compromise of information technology security data such as usernames, passwords and encryption keys, as well as security strategies and information about net- work infrastructure, which could allow unauthorized par- ties to gain access to additional information on our sys- tems. In addition, malfunctions in software or medical devices that make significant use of information technol- ogy, including our Alcon surgical equipment, could lead to a risk of direct harm to patients. In addition, our routine business operations increas- ingly involve our gathering personal information (includ- ing sensitive personal information) about patients, ven- dors, customers, employees, collaborators and others, through the use of information technologies such as the internet, social media, mobile technologies and technol- ogy-based medical devices. Breaches of our systems or those of our third-party contractors, or other failures to protect such information, could expose such people’s personal data to unauthorized persons. Any event involv- ing the substantial loss of personal data could give rise to significant liability, reputational harm, damaged rela- tionships with business partners, and potentially sub- stantial monetary penalties under laws enacted or being enacted around the world. Such events could also lead to restrictions on our ability to transfer personal data across country borders. We also use internet, social media and mobile tools as a means to communicate with the public, including about our products or about the diseases our products are intended to treat. However, such uses create risks, such as potential violations of rules regulating the pro- motion of prescription medicines and the potential loss of trade secrets or other intellectual property. In addi- tion, there continues to be significant uncertainties as to the rules that apply to such communications, and as to the interpretations that health authorities will apply in this context to the rules that do exist. As a result, despite our efforts to comply with applicable rules, there is a signif- icant risk that our use of internet, social media and mobile technologies for such purposes may cause us to none- theless be found in violation of them. Our dependence upon information technology, including any breaches of data security, technology dis- ruptions, privacy violations, or other impacts from the use of interconnected technologies, could give rise to the loss of trade secrets or other intellectual property, to the public exposure of personal information, and to interruptions to our operations, and could result in enforcement actions or liability, including potential gov- ernment fines, claims for damages, and shareholders’ litigation. Any significant events of this type could require us to expend significant resources beyond those we already invest to remediate any damage, to further mod- ify or enhance our protective measures, and to enable the continuity of our business, and could have a material adverse effect on our business, financial condition, results of operations, and reputation. We may fail to develop or take advantage of transformational technologies and business models. Rapid progress in medical and digital technologies and in the development of sometimes radical new business models is substantially transforming numerous industries around the world, creating new businesses and new opportunities for revenue and profit, while sometimes quickly rendering established businesses uncompetitive or obsolete. Such transformations, both positive and negative, may impact the healthcare industry, and numer- ous companies from the digital technology and other industries are seeking to enter the healthcare field. To take advantage of these opportunities, Novartis has embarked upon a digital transformation strategy, with the goal of making Novartis an industry leader in leveraging advanced analytics and other new technolo- gies. As part of this effort, we have created a new role of Chief Digital Officer, reporting directly to the CEO, charged with creating and executing a Companywide digital strategy, to be led by the Executive Committee of Novartis. In order to reach our goal, we expect to invest sub- stantial resources into efforts to improve the way we use data in drug discovery and development; to improve the ways we engage with patients, doctors and other stake- holders; and to automate business processes. With our commitment to using innovative science and digital tech- nologies to help create transformative treatments for patients, together with our expertise and the extensive data we have and continue to amass, we believe that we have an opportunity to transform our business model using digital technologies. There is no guarantee that our efforts toward a digi- tal transformation will succeed, or that we will success- fully transform our business model, or that we will be able to do so at any particular cost or any particular time. In order to succeed, we will be required to encourage a cul- tural change among our employees, attract and retain employees with appropriate skills and mindset, and suc- cessfully innovate across a variety of technology fields. At the same time, other companies with specialized expertise or business models are entering the 17 Item 3. Key Information healthcare field, from research and development to phar- maceutical distribution, potentially disrupting our rela- tionships with patients, healthcare professionals, cus- tomers, distributors and suppliers, with unknown potential consequences for us. For example, companies such as Amazon, which acquired PillPack; IBM, with its Watson project; Alphabet, with its subsidiaries Verily and Calico; and Amazon, Berkshire Hathaway and JPMor- gan, with their healthcare joint venture, as well as other established technology companies and specialized startup organizations, are aggressively seeking to move forward in this field. In addition, we face new competi- tors from different regions of the world, including China, which is moving aggressively to expand its role in the sciences and in many industries. Such new competitors may successfully impact our share of the healthcare value chain, or even develop products or technologies that could make our products uncompetitive or obsolete. In an effort to maintain and advance our position as a leader in healthcare and related technology, we have made significant efforts to develop and to collaborate with other organizations in the development of advanced therapy platforms, including CAR-T therapy, developed in collaboration with the University of Pennsylvania; gene therapy, through our acquisition of AveXis and the licens- ing of Luxturna outside the US from Spark Therapeutics; and radioligand therapy, through our acquisitions of Advanced Accelerator Applications and Endocyte, Inc. If we should fail in our efforts at a digital transforma- tion of our Company, or in bringing advanced therapy platforms to market, then there is a risk that we may fail to create the innovative new products, tools or tech- niques that the new medical and digital technologies may make possible, or may fail to create them as quickly and efficiently as such technologies may enable. We may also lose opportunities to engage with our stakeholders and to profit from improved business processes, and may lose the resources devoted to these efforts to transform our business. At the same time, should third parties suc- cessfully enter the healthcare field with disruptive new technologies or business models, then we potentially may see our business supplanted in whole or in part by these new entrants. Any such events could have a mate- rial adverse effect on our business, financial condition, or results of operations. Environmental, social and governance matters may impact our business and reputation. Increasingly, in addition to the importance of their finan- cial performance, companies are being judged by their performance on a variety of environmental, social and governance (ESG) matters, which are considered to con- tribute to the long-term sustainability of companies’ per- formance. A variety of organizations measure the performance of companies on such ESG topics, and the results of these assessments are widely publicized, including, for example, MSCI, Sustainalytics, the Dow Jones Sustain- ability Index and, in the healthcare industry, the Access to Medicine Index. In addition, investment in funds that specialize in companies that perform well in such assess- ments are increasingly popular, and major institutional investors, such as BlackRock, have publicly emphasized the importance of such ESG measures to their investment decisions. Topics taken into account in such assessments include the company’s efforts and impacts on climate change and human rights, ethics and compli- ance with law, and the role of the company’s board of directors in supervising various sustainability issues. In addition to the topics typically considered in such assessments, in our healthcare industry, issues of the public’s ability to access our medicines are of particular importance. We actively manage a broad range of such ESG mat- ters, taking into consideration their expected impact on the sustainability of our business over time, and on the potential impact of our business on society. For a descrip- tion of our activities on such topics, see “Item 4. Infor- mation on the Company—Item 4.B Business overview— Overview—Corporate responsibility.” However, in a rapidly changing world, there can be no certainty that we will manage such issues successfully, or that we will successfully meet society’s expectations as to our proper role. Any failure or perceived failure by us in this regard could have a material adverse effect on our rep- utation and on our business, financial condition, or results of operations, including the sustainability of our business over time. See also “—Our reliance on outsourcing key business functions to third parties heightens the risks faced by our businesses,” and “—Climate change, extreme weather events, earthquakes and other natural disasters could adversely affect our business,” below. Intangible assets and goodwill on our books may lead to significant impairment charges. We carry a significant amount of goodwill and other intangible assets on our consolidated balance sheet, pri- marily due to acquisitions, including, in particular, sub- stantial goodwill and other intangible assets obtained as a result of our acquisitions of Alcon and of certain oncology assets from GSK. As a result, we may incur significant impairment charges in the future if the fair value of the intangible assets and the groupings of cash-generating units containing goodwill would be less than their carrying value on the Group’s consolidated balance sheet at any point in time. We regularly review for impairment our long-lived intangible and tangible assets, including identifiable intangible assets, investments in associated companies, and goodwill. Goodwill, intangible assets with an indefi- nite useful life, acquired research projects not ready for use, and acquired development projects not yet ready for use are subject to impairment review at least annu- ally. Other long-lived assets are reviewed for impairment when there is an indication that an impairment may have occurred. Impairment testing under IFRS may lead to impairment charges in the future. Any significant impair- ment charges could have a material adverse effect on our results of operations and financial condition. In 2018, for example, we recorded intangible asset impairment charges of USD 1.2 billion. For a detailed discussion of how we determine whether an impairment has occurred, what factors could result in an impairment, and the impact of impairment charges on our results of operations, see “Item 5. Oper- ating and Financial Review and Prospects—Item 5.A Operating results—Critical accounting policies and 18 Item 3. Key Information estimates—Impairment of goodwill, intangible assets and property, plant and equipment” and “Item 18. Financial Statements—Note 1. Significant accounting policies” and “Item 18. Financial Statements—Note 10. Goodwill and intangible assets.” Political and economic instability may impact our results. Unpredictable political conditions currently exist in var- ious parts of the world, including a backlash in certain areas against free trade, anti-immigrant sentiment, social unrest, fears of terrorism, and the risk of direct conflicts between nations. In the US, the presidential administra- tion’s imposition of tariffs and opposition to free-trade agreements could have a negative impact on interna- tional trade. Similarly, there is a risk that barriers to free trade and the free movement of people may rise in Europe as a result of the UK’s “Brexit” efforts and the rise of nationalist, separatist and populist sentiment in various countries, sometimes exacerbated by large- scale migration flows. Furthermore, significant conflicts continue in parts of the Middle East, including conflicts involving Saudi Arabia and Iran, and with respect to places such as Russia, Ukraine and North Korea. Collec- tively, such difficult conditions could, among other things, disturb the international flow of goods and increase the costs and difficulties of international transactions. In addition, local economic conditions may adversely affect the ability of payers, as well as our distributors, customers, suppliers and service providers, to pay for our products, or otherwise to buy necessary inventory or raw materials, and to perform their obligations under agreements with us. Although we make efforts to moni- tor these third parties’ financial condition and their liquid- ity, our ability to do so is limited, and some of them may become unable to pay their bills in a timely manner, or may even become insolvent, which could negatively impact our business or results of operations. These risks may be elevated with respect to our interactions with fis- cally challenged government payers, or with third parties with substantial exposure to such payers. See also “— Our reliance on outsourcing key business functions to third parties heightens the risks faced by our busi- nesses,” below. Financial market issues may also result in a lower return on our financial investments, and a lower value on some of our assets. Alternatively, inflation could accel- erate, which could lead to higher interest rates, increas- ing our costs of raising capital. Uncertainties around future central bank and other economic policies in the US and EU, as well as high debt levels in certain other countries, could also impact world trade. Sudden increases in economic, currency or financial market vol- atility in different countries have also impacted, and may continue to unpredictably impact, our business or results of operations, including the conversion of our operating results into our reporting currency, the US dollar, as well as the value of our investments in our pension plans. For further information on such risks, see “—Foreign exchange fluctuations may adversely affect our earnings and the value of some of our assets,” and “—Any inaccu- racy in the assumptions and estimates used to calculate our pension plan obligations could substantially increase our pension-related expenses,” below. See also “—Our business is affected by pressures on pricing and reim- bursement for our products,” above, and “Item 5. Oper- ating and Financial Review and Prospects—Item 5.B Liquidity and capital resources—Effects of currency fluc- tuations.” There is also a risk that countries facing local finan- cial difficulties, including countries experiencing high inflation rates and highly indebted countries facing large capital outflows, may impose controls on the exchange of foreign currency. Such exchange controls could limit our ability to distribute retained earnings from our local affiliates, or to pay intercompany payables due from those countries. See also “Item 5. Operating and Financial Review and Prospects—Item 5.B Liquidity and capital resources— Condensed consolidated balance sheets,” and “Item 18. Financial Statements—Note 14. Trade receivables” and “Item 18. Financial Statements—Note 28. Financial instru- ments—additional disclosures.” Similarly, increased scrutiny of corporate taxes and executive pay may lead to significant business disrup- tions or other adverse business conditions, and may interfere with our ability to attract and retain qualified personnel. See “—Changes in tax laws or their applica- tion could adversely affect our results of operations” and “—An inability to attract and retain qualified personnel could adversely affect our business,” below. To the extent that economic and financial conditions directly affect consumers, then our Innovative Medicines and Sandoz Divisions may be impacted. Given the requirements in certain countries that patients directly pay an increasingly large contribution toward their own healthcare costs, there is a risk that consumers may cut back on prescription drugs to help cope with rising costs. In addition, the elective surgical and contact lens busi- nesses of our Alcon Division may be particularly sensi- tive to declines in consumer spending. At the same time, significant changes and potential future volatility in the financial markets, in the consumer and business environment, in the competitive landscape, and in the global political and security landscape make it increasingly difficult for us to predict our revenues and earnings into the future. As a result, any revenue or earn- ings guidance or outlook that we have given or might give may be overtaken by events, or may otherwise turn out to be inaccurate. Though we endeavor to give reason- able estimates of future revenues and earnings at the time we give such guidance, based on then-current knowledge and conditions, there is a significant risk that such guidance or outlook will turn out to be, or to have been, incorrect. Separately and collectively, such factors may have a material adverse effect on our revenues, results of oper- ations, financial condition and, if circumstances worsen, our ability to raise capital at reasonable rates. Our indebtedness could adversely affect our operations. As of December 31, 2018, we had USD 22.5 billion of non-current financial debt and USD 9.7 billion of current 19 Item 3. Key Information financial debt. Our current and long-term debt requires us to dedicate a portion of our cash flow to service inter- est and principal payments and, if interest rates rise, this amount may increase. As a result, our existing debt may limit our ability to use our cash flow to fund capital expen- ditures, to engage in transactions, or to meet other cap- ital needs, or otherwise may place us at a competitive disadvantage relative to competitors that have less debt. Our debt could also limit our flexibility to plan for and react to changes in our business or industry, and increase our vulnerability to general adverse economic and indus- try conditions, including changes in interest rates or a downturn in our business or the economy. We may also have difficulty refinancing our existing debt or incurring new debt on terms that we would consider to be com- mercially reasonable, if at all. Our reliance on outsourcing key business functions to third parties heightens the risks faced by our businesses. We outsource the performance of certain key business functions to third parties, and invest a significant amount of effort and resources into doing so. Such outsourced functions can include research and development collab- orations, manufacturing operations, warehousing and distribution activities, certain finance functions, market- ing activities, data management and others. We may par- ticularly rely on third parties in developing countries, including for the sales, marketing and distribution of our products, and to obtain the intermediate and raw mate- rials used in the manufacture of our products. Our reliance on outsourcing and third parties for the research and development or manufacturing of our prod- ucts may reduce the potential profitability of such prod- ucts. In addition, governments and the public are increas- ingly placing pressure on major corporations, including Novartis, to take responsibility for compliance with human rights and appropriate environmental practices, as well as other actions, of their third-party contractors around the world. Examples of this include the Conflict Minerals rule in the US, and the UK Modern Slavery Act. We place strict contractual requirements on such contractors to comply with law and with our high stan- dards. We also expend significant resources on efforts to screen out inappropriate contractors, to monitor the activities of those we have retained, and to seek their compliance with the law and with our expectations. Nonetheless, many of these companies have limited resources, and, in particular, do not have internal com- pliance resources comparable to those within our orga- nization. Ultimately, if the third parties fail to meet their obliga- tions to us, we may lose our investment in the collabora- tions and fail to receive the expected benefits. In addi- tion, should any of these third parties fail to comply with the law or should they act inappropriately in the course of their performance of services for us, there is a risk that we could be held responsible for their acts, that our reputation may suffer, and that penalties may be imposed upon us. Any such failures by third parties could have a material adverse effect on our business, financial condi- tion, results of operations, or reputation. Competition and failure to successfully develop biosimilars and other differentiated products may impact the success of our Sandoz Division. Our Sandoz Division faces intense competition from companies that market patented pharmaceutical prod- ucts, which sometimes take aggressive steps to delay the introduction of generic and biosimilar medicines, to limit the availability of exclusivity periods or to reduce their value. At the same time, Sandoz faces strong com- petition from other generic and biosimilar pharmaceuti- cal companies, which aggressively compete for market share, including through significant price competition. Such competitive actions by other patented, generic and biosimilar pharmaceutical manufacturers may increase the costs and risks associated with our efforts to intro- duce and market such products, may delay the introduc- tion or marketing of such products, and may further limit the prices at which we are able to sell these products and impact our results of operations. In particular, in the US in recent years, industrywide price competition among generic pharmaceutical companies and consol- idation of buyers have significantly hurt Sandoz sales. Expecting these trends to continue, we agreed to sell the Sandoz US dermatology business and generic US oral solids portfolio to Aurobindo Pharma USA Inc. In addition, Sandoz has invested heavily in the devel- opment of biosimilar drugs and other differentiated prod- ucts, with the expectation that such products offer the potential for higher profitability than less complex prod- ucts. Sandoz has invested in the development of such products despite the fact that their development is more difficult and expensive than the development of standard generic drugs, and despite the fact that regulations con- cerning the approval, marketing and sale of biosimilars in certain countries, including in the US, are still under development or not entirely clear. If Sandoz should fail in its efforts to develop and market biosimilars or other such differentiated products, or if the developing biosim- ilars regulations do not ultimately favor the development and sale of such products, or if we are unable to sell our biosimilar products for a sufficient price, then this could have an adverse effect on the success of our Sandoz Division, and we may fail to achieve expected returns on the investments by Sandoz in the development of bio- similars and other differentiated products. See also “—Our research and development efforts may not succeed” above, with regard to the risks involved in our efforts to develop biosimilars and differentiated generic products and to obtain exclusivity periods; and “—Ongoing consolidation among our distributors and retailers is increasing both the purchasing leverage of key customers and the concentration of credit risk,” below, with respect to the impact of such consolidation on our pricing. Any inaccuracy in the assumptions and estimates used to calculate our pension plan and other post-employment obligations could substantially increase our pension-related expenses. We sponsor pension and other post-employment bene- fit plans in various forms. These plans cover a significant portion of our current and former associates. While most of our plans are now defined contribution plans, certain of our associates remain participants in defined benefits 20 Item 3. Key Information plans. For these defined benefits plans, we are required to make significant assumptions and estimates about future events in calculating the present value of expected future plan expenses and liabilities. These include assumptions used to determine the discount rates we apply to estimated future liabilities and rates of future compensation increases. Assumptions and estimates used by Novartis may differ materially from the actual results we experience in the future, due to changing mar- ket and economic conditions, higher or lower withdrawal rates, or longer or shorter life spans of participants, among other variables. For example, in 2018, a decrease in the interest rate we apply in determining the present value of expected future defined benefit obligations of one-quarter of 1% would have increased our year-end defined benefit pension obligation for plans in Switzer- land, the US, the UK, Germany and Japan, which repre- sent 94% of the Group total defined benefit pension obli- gation, by USD 0.8 billion. Any differences between our assumptions and estimates and our actual experience could require us to make additional contributions to our pension funds. Further, additional employer contribu- tions might be required if plan funding falls below the lev- els required by local rules. Either such event could have a material effect on our results of operations and finan- cial condition. For more information on obligations under retirement and other post-employment benefit plans and underly- ing actuarial assumptions, see “Item 5. Operating and Financial Review and Prospects—Item 5.A Operating results—Critical accounting policies and estimates— Retirement and other post-employment benefit plans” and “Item 18. Financial Statements—Note 24. Post-em- ployment benefits for associates.” See also “—Political and economic instability may have a material adverse effect on our results,” above. Changes in tax laws or their application could adversely affect our financial results. Our multinational operations are taxed under the laws of the countries and other jurisdictions in which we oper- ate. However, the integrated nature of our worldwide operations can produce conflicting claims from revenue authorities in different countries as to the profits to be taxed in the individual countries, including potential dis- putes relating to the prices our subsidiaries charge one another for intercompany transactions, known as trans- fer pricing. The majority of the jurisdictions in which we operate have double tax treaties with other foreign juris- dictions, which provide a framework for mitigating the impact of double taxation on our revenues and capital gains. However, mechanisms developed to resolve such conflicting claims are largely untried, and can be expected to be very lengthy. In recent years, tax authorities around the world have increased their scrutiny of company tax filings, and have become more rigid in exercising any discretion they may have. As part of this, the Organization for Economic Co-operation and Development (OECD) has proposed a number of tax law changes under its Base Erosion and Profit Shifting (BEPS) Action Plans to address issues of transparency, coherence and substance. At the same time, the European Commission is final- izing its Anti Tax Avoidance Directive, which seeks to prevent tax avoidance by companies and to ensure that companies pay appropriate taxes in the markets where profits are effectively made and business is effectively performed. The EU also adopted a new Directive on Administrative Cooperation (DAC6) in 2018, which seeks additional reporting. In addition, the European Commis- sion continues to extend the application of its policies seeking to limit fiscal aid by member states to particular companies, and the related investigation of the member states’ practices regarding the issuance of rulings on tax matters relating to individual companies. These OECD and EU tax reform initiatives also need local country implementation, including in our home country of Switzerland, which may result in significant changes to established tax principles. Although we have taken steps to be in compliance with the evolving OECD and EU tax initiatives, and will continue to do so, signifi- cant uncertainties remain as to the outcome of these efforts. Switzerland is in the process of considering the implementation of corporate tax reform, which could become effective as early as the first quarter of 2019. However, the outcome of these efforts remains subject to change and could be enacted in a materially different form from what is currently proposed, or could be admin- istered or implemented in a manner different from our expectations. There is also a risk that the EU may not be satisfied with the outcome of Switzerland’s tax reform efforts, and take steps to seek further changes. Accord- ingly, there can be no assurance that Swiss corporate tax reform will not adversely affect our business or finan- cial condition. In addition, in the US, the Tax Cuts and Jobs Act, enacted at the end of 2017, included substantial changes to the US taxation of individuals and businesses. Although the law substantially decreased tax rates applicable to corporations in the US, we do not yet know what all of the consequences of this new statute will be, including whether the law will have any unintended consequences. In particular, significant uncertainties remain as to how the US government will implement the new law, includ- ing with respect to the tax qualification of interest deduc- tions, the concept of a territorial tax regime, royalty pay- ments and cost of goods sold. In general, such tax reform efforts, including with respect to tax base or rate, transfer pricing, intercom- pany dividends, cross-border transactions, controlled corporations, and limitations on tax relief allowed on the interest on intercompany debt, will require us to contin- ually assess our organizational structure against tax pol- icy trends, and could lead to an increased risk of inter- national tax disputes and an increase in our effective tax rate, and could adversely affect our financial results. Counterfeit versions of our products could harm our patients and reputation. Our industry continues to be challenged by the vulnera- bility of distribution channels to illegal counterfeiting and the presence of counterfeit products in a growing num- ber of markets and over the internet. Counterfeit prod- ucts are frequently unsafe or ineffective, and can poten- tially be life-threatening. To distributors and patients, counterfeit products may be visually indistinguishable from the authentic version. Reports of product 21 Item 3. Key Information ineffectiveness or adverse reactions to counterfeit drugs, or increased levels of counterfeiting could affect patient confidence in our authentic products, and could harm our business or lead to litigation. In addition, it is possible that a lack of efficacy or adverse events caused by unsafe counterfeit products could mistakenly be attributed to the authentic product. If a product of ours was the subject of counterfeits, we could incur substan- tial reputational and financial harm. Foreign exchange fluctuations may adversely affect our earnings and the value of some of our assets. Changes in exchange rates between the US dollar, our reporting currency, and other currencies can result in significant increases or decreases in our reported sales, costs and earnings as expressed in US dollars, and in the reported value of our assets, liabilities and cash flows. In addition to ordinary market risk, there is a risk that countries could take affirmative steps that could signifi- cantly impact the value of their currencies. Such steps could include “quantitative easing” measures and poten- tial withdrawals by countries from common currencies. In addition, countries facing local financial difficulties, including countries experiencing high inflation rates and highly indebted countries facing large capital outflows, may impose controls on the exchange of foreign cur- rency. Such exchange controls could limit our ability to distribute retained earnings from our local affiliates, or to pay intercompany payables due from those countries. See “—Political and economic instability may have a material adverse effect on our results,” below. Despite measures undertaken to reduce or hedge against foreign currency exchange risks, because a sig- nificant portion of our earnings and expenditures are in currencies other than the US dollar, including expendi- tures in Swiss francs that are significantly higher than our revenue in Swiss francs, any such exchange rate vol- atility may negatively and materially impact our results of operations and financial condition, and may impact the reported value of our net sales, earnings, assets and liabilities. In addition, the timing and extent of such vola- tility can be difficult to predict. Further, depending on the movements of particular foreign exchange rates, we may be materially adversely affected at a time when the same currency movements are benefiting some of our com- petitors. For more information on the effects of currency fluc- tuations on our consolidated financial statements and on how we manage currency risk, see “Item 5. Operat- ing and Financial Review and Prospects—Item 5.B Liquid- ity and capital resources—Effects of currency fluctua- tions,” “Item 11. Quantitative and Qualitative Disclosures About Market Risk,” and “Item 18. Financial Statements— Note 28. Financial instruments—additional disclosures.” Ongoing consolidation among our distributors and retailers is increasing both the purchasing leverage of key customers and the concentration of credit risk. Increasingly, a significant portion of our global sales is made to a relatively small number of drug wholesalers, retail chains and other purchasing organizations. For example, our three most important customers globally are all in the US, and accounted for approximately 16%, 13% and 7%, respectively, of Group net sales in 2018. The largest trade receivables outstanding were for these three customers, amounting to 12%, 10% and 6%, respec- tively, of the Group’s trade receivables at December 31, 2018. The trend has been toward further consolidation among distributors and retailers, both in the US and inter- nationally. As a result, we may be affected by fluctuations in the buying patterns of such customers, and these cus- tomers are gaining additional purchasing leverage, increasing the pricing pressures facing our businesses. These pressures can particularly impact our Sandoz Divi- sion, the generic products of which can often be obtained from numerous competitors. Moreover, we are exposed to a concentration of credit risk as a result of this con- centration among our customers. If one or more of our major customers experienced financial difficulties, the effect on us would be substantially greater than in the past, and could include a substantial loss of sales and an inability to collect amounts owed to us. Such events could have a material adverse effect on our business, financial condition, or results of operations. An inability to attract and retain qualified personnel could adversely affect our business. We highly depend upon skilled personnel in key parts of our organization, and we invest heavily in recruiting, train- ing and retaining qualified individuals, including signifi- cant efforts to enhance the diversity of our workforce. The loss of the service of key members of our organiza- tion – including senior members of our scientific and management teams, high-quality researchers and devel- opment specialists, and skilled personnel in developing countries – could delay or prevent the achievement of major business objectives. Our future growth will demand talented associates and leaders, yet the market for talent has become increasingly competitive. In particular, Emerging Growth Markets are expected to continue to be an important source of growth, but in many of these countries there is a limited pool of executives with the training and inter- national experience needed to work successfully in a global organization like Novartis. In addition, shifting demographic trends are expected to result in fewer students, fewer graduates and fewer people entering the workforce in the Western world in the next 10 years. Moreover, many members of younger generations around the world have changing expecta- tions toward careers, engagement and the integration of work in their overall lifestyles. The supply of talent for certain key functional and leadership positions is decreasing, and a talent gap is visible for some professions and geographies – engi- neers in Germany, for example. Recruitment is increas- ingly regional or global in specialized fields such as clin- ical development, biosciences, chemistry and information technology. In addition, the geographic mobility of talent is expected to decrease in the future, with talented indi- viduals in developed and developing countries anticipat- ing ample career opportunities closer to home than in the past. This decrease in mobility may be worsened by anti-immigrant sentiments in many countries, and laws discouraging immigration. See “—Political and economic instability may impact our results,” above. 22 Item 3. Key Information In addition, our ability to hire qualified personnel also depends on the flexibility to reward superior perfor- mance and to pay competitive compensation. Laws and regulations on executive compensation, including legis- lation in our home country, Switzerland, may restrict our ability to attract, motivate and retain the required level of qualified personnel. We face intense competition for an increasingly lim- ited pool of qualified individuals from numerous pharma- ceutical and biotechnology companies, universities, gov- ernmental entities, other research institutions, other companies seeking to enter the healthcare space, and companies in other industries. As a result, despite sig- nificant efforts on our part, we may be unable to attract and retain qualified individuals in sufficient numbers, which could have an adverse effect on our business, financial condition, or results of operations. Environmental liabilities may adversely impact our financial results. The environmental laws of various jurisdictions impose actual and potential obligations on us to remediate con- taminated sites, in some cases over many years. While we have set aside substantial provisions for worldwide environmental liabilities, there is no guarantee that addi- tional costs will not be incurred beyond the amounts for which we have provided in the Group consolidated finan- cial statements. If environmental contamination related to our facilities or products adversely impacts third par- ties, if we fail to properly manage the safety of our facil- ities and the environmental risks, or if we are required to further increase our provisions for environmental liabili- ties in the future, this could have a material adverse effect on our business, financial condition, results of opera- tions, and reputation. See also “Item 4. Information on the Company— Item 4.D Property, plants and equipment—Environmen- tal matters” and “Item 18. Financial Statements—Note 19. Provisions and other non-current liabilities.” Climate change, extreme weather events, earthquakes and other natural disasters could adversely affect our business. In recent years, extreme weather events and changing weather patterns such as storms, flooding, droughts and temperature changes have become more common. As a result, we are potentially exposed to varying natural disaster or extreme weather risks such as hurricanes, tornadoes, droughts or floods, or other events that may result from the impact of climate change on the environ- ment, such as sea level rise. For example, some of our production facilities that depend on the availability of sig- nificant water supplies are located in areas where water is increasingly scarce. Other facilities are located in places that, because of increasingly violent weather events, sea level rise, or both, are increasingly at risk of substantial flooding. As a result, we could experience increased production or other costs, business interrup- tions, destruction of facilities, and loss of life, all of which could have a material adverse effect on our business, financial condition, or results of operations. In addition, our corporate headquarters, the head- quarters of our Innovative Medicines Division, and certain of our major Innovative Medicines Division pro- duction and research facilities are located near earth- quake fault lines in Basel, Switzerland. Other major facil- ities are located near major earthquake fault lines in various locations around the world. In the event of a major earthquake, we could experience business interruptions, destruction of facilities, and loss of life, all of which could have a material adverse effect on our business, financial condition, or results of operations. Risks related to our ADRs The price of our ADRs and the US dollar value of any dividends may be negatively affected by fluctuations in the US dollar/Swiss franc exchange rate. Our American Depositary Shares (ADSs), each repre- senting one Novartis share and evidenced by American Depositary Receipts (ADRs), trade on the NYSE in US dollars. Since the shares underlying the ADRs are listed in Switzerland on the SIX Swiss Exchange (SIX) and trade in Swiss francs, the value of the ADRs may be affected by fluctuations in the US dollar/Swiss franc exchange rate. In addition, since 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 ADRs. If the value of the Swiss franc decreases against the US dollar, the price at which our ADRs trade may – and the value of the US dollar equivalent of any dividend will – decrease accordingly. Holders of ADRs may not be able to exercise pre- emptive rights attached to shares underlying ADRs. Under Swiss law, shareholders have pre-emptive rights to subscribe for issuances of new shares on a pro rata basis. Shareholders may waive their pre-emptive rights in respect of any offering at a general meeting of share- holders. Pre-emptive rights, if not previously waived, are transferable during the subscription period relating to a particular offering of shares and may be quoted on the SIX. US holders of ADRs may not be able to exercise the pre-emptive rights attached to the shares underlying their ADRs unless a registration statement under the US Securities Act of 1933 is effective with respect to such rights and the related shares, or an exemption from this registration requirement is available. In deciding whether to file such a registration statement, we would evaluate the related costs and potential liabilities, as well as the benefits of enabling the exercise by ADR holders of the pre-emptive rights associated with the shares underly- ing their ADRs. We cannot guarantee that a registration statement would be filed, or, if filed, that it would be declared effective. If pre-emptive rights could not be exercised by an ADR holder, JPMorgan Chase Bank, N.A., as depositary, would, if possible, sell the holder’s pre-emptive rights and distribute the net proceeds of the sale to the holder. If the depositary determines, in its dis- cretion, that the rights could not be sold, the depositary might allow such rights to lapse. In either case, the inter- est of ADR holders in Novartis would be diluted and, if the depositary allowed rights to lapse, holders of ADRs would not realize any value from the pre-emptive rights. 23 Item 4. Information on the Company Item 4. Information on the Company 4.A History and development of Novartis Novartis AG Novartis AG was incorporated on February 29, 1996, under the laws of Switzerland as a stock corporation (Aktiengesellschaft) with an indefinite duration. On December 20, 1996, our predecessor companies, Ciba-Geigy AG and Sandoz AG, merged into this new entity, creating Novartis. We are domiciled in and gov- erned 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 Novartis is a multinational group of companies special- izing in the research, development, manufacturing and marketing of a broad range of healthcare products led by innovative pharmaceuticals and also including high-quality generic pharmaceuticals and eye care prod- ucts. Novartis AG, our Swiss holding company, owns, directly or indirectly, all of our significant operating com- panies. For a list of our significant operating subsidiar- ies, see “Item 18. Financial Statements—Note 31. Princi- pal Group subsidiaries and associated companies.” The SEC maintains an internet site at http://www.sec. gov that contains reports, information statements, and other information regarding issuers that file electroni- cally with the SEC. Important corporate developments 2016‑2018 2018 December Novartis announces that on December 21, 2018, it completed the previously-announced acquisition of Endocyte, a US-based biopharmaceutical company focused on developing targeted therapeutics for cancer treatment, in a transaction valued at approximately USD 2.1 billion. Novartis announces that on December 19, 2018, it completed the acquisition of Tear Film Innovations, Inc., a pri- vately-held company and manufacturer of the iLux Device, a therapeutic device used to treat meibomian gland dys- function (MGD), a leading cause of dry eye. Novartis announces the appointment of Susanne Schaffert, Ph.D., as CEO Novartis Oncology and a member of the Executive Committee of Novartis (ECN), effective January 1, 2019. Dr. Schaffert succeeds Liz Barrett, who stepped down effective December 31, 2018. Novartis announces an offer to acquire CellforCure from LFB. CellforCure, a French company, is one of the first and largest contract development and manufacturing organizations producing cell and gene therapies in Europe. The transaction is subject to usual and customary closing conditions, including employee consultation process and necessary regulatory approvals. November Novartis announces that Alcon had filed an initial Form 20-F registration statement with the US Securities and Exchange Commission (SEC) in relation to the previously announced intention of Novartis to spin off the Alcon Divi- sion as an independent, publicly traded company. We expect to make an application to list the shares in Alcon on SIX and the NYSE under the ticker symbol “ALC.” Completion of the planned spin-off is subject to general market conditions, receipt of necessary authorizations, tax rulings and opinions, and shareholder approval at the 2019 Novartis annual shareholder meeting. If approvals are secured and conditions are met, the spin-off is expected to be completed in the first half of 2019. October Novartis announces that it has entered into a clinical development agreement with Pfizer that will include a study combining tropifexor and one or more Pfizer compounds for the treatment of nonalcoholic steatohepatitis (NASH). Novartis announces that it has entered into a licensing and equity agreement with Boston Pharmaceuticals for the development of three novel anti-infective drug candidates that are part of the Novartis Infectious Diseases port- folio, which have the potential to address the need for new agents to treat antibiotic-resistant Gram-negative infec- tions. Under the terms of the agreement, Boston Pharmaceuticals acquired worldwide rights to two complemen- tary candidates targeting carbapenem-resistant enterobacteriaceae (CRE) and one candidate targeting Pseudomonas infections. 24 Item 4. Information on the Company September Novartis announces it has agreed to sell selected portions of its Sandoz US portfolio, specifically the Sandoz US dermatology business and generic US oral solids portfolio, to Aurobindo Pharma USA Inc., for USD 0.9 billion in cash plus USD 0.1 billion in potential earn-outs. This transaction is expected to close in 2019, subject to the com- pletion of customary closing conditions. Novartis announces that it plans to continue the transformation of its manufacturing network and services busi- nesses, including a planned workforce reduction in Switzerland over a four-year period. Novartis also plans to con- tinue the ongoing transfer of transactional activities to the five global service centers within Novartis Business Ser- vices, and to begin to transfer managerial service capabilities to these service centers. August Novartis announces the appointment of Dr. Klaus Moosmayer as Chief Ethics, Risk and Compliance Officer and a member of the ECN, reporting to the CEO of Novartis, effective December 1, 2018. July Novartis announces that it has signed a renewed Memorandum of Understanding with the World Health Organiza- tion to extend its agreement for the donation of Egaten (triclabendazole) for the treatment of liver fluke (fasciolia- sis) until 2022. Novartis announces that it has entered into an exclusive in-license agreement with Galapagos NV and MorphoSys AG for an investigational biologic compound, MOR106, a novel antibody directed against IL-17C. This transaction became effective on September 10, 2018, upon the expiration of the applicable waiting period under the Hart-Scott- Rodino Antitrust Improvements Act of 1976. June Novartis announces its intention to seek shareholder approval for a 100% spin-off of its Alcon Division into a stand- alone public company. In addition to shareholder approval, completion of the proposed Alcon spin-off remains sub- ject to certain conditions precedent, such as no material adverse events, receipt of necessary authorizations as well as tax rulings and opinions. Novartis announces that it will initiate a share buyback of up to USD 5 billion to be executed by the end of 2019. Novartis announces the completion on June 1, 2018, of its previously announced divestment to GlaxoSmithKline PLC of its 36.5% stake in GSK Consumer Healthcare Holdings Ltd. for a payment of USD 13.0 billion in cash. The divestment brings to an end Novartis participation in its consumer healthcare joint venture with GSK, which was formed in 2015 as part of the Novartis portfolio transformation. May Novartis announces that Shannon Thyme Klinger, previously Chief Ethics, Risk and Compliance Officer, was appointed Group General Counsel effective June 1, 2018, and will continue as a member of the ECN, following the decision by Felix R. Ehrat to retire from the Company. Novartis announces that Robert Weltevreden will be appointed as Head of Novartis Business Services (NBS) and a member of the ECN, reporting to the CEO of Novartis, effective June 1, 2018. Novartis announces the completion of its previously announced cash tender offer to purchase all the outstand- ing shares of common stock of AveXis, Inc., a US-based clinical stage gene therapy company. The lead AveXis product candidate, AVXS-101, has the potential to be the first-ever one-time gene replacement therapy for spinal muscular atrophy. This acquisition was completed on May 15, 2018. April Novartis announces the appointment of John Tsai, M.D., as Head of Global Drug Development (GDD) and Chief Medical Officer of Novartis, and a member of the ECN, reporting to the CEO of Novartis, effective May 1, 2018. Dr. Tsai succeeds Dr. Narasimhan, who became CEO of Novartis on February 1, 2018. Dr. Robert Kowalski, who led GDD ad interim from February 1, 2018, will resume his responsibilities as Head of Global Regulatory Affairs for GDD. Novartis announces that its Sandoz Division has entered into a collaboration with Pear Therapeutics to com- mercialize and continue development of novel prescription digital therapeutics, including reSET for patients with substance use disorder and reSET-O for patients with opioid use disorder who are currently receiving buprenor- phine. Novartis announced the commercial launch of reSET for patients with substance use disorder in November 2018 and announced FDA clearance of reSET-O for patients with opioid use disorder in December 2018 and launch in January 2019. Novartis announces a five-year commitment to the fight against malaria in conjunction with the 7th Multilateral Initiative on Malaria Conference and the Malaria Summit of the Commonwealth Heads of Government meeting. As part of its commitment, Novartis will invest more than USD 100 million over the next five years to advance research and development of next-generation treatments to combat emerging resistance to artemisinin and other currently used antimalarials. The Company will also implement an equitable pricing strategy to maximize patient access in malaria-endemic countries when these new treatments become available. 25 Item 4. Information on the Company March Novartis announces that it has entered into a collaboration and licensing agreement with the Wyss Institute for Biologically Inspired Engineering at Harvard University and the Dana-Farber Cancer Institute to develop biomate- rial systems for its portfolio of immuno-oncology therapies. Novartis announces that Bertrand Bodson, Chief Digital Officer; Steffen Lang, Global Head Novartis Technical Operations; and Shannon Klinger, Chief Ethics, Risk and Compliance Officer, have been appointed to the ECN effec- tive as of April 1, 2018. André Wyss, President Novartis Operations, has decided to step down from the ECN on April 1, 2018, to pursue his career outside of Novartis. Novartis announces an additional strategic alliance with Science 37 to design and initiate up to 10 new clinical trials over the next three years, which are intended to blend virtual and traditional clinical trial models, with increas- ing degrees of decentralization toward a mostly “site-less” model. Novartis announces a collaboration with Pear Therapeutics to develop novel prescription digital therapeutics, software applications designed to effectively treat disease and improve clinical outcomes for patients, for schizo- phrenia and multiple sclerosis. February Novartis announces an alliance with the Bill & Melinda Gates Foundation to advance development of Novartis drug candidate KDU731 for the treatment of cryptosporidiosis. Novartis completes euro (EUR) denominated bond offerings totaling EUR 2.25 billion. January Novartis announces on January 22, 2018, that it had successfully completed its previously announced tender offer for all of the then-outstanding ordinary shares, including ordinary shares represented by American Depositary Shares (ADSs), of AAA. As of the expiration of the offer on January 19, 2018, approximately 97% of the then-out- standing fully diluted ordinary shares, including ordinary shares represented by ADSs, were validly tendered. In addition, on January 22, 2018, Novartis commenced a subsequent offering period that expired as scheduled on January 31, 2018. As of the expiration of the subsequent offering period, an additional 1.8% of the outstanding shares were validly tendered, resulting in an increase in Novartis ownership in AAA to 98.7% of all outstanding ordi- nary shares, including ordinary shares represented by ADSs. AAA is a radiopharmaceutical company headquar- tered in Saint Genis-Pouilly, France, that develops, produces and commercializes molecular nuclear medicines – including Lutathera (USAN: lutetium Lu 177 dotatate/INN: lutetium (177Lu) oxodotreotide), a first-in-class radioligand therapy product for neuroendocrine tumors – and diagnostic products. Novartis announces a licensing agreement and a manufacturing and supply agreement with Spark Therapeu- tics to develop, register and commercialize in markets outside the US voretigene neparvovec, a gene therapy approved as Luxturna in the EU in November 2018 for the treatment of patients with vision loss due to a genetic biallelic mutation of the RPE65 (retinal pigment epithelial 65kDa protein) gene and who have enough viable retinal cells. Novartis announces a global collaboration between Sandoz and Biocon Ltd. to develop, manufacture and com- mercialize multiple biosimilars in immunology and oncology. Novartis announces that Elizabeth (Liz) Barrett has been appointed CEO Novartis Oncology and a member of the ECN, effective February 1, 2018. 2017 December Novartis announces that Bruno Strigini, CEO Novartis Oncology, has decided to retire from Novartis for personal reasons. November Novartis announces an expanded collaboration with Amgen and the Banner Alzheimer’s Institute to collaborate on a new Generation Study 2 to assess whether investigational BACE1 inhibitor CNP520 can prevent or delay the symptoms of Alzheimer’s disease in a high-risk population. October Novartis announces that it has made significant progress in its ongoing strategic review of the Alcon Division and has examined all options, ranging from retaining the business to a capital markets solution (e.g., an IPO or a spin- off). As part of this, we updated Alcon’s strategic plan, which confirms that it has the potential to grow sales at or above market while delivering profitability at least in line with the industry. Novartis announces that its over-the-counter ophthalmic products and certain surgical diagnostic products will transfer from the Innovative Medicines Division to the Alcon Division effective January 1, 2018. September Novartis announces a collaboration with UC Berkeley to establish the Novartis-Berkeley Center for Proteomics and Chemistry Technologies. 26 Item 4. Information on the Company Novartis announces that, effective February 1, 2018, Vasant (Vas) Narasimhan, M.D., will succeed Joseph Jimenez as CEO of Novartis, who had indicated his desire to retire after eight years as CEO. Robert Kowalski, Pharm.D., Head of Global Regulatory Affairs, will assume ad-interim leadership of our Global Drug Development organization, effective February 1, 2018. August Novartis announces that, effective January 1, 2018, Bertrand Bodson has been appointed to the new role of Chief Digital Officer, reporting to the CEO of Novartis. Mr. Bodson is responsible for creating and executing a company- wide digital strategy. As part of this strategy, we plan to improve the ways we use data in drug discovery and devel- opment, engage with patients, doctors and other stakeholders, as well as to automate business processes. June Novartis announces that it has entered into a clinical research collaboration in which Bristol-Myers Squibb is to investigate the safety, tolerability and efficacy of Mekinist (trametinib) in combination with Opdivo® (nivolumab) and Opdivo® + Yervoy® (ipilimumab) regimen as a potential treatment option for metastatic colorectal cancer in patients with microsatellite stable tumors where the tumors are proficient in mismatch repair (MSS mCRC pMMR). Novartis announces a collaboration with IBM Watson Health to explore development of a cognitive solution that uses real-world data and advanced analytical techniques with the aim to provide better insights on the expected outcomes of breast cancer treatment options. May Novartis announces the launch of Better Hearts Better Cities, an innovative initiative to address the high rates of high blood pressure in low-income urban communities. April Novartis announces an expanded collaboration agreement with Amgen to co-commercialize erenumab (AMG 334) in the US, currently being investigated for the prevention of migraine. This agreement builds on the previously announced 2015 global collaboration between Novartis and Amgen. Novartis announces that it has entered into a clinical trial agreement with Allergan plc to conduct a Phase IIb study involving the combination of a Novartis FXR agonist and Allergan’s cenicriviroc for the treatment of nonalco- holic steatohepatitis (NASH). Novartis announces that it has exercised an option to in-license ECF843, a recombinant form of human lubri- cin from Lubris, LLC, for ophthalmic indications worldwide (outside Europe). This transaction closed and Novartis received its exclusive license on April 21, 2017. March Novartis completes euro-denominated bond offerings in an amount equivalent to approximately USD 2 billion. February Novartis completes a USD 3 billion bond offering under its SEC Registration Statement on Form F-3. January Novartis announces that it is considering options for the Alcon Division. The review will explore all options, ranging from retaining all or part of the business to separation via a capital markets transaction (e.g., IPO or spin-off), in order to determine how to best maximize value for our shareholders. Novartis announces that it is initiating a share buyback of up to USD 5.0 billion in 2017 under existing share- holder authority. Novartis announces that it has entered into a collaboration and option agreement with Ionis Pharmaceuticals, Inc. (Ionis), and its affiliate Akcea Therapeutics, Inc. (Akcea), to license two investigational treatments with the poten- tial to significantly reduce cardiovascular risk in patients suffering from high levels of lipoproteins known as Lp(a) and ApoCIII. In addition, Novartis entered into a stock purchase agreement with Ionis and Akcea. This transaction was completed on February 14, 2017. 2016 December Novartis announces that it has entered into a definitive agreement for the acquisition of Encore Vision, Inc., a pri- vately held company focused on the development of UNR844 (formerly EV06), an investigational, first-in-class, potentially disease-modifying topical treatment for presbyopia. This acquisition was completed on January 20, 2017. Novartis announces the signing of an exclusive option, collaboration and license agreement with Conatus Pharmaceuticals Inc., for the global rights to emricasan, an investigational, first-in-class, oral, pan-caspase inhibi- tor for the treatment of nonalcoholic steatohepatitis (NASH) with advanced fibrosis and cirrhosis of the liver. Novartis 27 Item 4. Information on the Company exercised the option on May 4, 2017. Novartis obtained an exclusive, worldwide license to develop and commer- cialize products containing emricasan on July 5, 2017. Novartis announces that it has entered into a definitive agreement for the acquisition of Ziarco Group Limited, a privately held company focused on the development of novel treatments in dermatology, including ZPL389 (adri- forant), a once-daily oral H4 receptor antagonist in development for atopic dermatitis. This acquisition was com- pleted on January 20, 2017. November Novartis announces that it has acquired Reprixys Pharmaceuticals Corporation and SEG101 (crizanlizumab) for reduction of pain crises in sickle cell disease. September Novartis completes two euro-denominated bond offerings totaling EUR 1.75 billion. June Novartis announces that it has entered into a collaboration and licensing agreement with Xencor for the develop- ment of bispecific antibodies for treating cancer. Novartis announces that it will further expand its longstanding partnership with Medicines for Malaria Venture. Novartis will lead the development of antimalarial compound KAF156 (ganaplacide) with scientific and financial support from Medicines for Malaria Venture in collaboration with the Bill & Melinda Gates Foundation. May Novartis announces changes to focus its Pharmaceuticals Division by creating two business units: Novartis Pharmaceuticals and Novartis Oncology. These business units form the Innovative Medicines Division of Novartis. The CEO of each business unit reports directly to the CEO of Novartis, and both joined the ECN effective July 1, 2016. February Shareholders authorize the Novartis Board of Directors to execute share buybacks within the framework of a sev- enth share repurchase program that will allow Novartis to repurchase shares for cancellation up to a maximum of CHF 10 billion. Novartis announces that it has entered into an agreement to acquire Transcend Medical, Inc., a privately held, US-based company focused on developing minimally invasive surgical devices to treat glaucoma, such as the CyPass Micro-Stent. This acquisition was completed on March 23, 2016. Novartis announces that it has acquired from Pfizer the rights for the development and commercialization of PF-06438179 (biosimilar infliximab) in the European Economic Area. January Novartis announces leadership changes effective February 1, 2016. Mike Ball has been appointed Division Head and CEO Alcon, succeeding Jeff George; Dr. Vas Narasimhan has been appointed Global Head Drug Development and Chief Medical Officer, a new position in the ECN; and André Wyss has been appointed President, Novartis Operations. Novartis announces that it is taking a number of steps to further build on its strategy, including focusing the Alcon Division on its Surgical and Vision Care franchises and strengthening the ophthalmic medicines business by transferring Alcon’s Ophthalmic Pharmaceuticals products to the Innovative Medicines Division, and by shifting selected mature, non-promoted pharmaceutical products from the Innovative Medicines Division into the Sandoz Division, which changes were operationally completed as of April 1, 2016; and by centralizing manufacturing oper- ations across divisions within a single technical operations unit; increasing Group-wide coordination of drug devel- opment by establishing a single Global Head of Drug Development and centralizing certain common functions such as the Chief Medical Office, which changes were operationally completed as of July 1, 2016. Novartis announces a collaboration and licensing agreement with Surface Oncology, which gives Novartis access to four preclinical programs in immuno-oncology. For information on our principal expenditures on property, plants and equipment, see “Item 4. Information on the Company—Item 4.D Property, plants and equipment.” For information on our significant expenditures in research and development, see the sections headed “Research and Development” included in the descriptions of our Innovative Medicines Division and Alcon Division, and the section headed “Development and Registration” included in the description of our Sandoz Division under “Item 4. Information on the Company—Item 4.B Business overview.” For information on other principal capital expenditures and divestitures, see “Item 5. Operating and Financial Review and Prospects—Item 5.A Operating results—Factors affecting comparability of year-on-year results of operations.” 28 Item 4. Information on the Company 4.B Business overview Overview As a leading global medicines company, we use innovative science and digital technologies to create transforma- tive treatments in areas of great medical need. In our quest to find new medicines, we consistently rank among the world’s top companies investing in research and development. Novartis products reach more than 800 million people globally and we are finding innovative ways to expand access to our latest treatments. Our purpose is to reimagine medicine to improve and extend people’s lives. Our vision is to be a trusted leader in changing the practice of medicine. Our strategy is to focus Novartis as a leading medicines company powered by advanced therapy platforms and data science. In 2018, Novartis achieved net sales of USD 51.9 bil- lion, while net income amounted to USD 12.6 billion. Headquartered in Basel, Switzerland, our Group compa- nies employed 125,000 full-time equivalent associates as of December 31, 2018. Our products are sold in approximately 155 countries around the world. The Group comprises three global operating divi- sions: • Innovative Medicines: innovative patent-protected pre- scription medicines • Sandoz: generic pharmaceuticals and biosimilars • Alcon: surgical and vision care products In June 2018, we announced that we plan to spin off Alcon into a separately-traded standalone company. As two distinct publicly traded companies, we believe Novartis and Alcon will be better positioned to capital- ize on significant growth opportunities and focus resources on their respective businesses and strategic priorities. Our divisions are supported by the following cross-di- visional organizational units: the Novartis Institutes for BioMedical Research, Global Drug Development, Novartis Technical Operations and Novartis Business Services. The financial results of these organizational units are included in the results of the divisions for which their work is performed. As part of the planned spin-off of Alcon, efforts are being undertaken to prepare for the separation of Alcon from Novartis and to enable Alcon to operate as a standalone public company. As part of these efforts, Alcon has formed, and will continue to form, its own support functions, including its own service orga- nization. The Novartis Institutes for BioMedical Research (NIBR) is the innovation engine of Novartis, which con- ducts drug discovery research and early clinical devel- opment trials for our Innovative Medicines Division and also collaborates with our Sandoz Division. Approxi- mately 6 000 full-time equivalent scientists and associ- ates at NIBR are working to discover new medicines for various diseases at sites located in the US, Switzerland and China. For more information about NIBR, see “— Innovative Medicines—Research and development— Research program” below. Our Global Drug Development (GDD) organization oversees all drug development activities for our Innovative Medicines Division and the biosimilars portfolio of our Sandoz Division. The development of products for the Surgical and Vision Care franchises within our Alcon Divi- sion and of small-molecule generics for our Sandoz Divi- sion is not included in GDD. GDD works collaboratively with NIBR, Innovative Medicines and Sandoz to execute our overall pipeline strategy and takes an enterprise approach to pipeline portfolio management. GDD incor- porates centralized global functions such as Regulatory Affairs and Global Development Operations, as well as Global Development units aligned with our business fran- chises. GDD includes approximately 11 000 full-time equivalent associates worldwide. Novartis Technical Operations (NTO) was estab- lished to centralize management of our manufacturing operations and supply chain across our Innovative Medicines and Sandoz Divisions, with a goal of further improving efficiency. Manufacturing for Alcon’s Surgical and Vision Care franchises continues to be managed by our Alcon Division. NTO is expected to optimize capac- ity planning and adherence to quality standards, and to lower costs through simplification, standardization and external spend optimization. Centralization is also expected to improve our ability to develop next-genera- tion technologies, implement continuous manufacturing and share best practices across divisions. NTO includes approximately 25 200 full-time equivalent associates and 64 manufacturing sites across our Innovative Medicines and Sandoz Divisions. Novartis Business Services (NBS), our shared ser- vices organization, delivers integrated solutions to all Novartis divisions and units worldwide. NBS seeks to drive efficiency and effectiveness across Novartis by simplifying and standardizing services across six service domains: human resources, real estate and facility ser- vices, procurement, information technology, commercial and medical support activities, and financial reporting and accounting operations. NBS has approximately 10 500 full-time equivalent associates in more than 30 countries. NBS works to leverage the full scale of Novartis to create value across the Company and to free up resources to invest in innovation and our product pipe- line. NBS continues to transfer the delivery of selected services to its five Global Service Centers in Dublin, Ire- land; Hyderabad, India; Kuala Lumpur, Malaysia; Mexico City, Mexico; and Prague, Czech Republic. As of January 1, 2019, Novartis Internal Audit, Busi- ness Practices Office and Global Security were com- bined into one function called Novartis Business Assur- ance & Advisory (NBAA). 29 Item 4. Information on the Company Innovative Medicines Division Our Innovative Medicines Division researches, develops, manufactures, distributes and sells patented prescrip- tion medicines to enhance health outcomes for patients and healthcare providers. Innovative Medicines is orga- nized into two global business units: Novartis Oncology and Novartis Pharmaceuticals. Novartis Pharmaceuticals consists of the global business franchises Ophthalmol- ogy; Neuroscience; Immunology, Hepatology and Der- matology; Respiratory; Cardio-Metabolic; and Estab- lished Medicines. Sandoz Division Our Sandoz Division develops, manufactures, distributes and sells prescription medicines as well as pharmaceu- tical active substances that are not protected by valid and enforceable third-party patents. Sandoz is organized globally into three franchises: Retail Generics, Anti-In- fectives and Biopharmaceuticals. In Retail Generics, Sandoz develops, manufactures and markets active ingredients and finished dosage forms of pharmaceuticals to third parties. Retail Generics includes the areas of car- diovascular, central nervous system, dermatology, gas- trointestinal and hormonal therapies, metabolism, oncology, ophthalmics, pain, and respiratory, as well as finished dosage form anti-infectives sold to third parties. In Anti-Infectives, Sandoz manufactures and supplies active pharmaceutical ingredients and intermediates – mainly antibiotics – for internal use by Retail Generics and for sale to third-party customers. In Biopharmaceu- ticals, Sandoz develops, manufactures and markets pro- tein- or other biotechnology-based products, including biosimilars, and provides biotechnology manufacturing services to other companies. Alcon Division Our Alcon Division, a global leader in eye care, re- searches, develops, manufactures, distributes and sells eye care products. Alcon is organized into two global business franchises: Surgical and Vision Care. Surgical researches, develops, manufactures, distributes and sells ophthalmic products for cataract surgery, vitreo- retinal surgery, refractive laser surgery and glaucoma surgery. The Surgical portfolio also includes implant- ables, consumables and surgical equipment required for these procedures and supports the end-to-end pro- cedure needs of the ophthalmic surgeon. Vision Care researches, develops, manufactures, distributes and sells daily disposable, reusable, and color-enhancing contact lenses and a comprehensive portfolio of ocular health products, including products for dry eye, contact lens care and ocular allergies, as well as ocular vitamins and redness relievers. Alcon also provides services, training, education and technical support for both the Surgical and Vision Care businesses. Effective January 1, 2018, we transferred our over the counter ophthalmic products and certain surgical diag- nostic products (2017 sales of USD 747 million) from the Innovative Medicines Division to the Alcon Division. Our prescription Ophthalmic medicines business remains with the Innovative Medicines Division. In compliance with IFRS, beginning with our first-quarter 2018 results, Novartis updated its segment financial information to reflect this transfer, both for the current and prior years, to aid comparability of year on year results. Corporate activities We separately report the results of Corporate activities. The financial results of our Corporate activities include the costs of the Group headquarters and those of cor- porate coordination functions in major countries. In addi- tion, Corporate includes other items of income and expense that are not attributable to specific segments, such as certain revenues from intellectual property rights and certain expenses related to post-employment benefits, environmental remediation liabilities, charita- ble activities, donations and sponsorships. Corporate responsibility We are taking steps to continue to build trust with key stakeholders and society. We aim to hold ourselves to the highest ethical standards, be part of the solution on pricing and access to medicines, help tackle global health challenges, and be a responsible citizen wherever we operate. Holding ourselves to the highest ethical standards We continue to embed a principles based approach to compliance through the new Professional Practices Pol- icy (P3), which in 2018 replaced separate divisional com- pliance policies. We believe this approach will help ensure that employees act in the best interest of patients, physicians and Novartis. Since 2016, we have adjusted the ratio of fixed to vari- able total compensation for our sales force to help ensure that the target variable component is a maximum of 35% of total compensation, on a country average basis. To receive any form of variable compensation, each employee, including the sales force, must perform to a minimum standard with regard to our Values and Behaviors, which include acting with integrity. For our sales force, in particular, 20% of target variable pay is based on demonstration of our Values and Behaviors. We are in the process of implementing these standards in every country in which Novartis operates. Ultimately, no sales representative will receive the variable compen- sation unless he or she meets expectations with respect to Values and Behaviors. In 2018, we assessed the roll- out of the new incentive system with positive results. Across divisions, there was a 54% reduction in the num- ber of reported complaints of fraud or professional prac- tices in the sales force in 2018 compared to 2017. Despite this progress, we are still facing questions about our business practices. Following the issue with Essential Consultants, when our political consultancy practices came into question, we took steps to improve oversight and help prevent similar matters in the future. We have strengthened the relevant contracting and due diligence processes to help ensure more ownership and 30 Item 4. Information on the Company transparency at a senior management level. For exam- ple, before Novartis engages political consultants, we will secure an independent due diligence report from an external partner. In addition, we continue to strengthen our Integrity & Compliance (I&C) function. In 2018, we combined our risk management and compliance functions in a single organization to help enable more effective risk manage- ment and mitigation efforts. We created the role of Chief Ethics, Risk and Compliance Officer to head the com- bined organization, and we elevated this role to the Exec- utive Committee of Novartis (ECN). To help monitor and enforce our integrity standards, we added more than 100 people to the I&C function in recent years. The expanded team has increased the number of country visits to share learnings from across the organization, reaching about 220 in 2018. We also harmonized our I&C risk assessment and monitoring pro- cess and control activities into a single, continuous pro- cess supported by an online tool. We continue to evolve our reporting and data analyt- ics to provide centralized and aggregated data across the risk functions to identify trends and help improve risk mitigation. For instance, in the last two years, we have seen a positive trend in generally effective internal com- pliance audits. At the same time, our whistleblower hotline continues to receive reports of suspected cases where employees may have failed to follow our ethical guidelines. However, the proportion of substantiated alle- gations related to ethics and compliance matters remains stable. We believe these are indications that our efforts are starting to pay off. We also started to employ data analytics for better monitoring and risk prevention. For example, in the US and China, the team leverages big data to monitor various aspects of engagement with healthcare professionals. Being part of the solution on pricing and access Our medications reach more than 800 million people worldwide every year, but billions more still lack access to essential medicines and healthcare. We are making a fundamental shift in the way we do business and are reimagining how to expand access to critical healthcare innovations. We launched the Novartis Access Principles, embark- ing on a journey to systematically integrate access strat- egies into how we research, develop and deliver our new medicines globally. These strategies include adopting innovative pricing and access models, refocusing research and development based on society’s health- care needs, and supporting approaches to streng then healthcare systems. We made significant progress in set- ting up our internal systems and training our internal teams on our new business standards. The ECN reviewed plans for key brands in launch phase to assess access strategies targeting underserved populations. For exam- ple, Aimovig, our innovative medicine for the treatment of migraine, is supported by programs designed to help accelerate access both before and after reimbursement, as well as to speed up introduction and access in low- and middle-income countries (LMICs). We are also co- creating employer-based access schemes in selected markets, including Russia and Mexico. We aim to price our medicines responsibly, based on the value they deliver to patients, healthcare systems and society. In the US we recently implemented guide- lines for limiting average net price increases across our portfolio to the healthcare inflation rate, and we publish average price increases annually in the Novartis in Soci- ety US report. In addition, we take local affordability into account when pricing our medicines. In LMICs, for instance, we introduced more affordable local brands of many innovative therapies, such as our heart failure treatment Entresto, to help speed up and improve access where there is inadequate healthcare coverage or reimburse- ment. Through our continued efforts and an impactful access strategy, the number of patients reached with Entresto in LMICs grew two-and-a-half-fold in the last 12 months. Overall, we have launched more than 60 local brands across more than 30 developing markets, reach- ing more than 220 000 additional patients to date. In addition, we are now able to reduce the time lag between availability of medicines in higher- and lower-income countries. For example, the first Entresto local brand was launched within 12 months of the launch in the European Union. We plan to further expand these strategies. Through our Novartis Social Business (NSB) group, we continue to pursue unique social business models, such as the Novartis Access and Healthy Family pro- grams, to help expand access to healthcare in lower-in- come countries. Novartis Access, which offers a portfo- lio of 15 medicines to governments, nongovernmental organizations and other institutional customers for USD 1 per treatment, per month, delivered almost 2.3 million monthly treatments to five countries in 2018, and Healthy Family reached 7.8 million people with health education initiatives. Since January, NSB has adapted its product and price offering in six African and Asian countries, expanding reach to patients across all income levels. Novartis does not file or enforce patents in least developed countries or low- income countries. In late 2018, we reviewed our approach to patent filing in LMICs in an effort to better align it with the local socio-eco- nomic circumstances that exist in many of these coun- tries. As a result, effective 2019, we decided to stop fil- ing patent applications in nine LMICs, where Novartis had previously filed. In addition, in the remaining LMICs, we will aim to restrict patent filings to those patent appli- cations covering new molecules or new chemical enti- ties. Novartis is also a founding member of the Patent Information Initiative for Medicines (Pat-INFORMED), a unique public online resource launched in September 2018 that provides basic patent information for medicines of participating companies, and that aims to help pro- curement agencies around the world better understand patent status to help inform procurement decisions. As of December, Novartis has listed patent information for all of our small- molecule medicines, which goes sig- nificantly beyond Pat-INFORMED’s near-term goal of capturing information for medicines in a more limited number of disease areas. We regularly review our early- and late-stage devel- opment programs to identify further opportunities for adapting our existing medicines to address unmet patient needs in countries with a high disease burden. In 2018, 31 Item 4. Information on the Company 14 project proposals were endorsed to move forward. They include the development of a child-friendly formu- lation of hydroxyurea for treatment of sickle cell disease in Africa; the use of Entresto in heart failure related to Chagas disease; a project to identify potential differ- ences in the pharmacokinetics of drugs in African patients, where such data is lacking; and the creation of a new Coartem formulation to treat infants below 5 kilo- grams of body weight. Tackling global health challenges Novartis has a long history of helping tackle some of the biggest global health challenges, particularly leprosy and malaria. The Novartis Foundation helped found the Global Partnership for Zero Leprosy in 2018. It brings together international organizations and national leprosy pro- grams, with support from the World Health Organization, to accelerate pro gress toward eliminating the disease. The Novartis Foundation and Microsoft are partnering to develop a proof-of-concept digital health tool, enabled by artificial intelligence, and a Leprosy Intelligent Image Atlas – in collaboration with local investigators from the Oswaldo Cruz Foundation in Brazil – to aid in the early detection of leprosy. The launch of the first public ver- sion of the atlas is planned for 2019. In April, we renewed our commitment to malaria elim- ination, pledging USD 100 million to research and develop next-generation antimalarials over the next five years. In addition, we will help expand access to antimalarials for- mulated for children, and we plan to implement programs to strengthen healthcare systems in four sub-Saharan countries. We also launched efforts in other areas where we believe we can have significant impact. In October, in Latin America, we kicked off our partnership with the World Heart Federation to develop a roadmap for addressing Chagas disease, the second most common cause of chronic heart failure in Latin America. In Ghana, we kicked off a collaboration with the gov- ernment and local partners to establish our commitment to sickle cell disease (SCD) in Africa. This collaboration aims to support the development of treatment guidelines; strengthen the healthcare system by establishing centers of excellence to advance newborn screening and train scientists; accelerate registration and launch of hydroxy- urea for the treatment of SCD; and integrate the needs Innovative Medicines of patients into our drug development strategy. We plan to launch our commitment in 2019 and to also expand our efforts to other countries in sub-Saharan Africa. Being a responsible citizen Building trust with society requires doing business responsibly wherever we operate. This includes minimiz- ing our environmental impact, managing risk in our sup- ply chain, respecting human rights and being transpar- ent. We have adopted a more ambitious 2030 environ- mental sustainability strategy, aiming for carbon neutral- ity, plastic neutrality and water sustainability. We have already taken steps to mitigate our exposure to environ- mental risk, completing a series of comprehensive sup- plier audits and taking relevant actions. For example, in the Hyderabad area of India, we are severing ties with six suppliers that failed to comply with our Supplier Code, and we are working with nine suppliers to improve their performance in critical areas such as operational effi- ciency, waste management, and use of natural resources. These suppliers share our values for environmental stew- ardship and employee health and safety. In October, our Third-Party Risk Management pro- gram went live in Mexico. The program is to be rolled out globally in 2019 in a phased regional approach, begin- ning in the Americas (including the US) and followed by Asia-Pacific and Europe later in the year. After completing human rights impact assessments in our own operations in Egypt, Turkey, China and Malay- sia, we have established that we have strong policies and solid processes to identify and manage potential human rights risks. We have also identified common risk areas that require additional follow up action in 2019. For exam- ple, we need more regular and broader engagement and consultation with external stakeholders at a local level – including representatives from patient groups, local com- munities, health authorities and third-party partners – to gain a better understanding of issues; to help ensure that formal grievance mechanisms and processes are in place for communities living close to our manufacturing operations; and, in some markets, to address risks asso- ciated with our outsourced workforce. For additional information, see “—Item 4.B Business overview—Sandoz.” Overview Our Innovative Medicines Division is a world leader in offering innovation-driven, patent-protected medicines to patients and physicians. The Innovative Medicines Division researches, develops, manufactures, distributes and sells patented pharmaceuticals, and is composed of two global business units: Novartis Oncology and Novartis Pharmaceuticals. The Novartis Oncology business unit is responsible for the commercialization of products in the areas of cancer and hematologic disorders. The Novartis Pharmaceuticals business unit is organized into the fol- lowing global business franchises responsible for the commercialization of various products in their respec- tive therapeutic areas: Ophthalmology; Neuroscience; Immunology, Hepatology and Dermatology; Respiratory; Cardio-Metabolic; and Established Medicines. Following an internal reorganization announced on January 27, 2016, 19 mature products were transferred from our Innovative Medicines Division to the Retail Generics franchise of our Sandoz Division, and the 32 Item 4. Information on the Company Ophthalmic Pharmaceuticals products of Alcon were transferred to our Innovative Medicines Division, effec- tive as of January 1, 2018. We subsequently transferred our over-the-counter ophthalmic products and certain surgical diagnostic products (2017 sales of USD 747 million) from the Innovative Medicines Division to the Alcon Division, effec- tive January 1, 2018. Our prescription Ophthalmic medicines business remains with the Innovative Medicines Division. In compliance with IFRS, beginning with our first-quarter 2018 results, Novartis updated its segment financial information to reflect this transfer, both for the current and prior years, to aid comparability of year-on-year results. The Innovative Medicines Division is the largest con- tributor among the divisions of Novartis and reported consolidated net sales of USD 34.9 billion in 2018, which represented 67% of the Group’s net sales. The product portfolio of the Innovative Medicines Division includes more than 60 key marketed products, many of which are leaders in their respective therapeu- tic areas. Innovative Medicines Division products The following table and summaries describe certain key marketed products in our Innovative Medicines Division. While we typically seek to sell our marketed products throughout the world, not all products and indications are currently available in every country. In addition, a product may be available under different brand names depending on country and indication. Some of the prod- ucts listed below have lost patent protection or are oth- erwise subject to generic competition. Others are sub- ject to patent challenges by potential generic competitors. Please see “—Intellectual property” for general informa- tion on intellectual property and regulatory data protec- tion, and for further information on the status of patents and exclusivity for Innovative Medicines Division prod- ucts. 33 Selected marketed products Novartis Oncology business unit Business franchise Product Common name Oncology Afinitor/Votubia and Afinitor Disperz/Votubia dispersible tablets everolimus Arzerra ofatumumab Item 4. Information on the Company Indications (vary by country and/or formulation) In combination with exemestane for postmenopausal women with advanced hormone receptor-positive (HR+)/human epidermal growth factor receptor 2-negative (HER2-) breast cancer after failure of treatment with letrozole or anastrozole, or after recurrence or progression following treatment with a non-steroidal aromatase inhibitor Advanced renal cell carcinoma after failure of treatment with VEGF-targeted therapy, or after failure of treatment with sunitinib or sorafenib Advanced neuroendocrine tumors of gastrointestinal, lung or pancreatic origin Renal angiomyolipoma associated with tuberous sclerosis complex (TSC) in patients not requiring immediate surgery Subependymal giant cell astrocytoma associated with TSC in patients not requiring immediate surgery Adjunctive treatment of patients aged 2 years and older with TSC-associated partial-onset and refractory seizures Treatment of patients with chronic lymphocytic leukemia (CLL) who are refractory to fludarabine and alemtuzumab In combination with an alkylator-based regimen for the treatment of patients with CLL who have not received prior therapy and are not eligible for fludarabine- based therapy Maintenance/extended treatment for patients with CLL who are in complete or partial response after at least two lines of induction therapy In combination with fludarabine and cyclophosphamide for the treatment of patients with relapsed CLL Exjade and Jadenu deferasirox Chronic iron overload due to blood transfusions and non-transfusion-dependent thalassemia Farydak panobinostat Relapsed and/or refractory multiple myeloma, in combination with bortezomib and dexamethasone, after at least two prior regimens including bortezomib and an immunomodulatory agent Femara letrozole Gleevec/Glivec imatinib mesylate/ imatinib Jakavi ruxolitinib Kisqali ribociclib Kymriah tisagenlecleucel HR+ early breast cancer in postmenopausal women following surgery (upfront adjuvant therapy) Early breast cancer in postmenopausal women following standard tamoxifen therapy (extended adjuvant therapy) Advanced breast cancer in postmenopausal women (both as first- and second-line therapies) Certain forms of Philadelphia chromosome-positive chronic myeloid leukemia Certain forms of KIT-positive gastrointestinal stromal tumors Certain forms of acute lymphoblastic leukemia Dermatofibrosarcoma protuberans Hypereosinophilic syndrome Aggressive systemic mastocytosis Myelodysplastic/myeloproliferative diseases Disease-related splenomegaly or symptoms in adult patients with primary myelofibrosis (also known as chronic idiopathic myelofibrosis), post-polycythemia vera myelofibrosis or post-essential thrombocythemia myelofibrosis Polycythemia vera in adult patients who are resistant to or intolerant of hydroxyurea In combination with an aromatase inhibitor as initial endocrine-based therapy for the treatment of pre-, peri- or postmenopausal women with HR+/HER2- locally advanced or metastatic breast cancer In combination with fulvestrant as first- or second-line therapy for the treatment of postmenopausal women with HR+/HER2- advanced or metastatic breast cancer Children and young adults with relapsed or refractory B-cell acute lymphoblastic leukemia Adult patients with relapsed or refractory diffuse large B-cell lymphoma Lutathera USAN: lutetium Lu 177 dotatate/ INN: lutetium (177Lu) oxodotreotide Treatment of somatostatin receptor-positive gastroenteropancreatic neuroendocrine tumors (GEP-NETs) in adults Treatment of unresectable or metastatic, progressive, well-differentiated (G1 and G2), somatostatin receptor-positive GEP-NETs in adults Promacta/Revolade eltrombopag Thrombocytopenia in adult and pediatric patients 1 year and older with chronic immune (idiopathic) thrombocytopenia who have had an insufficient response to corticosteroids or immunoglobulins Thrombocytopenia in patients with chronic hepatitis C to allow initiation and maintenance of interferon-based therapy As first-line therapy in patients with severe aplastic anemia, and as second-line therapy in patients with severe aplastic anemia who have had an insufficient response to immunosuppressive therapy 34 Formulation Tablet Dispersible tablet for oral suspension Intravenous infusion Dispersible tablet for oral suspension Oral film-coated tablet Granules Capsule Tablet Tablet Capsule Tablet Tablet Suspension for intravenous infusion Dispersion for intravenous infusion Solution for intravenous infusion Film-coated tablet Item 4. Information on the Company Business franchise Product Rydapt Common name Indications (vary by country and/or formulation) midostaurin In combination with standard cytarabine and daunorubicin induction and cytarabine consolidation chemotherapy for the treatment of adult patients with newly diagnosed acute myeloid leukemia (AML) who are FLT3 mutation-positive, as detected by an FDA-approved test (Rydapt is not indicated as a single-agent induction therapy for the treatment of patients with AML) For the treatment of adult patients with aggressive systemic mastocytosis, systemic mastocytosis with associated hematological neoplasm, or mast cell leukemia Formulation Capsule Sandostatin LAR and Sandostatin SC octreotide acetate Acromegaly Symptom control for certain forms of neuroendocrine tumors Treatment of advanced neuroendocrine tumors of the midgut or of unknown primary origin Vial Ampoule/pre-filled syringe Signifor and Signifor LAR pasireotide Cushing’s disease Acromegaly Tafinlar + Mekinist dabrafenib + trametinib Tasigna nilotinib Tykerb/Tyverb lapatinib Unresectable or metastatic melanoma with BRAF V600E or V600K mutations, as detected by a validated test Adjuvant treatment of patients with stage III melanoma with a BRAF V600 mutation, following complete resection Locally advanced or metastatic anaplastic thyroid cancer with a BRAF V600E mutation and no satisfactory locoregional treatment options Metastatic non-small cell lung cancer with a BRAF V600E mutation, as detected by a validated test Certain forms of chronic myeloid leukemia in adult and pediatric patients resistant or intolerant to prior treatment, including Gleevec/Glivec First-line chronic myeloid leukemia in adult and pediatric patients In combination with capecitabine for the treatment of patients with human epidermal growth factor receptor 2-positive (HER2+) advanced or metastatic breast cancer who have progressed on prior trastuzumab therapy In combination with an aromatase inhibitor (specifically letrozole in the US) for the treatment of patients with hormone-sensitive metastatic breast cancer In combination with trastuzumab for patients with hormone receptor-negative (HR-) metastatic disease that has progressed on prior trastuzumab therapy/ therapies plus chemotherapy In combination with paclitaxel for first-line treatment of patients with HER2+ metastatic breast cancer for whom trastuzumab is not appropriate Solution for subcutaneous injection in ampoule Powder and solvent for suspension for IM injection Capsule (Tafinlar) Tablet (Mekinist) Capsule Tablet Votrient pazopanib Advanced renal cell carcinoma Certain types of advanced soft tissue sarcoma after prior chemotherapy Tablet Zometa zoledronic acid Skeletal-related events from bone metastases Hypercalcemia of malignancy Zykadia ceritinib Advanced or metastatic non-small cell lung cancer that is anaplastic lymphoma kinase-positive Vial/4 mg ready-to-use Capsule 35 Item 4. Information on the Company Novartis Pharmaceuticals business unit Business franchise Common name Product Indications (vary by country and/or formulation) Ophthalmology Azarga/Azorga brinzolamide and timolol Decrease of intraocular pressure in adult patients with open-angle glaucoma or ocular hypertension for whom monotherapy provides insufficient intraocular pressure reduction Formulation Eye drops Ciprodex Duotrav ciprofloxacin and dexamethasone Treatment of bacterial ear infections Ear drops travoprost and timolol Reduction of elevated intraocular pressure in patients with open-angle glaucoma or ocular hypertension Eye drops Durezol difluprednate Treatment of inflammation and pain associated with ocular surgery Treatment of endogenous anterior uveitis Eye drops Lucentis ranibizumab Luxturna voretigene neparvovec Neovascular age-related macular degeneration Visual impairment due to diabetic macular edema Visual impairment due to macular edema secondary to central retinal vein occlusion Visual impairment due to macular edema secondary to branch retinal vein occlusion Visual impairment due to choroidal neovascularization secondary to pathologic myopia Visual impairment due to choroidal neovascularization secondary to other pathologies Treatment of adult and pediatric patients with vision loss due to inherited retinal dystrophy caused by confirmed biallelic RPE65 mutations and who have sufficient viable retinal cells Pataday and Pazeo olopatadine Signs and symptoms of allergic conjunctivitis Ocular itching associated with allergic conjunctivitis Patanol Simbrinza olopatadine Signs and symptoms of allergic conjunctivitis brinzolamide and brimonidine tartrate Decrease of elevated intraocular pressure in adult patients with open-angle glaucoma or hypertension for whom monotherapy provides insufficient intraocular pressure reduction Intravitreal injection Subretinal injection Eye drops Eye drops Eye drops Travatan, Travatan Z, Travatan BAK-Free, Izba travoprost Reduction of elevated intraocular pressure in patients with open-angle glaucoma or ocular hypertension Eye drops Immunology, Cosentyx Hepatology and Dermatology secukinumab Active ankylosing spondylitis Active psoriatic arthritis Moderate-to-severe plaque psoriasis Pustular psoriasis Ilaris canakinumab Cryopyrin-associated periodic syndromes Tumor necrosis factor receptor-associated periodic syndrome Hyperimmunoglobulin D syndrome/mevalonate kinase deficiency Familial Mediterranean fever Systemic juvenile idiopathic arthritis Gouty arthritis Adult-onset Still’s disease Xolair omalizumab Chronic spontaneous urticaria/chronic idiopathic urticaria See also “Respiratory” Neuroscience Aimovig erenumab Preventive treatment of migraine Extavia interferon beta-1b Relapsing-remitting and/or relapsing forms of multiple sclerosis (MS) in adult patients, and for patients who have had a single clinical event suggestive of MS and are at high risk of developing clinically definite MS Gilenya fingolimod Relapsing forms of MS Respiratory Onbrez Breezhaler indacaterol Chronic obstructive pulmonary disease Seebri Breezhaler Ultibro Breezhaler glycopyrronium bromide indacaterol and glycopyrronium bromide Chronic obstructive pulmonary disease Chronic obstructive pulmonary disease Xolair omalizumab Moderate to severe allergic asthma See also “Immunology, Hepatology and Dermatology” Auto-injector Lyophilized, pre-filled syringe Solution for injection Lyophilized powder for reconstitution for subcutaneous injection Liquid formulation in pre-filled syringe Lyophilized powder in vial Subcutaneous injection Subcutaneous injection Capsule Inhalation powder hard capsules Inhalation powder hard capsules Inhalation powder hard capsules Lyophilized powder in vial Liquid formulation in pre-filled syringe Cardio‑ Metabolic Entresto sacubitril/valsartan Symptomatic chronic heart failure with reduced ejection fraction Tablet in adults 36 Item 4. Information on the Company Business franchise Established Medicines Product Cibacen Common name Indications (vary by country and/or formulation) benazepril hydrochloride Hypertension Adjunct therapy in congestive heart failure Progressive chronic renal insufficiency Comtan entacapone Parkinson’s disease patients who experience end-of-dose motor (or movement) fluctuations Diovan valsartan Hypertension Heart failure Post-myocardial infarction Diovan HCT/Co‑Diovan valsartan and Hypertension hydrochlorothiazide Eucreas vildagliptin and metformin Type 2 diabetes Formulation Tablet Tablet Tablet Capsule Oral solution Tablet Tablet Exelon rivastigmine Mild-to-moderate Alzheimer’s disease dementia Severe Alzheimer’s disease dementia Dementia associated with Parkinson’s disease Capsule Oral solution Transdermal patch Exforge Exforge HCT valsartan and amlodipine besylate Hypertension Hypertension valsartan, amlodipine besylate and hydrochlorothiazide Focalin and Focalin XR dexmethylphenidate Attention deficit hyperactivity disorder HCl and dexmethylphenidate extended release Tablet Tablet Tablet Capsule Galvus vildagliptin Type 2 diabetes Lescol and Lescol XL fluvastatin sodium Hypercholesterolemia and mixed dyslipidemia in adults Secondary prevention of major adverse cardiac events Slowing the progression of atherosclerosis Heterozygous familial hypercholesterolemia in children and adolescents Tablet Capsule (Lescol) Tablet (Lescol XL) Myfortic mycophenolic acid Prophylaxis of organ rejection in patients receiving allogeneic renal transplants (as mycophenolate sodium) Gastro-resistant tablet Neoral/Sandimmune cyclosporine, USP Modified Prevention of rejection following certain organ transplantation Non-transplantation autoimmune conditions such as severe psoriasis and severe Oral solution Intravenous rheumatoid arthritis (Sandimmune) Capsule Ritalin Ritalin LA methylphenidate HCl Attention deficit hyperactivity disorder and narcolepsy methylphenidate HCl-modified release Attention deficit hyperactivity disorder Simulect basiliximab Prevention of acute organ rejection in de novo renal transplantation Stalevo carbidopa, levodopa Parkinson’s disease patients who experience end-of-dose motor and entacapone (or movement) fluctuations Tegretol carbamazepine Epilepsy Pain associated with trigeminal neuralgia Acute mania and bipolar affective disorders Alcohol withdrawal syndrome Painful diabetic neuropathy Diabetes insipidus centralis Polyuria and polydipsia of neurohormonal origin Trileptal oxcarbazepine Epilepsy Tyzeka/Sebivo telbivudine Chronic hepatitis B Voltaren/Cataflam diclofenac sodium/ potassium/resinate/ Post-traumatic and postoperative pain, inflammation and swelling free acid Inflammatory and degenerative forms of rheumatism Painful and/or inflammatory conditions in gynecology Other painful and/or inflammatory conditions such as renal and biliary colic; migraine attacks; and as adjuvant in severe ear, nose and throat infections Post-traumatic inflammation of the tendons, ligaments, muscles and joints Localized forms of soft-tissue and degenerative rheumatism Zortress/Certican everolimus Prevention of organ rejection (heart, liver and kidney) 37 Tablet Capsule Vial for injection or infusion Tablet Tablet Chewable tablet Oral suspension Suppository Tablet Oral suspension Tablet Oral solution Tablet Capsule Oral drops/ oral suspension Ampoule for injection Suppository Gel Powder for oral solution Transdermal patch Tablet Dispersible tablet Item 4. Information on the Company Key marketed products Novartis Oncology business unit Oncology • Tasigna (nilotinib) is a signal transduction inhibitor of the BCR-ABL tyrosine kinase. Since its launch in 2007, Tasigna has been approved in more than 125 countries to treat patients with Philadelphia chromosome-posi- tive chronic myeloid leukemia (Ph+ CML) in the chronic and/or accelerated phase who are resistant or intoler- ant to existing treatment, including Gleevec/Glivec, and to treat newly diagnosed patients in the chronic phase. In June 2017, the European Commission (EC) approved the inclusion of treatment-free remission data in the summary of product characteristics for Tasigna. In December 2017, the FDA also approved the inclusion of treatment-free remission data in the US label for Tasigna. In November 2017, the EC approved Tasigna for the treatment of newly diagnosed pediatric patients with Ph+ CML in the chronic phase (CP), and Ph+ CML-CP pediatric patients with resistance or intoler- ance to prior therapy including imatinib. In March 2018, the FDA approved Tasigna for this pediatric indication. • Sandostatin SC (octreotide acetate for injection) and Sandostatin LAR (octreotide acetate for injectable sus- pension) are somatostatin analogs indicated for the treatment of patients with acromegaly, a chronic dis- ease caused by the over-secretion of growth hormone in adults. Sandostatin is also indicated for the treatment of patients with certain symptoms associated with car- cinoid tumors and other types of gastrointestinal and pancreatic neuroendocrine tumors. Additionally, Sandostatin LAR is approved in more than 60 coun- tries for the treatment of patients with advanced neu- roendocrine tumors of the midgut or unknown primary tumor location. Sandostatin SC was first launched in 1988 and is approved in more than 100 countries. • Gleevec/Glivec (imatinib mesylate/imatinib) is a kinase inhibitor approved as a targeted therapy for adult and pediatric patients with Ph+ CML in the chronic phase. It is also approved to treat patients with Ph+ CML in the blast, accelerated or chronic phase after failure with interferon; to treat patients with metastatic and/ or unresectable gastrointestinal stromal tumors (GIST) that are KIT (CD117)-positive (KIT+); and as an adjuvant treatment for certain adult patients following resection of KIT+ GIST. First launched in 2001, Gleevec/Glivec is approved in approximately 125 countries. It is approved in more than 80 countries as a post-surgery therapy for certain adult patients with KIT+ GIST. Additionally, Gleevec/Glivec is approved in the US, the EU and Japan to treat Ph+ acute lymphoblastic leukemia (a rapidly progressive form of leukemia); in the US and EU to treat dermatofibrosarcoma protuberans (a rare solid tumor), hypereosinophilic syndrome, myelodysplastic/myelop- roliferative diseases and other rare blood disorders; and in the US (as Gleevec) to treat aggressive systemic mastocytosis. • Afinitor/Votubia (everolimus) is an oral inhibitor of the mTOR pathway. Afinitor is approved in more than 120 countries, including the US, EU member states and Japan, for patients with advanced renal cell carcinoma whose disease has progressed during or after treat- ment with vascular endothelial growth factor-targeted therapy (in the EU), or after failure of treatment with sunitinib or sorafenib (in the US). Additionally, Afinitor is approved in more than 110 countries, including the US, EU member states and Japan, for patients with pro- gressive neuroendocrine tumors (NETs) of pancreatic origin that are unresectable, locally advanced or met- astatic; in more than 45 countries, including the US and EU member states, for patients with progressive, well-differentiated, nonfunctional NETs of gastrointes- tinal or lung origin that are unresectable, locally advanced or metastatic; and in 117 countries, in com- bination with exemestane, for postmenopausal women with advanced hormone receptor-positive (HR+)/ human epidermal growth factor receptor 2-negative (HER2-) breast cancer after recurrence or progression following treatment with a nonsteroidal aromatase inhibitor (in the EU), or after failure of treatment with letrozole or anastrozole (in the US). All oncology indi- cations are approved under the trade name Afinitor, in the tablet formulation. Everolimus, under the trade name Afinitor in the US and Votubia in the EU, is also approved in more than 100 countries to treat patients with tuberous sclerosis complex (TSC) who have sub- ependymal giant cell astrocytoma (SEGA) not requir- ing immediate surgery, and in more than 95 countries to treat patients with TSC who have renal angiomyoli- poma not requiring immediate surgery. The dispersible tablets for oral suspension formulation are approved in more than 40 countries – including the US (under the trade name Afinitor Disperz), EU member states (under the trade name Votubia) and Japan (under the trade name Afinitor) – for patients with TSC who have SEGA. Dispersible tablets are also approved in more than 30 countries – including EU member states (as Votubia) and the US (as Afinitor Disperz) – as adjunc- tive treatment for patients aged 2 years and older with TSC-associated partial-onset seizures. Everolimus is available under the trade names Zortress/Certican for use in transplantation in the US and EU, respectively. It is exclusively licensed to Abbott and sublicensed to Boston Scientific for use in drug-eluting stents. • Promacta/Revolade (eltrombopag) is a once-daily oral thrombopoietin receptor agonist that works by stimu- lating bone marrow cells to produce platelets. It is the only approved once-daily oral thrombopoietin recep- tor agonist, and is marketed under the brand name Promacta in the US and Revolade in most countries outside the US. It is approved in more than 90 coun- tries for the treatment of thrombocytopenia in adult patients with chronic immune (idiopathic) thrombocy- topenia (ITP) who have had an inadequate response or are intolerant to other treatments. In the US and EU, Promacta/Revolade is approved for pediatric patients 1 year and older with chronic ITP who have had an insuf- ficient response to other treatments. Promacta/ Revolade is also approved in more than 40 countries for the treatment of thrombocytopenia in patients with chronic hepatitis C to allow them to initiate and main- tain interferon-based therapy. It is approved in the US and Japan for aplastic anemia as first-line therapy, and in 45 countries for the treatment of patients with severe 38 Item 4. Information on the Company aplastic anemia (SAA) who are refractory to other treatments (including in the EU for adults with acquired SAA who were either refractory to prior immunosup- pressive therapy or heavily pretreated and are unsuit- able for hematopoietic stem cell transplant). Promacta/ Revolade is marketed under a collaboration agreement between Ligand Pharmaceuticals, Inc. and Novartis. • Tafinlar + Mekinist (dabrafenib + trametinib) is a com- bination therapy approved for the treatment of patients with unresectable or metastatic melanoma with a BRAF V600 mutation; the adjuvant treatment of patients with stage III melanoma with a BRAF V600 mutation; the treatment of patients with advanced non- small cell lung cancer with a BRAF V600 mutation; and the treatment of patients with locally advanced or met- astatic anaplastic thyroid cancer with a BRAF V600 mutation. Usage in the adjuvant treatment of melanoma was approved in the US, the EU, Japan and other coun- tries worldwide in 2018, making Tafinlar + Mekinist the first targeted therapy approved in this setting. The 2018 FDA approval of Tafinlar + Mekinist for the treatment of anaplastic thyroid cancer represented the first approval of any therapy in the US for this aggressive form of thyroid cancer. Tafinlar and Mekinist are kinase inhibitors of BRAF and MEK1/2, respectively, and are also indicated as single agents to treat patients with unresectable or metastatic melanoma with a BRAF V600 mutation. Novartis has worldwide exclusive rights to develop, manufacture and commercialize trametinib granted by Japan Tobacco Inc. • Exjade and Jadenu (deferasirox) is an oral iron chela- tor approved for the treatment of chronic iron overload due to blood transfusions in patients 2 years of age and older, and of chronic iron overload in patients 10 years of age and older with non-transfusion-depen- dent thalassemia. Exjade, a dispersible tablet for oral suspension, was first approved in 2005 and is now approved in more than 100 countries, including the US, the EU and Japan. An oral film-coated tablet formula- tion that can be swallowed or crushed is also approved in countries including the US and Canada (under the Jadenu or Exjade trade name, depending on the coun- try). Additionally, the formulation has been developed as granules and is approved in the US, the EU and Japan. • Jakavi (ruxolitinib) is an oral inhibitor of the JAK1 and JAK2 tyrosine kinases. It is the first JAK inhibitor indi- cated for the treatment of disease-related splenomeg- aly or symptoms in adult patients with primary myelo- fibrosis, post-polycythemia vera myelofibrosis or post-essential thrombocythemia myelofibrosis, and for the treatment of adult patients with polycythemia vera who are resistant or intolerant to hydroxyurea. Jakavi is currently approved in more than 100 countries for patients with myelofibrosis, and in more than 75 coun- tries – including EU member states and Japan – for patients with polycythemia vera. Novartis licensed ruxolitinib from Incyte Corporation for development and commercialization in the indications of oncology, hematology and Graft-versus-host disease outside the US. Ruxolitinib, marketed in the US as Jakafi® by Incyte Corporation, was approved by the FDA for the treat- ment of patients with intermediate or high-risk myelo- fibrosis, including primary myelofibrosis, post-polycy- themia vera myelofibrosis and post-essential thrombocythemia myelofibrosis. Jakafi® was also approved by the FDA for the treatment of patients with polycythemia vera who have had an inadequate response or are intolerant to hydroxyurea. • Votrient (pazopanib) is a small-molecule tyrosine kinase inhibitor that targets a number of growth fac- tors to limit new blood vessel and tumor growth and cell survival. Votrient is approved in the US for the treat- ment of patients with advanced renal cell carcinoma (RCC), and in the EU for first-line treatment of adult patients with advanced RCC and for patients who have received prior cytokine therapy for advanced disease. Votrient is also indicated for the treatment of patients with advanced soft tissue sarcoma (STS) who have received prior chemotherapy (efficacy in adipocytic STS or gastrointestinal stromal tumors has not been demonstrated), and in the EU for the treatment of adult patients with selective subtypes of advanced STS who have received prior chemotherapy for metastatic dis- ease or who have progressed within 12 months after (neo)adjuvant therapy. Votrient is approved in more than 100 countries worldwide for advanced RCC and in more than 90 countries for advanced STS. • Kisqali (ribociclib) is a cyclin-dependent kinase inhibi- tor, a class of drugs that helps slow the progression of cancer by inhibiting two proteins called cyclin-depen- dent kinase 4 and 6 (CDK4/6). It is indicated for the treatment of postmenopausal women (and, in the US, pre- or perimenopausal women) with HR+/HER2- locally advanced or metastatic breast cancer as initial endocrine-based therapy in combination with an aro- matase inhibitor. In the US and the EU, Kisqali is also indicated for use in combination with fulvestrant as first- or second-line therapy in postmenopausal women. Kisqali was originally approved in the US in 2017 and is now approved in more than 70 countries, including EU member states. In 2017, the FDA also approved the Kisqali Femara Co-Pack (ribociclib tab- lets and letrozole tablets). Kisqali was developed by the Novartis Institutes for BioMedical Research under a research collaboration with Astex Pharmaceuticals. • Kymriah (tisagenlecleucel) suspension for intravenous infusion is a CD19-directed genetically modified autol- ogous chimeric antigen receptor T-cell (CAR-T) ther- apy. Kymriah received FDA approval in 2017 for the treatment of patients up to 25 years of age with B-cell precursor acute lymphoblastic leukemia (ALL) that is refractory or in second or later relapse, and in May 2018 for the treatment of adult patients with relapsed or refractory (r/r) large B-cell lymphoma, including diffuse large B-cell lymphoma (DLBCL), high-grade B-cell lym- phoma, and DLBCL arising from follicular lymphoma. Kymriah is not indicated for the treatment of patients with primary central nervous system lymphoma. Kymriah is also approved in countries including EU 39 Item 4. Information on the Company member states and Switzerland for the treatment of children and young adults with r/r B-cell ALL, and adult patients with r/r DLBCL. • Lutathera (USAN: lutetium Lu 177 dotatate/INN: lute- tium (177Lu) oxodotreotide) is a lutetium Lu 177-labeled somatostatin analog peptide. It is a radioligand therapy and comprises a targeting molecule that carries a radioactive component. Lutathera has received orphan drug designation from the FDA and the EMA. In the US, Lutathera is approved for the treatment of somatosta- tin receptor-positive gastroenteropancreatic neuroen- docrine tumors (GEP-NETs), including foregut, midgut and hindgut neuroendocrine tumors, in adults. In Europe, it is approved for the treatment of unresect- able or metastatic, progressive, well-differentiated (G1 and G2), somatostatin receptor-positive GEP-NETs in adults. Novartis Pharmaceuticals business unit Ophthalmology • Lucentis (ranibizumab) is a recombinant humanized high-affinity antibody fragment that binds to vascular endothelial growth factor A (VEGF-A), a key mediator of intraocular neovascularization. Lucentis is an anti-VEGF therapy specifically designed for the eye, minimizing systemic exposure. It is approved for six indications: neovascular (wet) age-related macular degeneration (nAMD), visual impairment due to dia- betic macular edema (DME), visual impairment due to macular edema secondary to branch retinal vein occlu- sion (BRVO), visual impairment due to macular edema secondary to central retinal vein occlusion (CRVO), visual impairment due to choroidal neovascularization secondary to pathologic myopia (myopic CNV), and visual impairment due to choroidal neovascularization (CNV) secondary to other pathologies. Lucentis is avail- able in more than 110 countries, and the Lucentis pre-filled syringe has launched in 37 countries. Lucentis is licensed from Genentech, and Novartis holds the rights to commercialize the product outside the US. Genentech holds the rights to commercialize Lucentis in the US. For further information, see “Item 18. Finan- cial Statements—Note 26. Transactions with related parties—Genentech/Roche.” • Travatan (travoprost), Travatan Z (travoprost) and Duotrav (travoprost/timolol) are indicated for the reduction of elevated intraocular pressure (IOP) in patients with open-angle glaucoma or ocular hyper- tension. Single-agent travoprost products (Travatan, Travatan Z, Travatan BAK-Free and Izba) are prescribed as first-line agents and are marketed in more than 110 countries, including the US and EU member states. Duotrav is a fixed-dose combination solution of the prostaglandin analog travoprost with the beta-blocker timolol, and is approved as a second-line treatment in adults for the reduction of IOP in patients with open-an- gle glaucoma or ocular hypertension who are insuffi- ciently responsive to topical beta-blockers or prosta- glandin analogs. Duotrav is currently marketed in more than 105 countries, including EU member states. • Luxturna (voretigene neparvovec) is a one-time gene therapy approved in the EU in November 2018 to treat children and adults with vision loss caused by muta- tions in both copies of the RPE65 gene and who have sufficient viable retinal cells. In January 2018, Spark Therapeutics entered into a licensing agreement and a manufacturing and supply agreement with Novartis covering development, registration and commercial- ization rights to Luxturna in markets outside the US. Upon the transfer of the EU marketing authorization from Spark Therapeutics to Novartis, Novartis plans to commercialize Luxturna in the EU/EEA, with Spark Therapeutics as supplier of the gene therapy. Immunology, Hepatology and Dermatology • Cosentyx (secukinumab) is a fully human monoclonal antibody that selectively inhibits circulating interleu- kin-17A (IL-17A), a cytokine involved in the pathogene- sis of psoriasis, ankylosing spondylitis and psoriatic arthritis. Cosentyx is approved in more than 90 coun- tries, including the US, EU member states and Japan, for the treatment of moderate-to-severe plaque psori- asis. It is approved in more than 80 countries, includ- ing the US, EU member states and Japan, for the treat- ment of adults with ankylosing spondylitis and psoriatic arthritis. Cosentyx is also approved in Japan for the treatment of pustular psoriasis and psoriasis vulgaris. In 2017, a label update for Cosentyx was approved in the EU based on data showing long-term superiority over Stelara® (ustekinumab) in moderate-to-severe plaque psoriasis, along with efficacy in the treatment of moderate-to-severe scalp psoriasis – one of the most difficult-to-treat forms of the disease. In 2018, the FDA approved a label update for Cosentyx to include moderate-to-severe scalp psoriasis, and new evidence that Cosentyx inhibits progression of joint structural damage in psoriatic arthritis. • Xolair (omalizumab) is a recombinant, DNA-derived, humanized IgG1 monoclonal antibody. Xolair is designed to block IgE, which limits the release of mediators in the early and late phases of the allergic cascade. It is currently approved in more than 90 countries, includ- ing the US, EU member states and Japan, as a treat- ment for chronic spontaneous urticaria (CSU), also known as chronic idiopathic urticaria (CIU). In the EU, Xolair is indicated as add-on therapy for the treatment of CSU in adults and adolescents 12 years of age and older with inadequate response to H1 antihistamine treatment. In the US, Xolair is approved to treat adults and adolescents 12 years of age and older with CIU who remain symptomatic despite H1 antihistamine treatment. (See also Xolair in “Respiratory” below.) We co-promote Xolair with Genentech in the US and share a portion of operating income, but we do not record any US sales. Novartis records all sales of Xolair out- side the US. For further information, see “Item 18. Financial Statements—Note 26. Transactions with related parties—Genentech/Roche.” • Ilaris (canakinumab) is a selective, high-affinity fully human monoclonal antibody that inhibits interleukin-1 beta (IL-1 beta), a key cytokine in the inflammatory path- way. Ilaris is approved in the US, EU member states and 40 Item 4. Information on the Company Japan to treat systemic juvenile idiopathic arthritis and various auto-inflammatory conditions, such as cryopy- rin-associated periodic syndromes and other distinct periodic fevers (also known as hereditary periodic fevers). It is also approved in the EU for adult-onset Still’s disease and the symptomatic treatment of refrac- tory acute gouty arthritis. Ilaris is approved in one or more indications in approximately 70 countries world- wide. Neuroscience • Gilenya (fingolimod) is an oral disease-modifying ther- apy approved to treat relapsing forms of multiple scle- rosis (MS). It has a reversible lymphocyte redistribution effect targeting both focal and diffuse central nervous system damage caused by MS. In the US, Gilenya is indicated for relapsing forms of MS in patients who are 10 years of age and older. In the EU, Gilenya is indicated for adult patients who have high disease activity despite treatment with at least one disease-modifying agent, or who have rapidly evolving severe relapsing-remit- ting MS. Additionally, it received European Commission approval in November 2018 for the treatment of chil- dren and adolescents with relapsing-remitting MS. Results from the Phase IIIb ASSESS study, announced in October 2018, showed that Gilenya 0.5 mg is supe- rior in reducing relapses to glatiramer acetate in a con- trolled, head-to-head trial. Treatment with Gilenya 0.5 mg resulted in a 40.7% relative reduction in the rate of relapses over one year, compared to patients on glati- ramer acetate 20 mg. Adults taking Gilenya 0.25 mg achieved a numerical risk reduction in relapses com- pared to the comparator, but did not reach statistical significance. Gilenya is currently approved in more than 80 countries around the world. Gilenya is licensed from Mitsubishi Tanabe Pharma Corporation. • Aimovig (erenumab) is designed specifically to block the calcitonin gene-related peptide receptor (CGRP-R), which plays a critical role in migraine. It is the first FDA- and EMA-approved CGRP-targeted therapy for the prevention of migraine in adults. Aimovig received US approval in May 2018 and EU approval in July 2018, and is currently approved in 37 countries worldwide. Aimovig is co-commercialized with Amgen in the US, where Amgen records sales, and Novartis has exclu- sive commercialization rights for all territories exclud- ing the US and Japan. Respiratory • Xolair (omalizumab) is approved for the treatment of moderate-to-severe, or severe, persistent allergic asthma in children (age 6 and older) and adults. It has been approved in more than 90 countries, including the US since 2003, the EU since 2005, Japan since 2009, and China since 2018. Xolair is provided as lyo- philized powder for resolution, and as liquid formula- tion in a pre-filled syringe. In December 2018, the Euro- pean Commission approved the Xolair pre-filled syringe for self-administration across all indications. (See also Xolair in “Immunology, Hepatology and Dermatology” above.) We co-promote Xolair with Genentech in the US and share a portion of operating income, but we do not record any US sales. Novartis records all sales of Xolair outside the US. For further information, see “Item 18. Financial Statements—Note 26. Transactions with related parties—Genentech/Roche.” Cardio‑Metabolic • Entresto (sacubitril/valsartan) is a first-in-class angio- tensin receptor/neprilysin inhibitor indicated for the treatment of symptomatic chronic heart failure with reduced ejection fraction (HFrEF). It acts to enhance the protective neurohormonal systems of the heart (neprilysin system) while simultaneously suppressing the harmful system (the renin-angiotensin-aldosterone system, or RAAS). Entresto was approved in the US and in the EU in 2015. It is now approved in more than 100 countries and launched in more than 90 countries. Both European Society of Cardiology heart failure guidelines and US heart failure guidelines have given a Class I recommendation, the strongest class of rec- ommendation, for the use of sacubitril/valsartan in patients with HFrEF. Established Medicines • Galvus (vildagliptin), an oral DPP-4 inhibitor, and Eucreas, a single-pill combination of vildagliptin and metformin, are indicated for the treatment of type 2 diabetes. The products were first approved in 2007. Galvus is currently approved in more than 130 coun- tries, including EU member states, Japan (as Equa), Latin America and Asia-Pacific. Eucreas is currently approved in more than 125 countries. It was the first single-pill combination of a DPP-4 inhibitor and met- formin approved in Japan (as EquMet) and Europe, and is marketed as Galvus Met in most non-EU countries. In the EU, Galvus received approval for expanded use as a second-line monotherapy for type 2 diabetes patients who cannot take metformin. The EU also approved Galvus in combination with insulin, with or without metformin, for type 2 diabetes when diet, exer- cise and a stable dose of insulin do not result in glyce- mic control, and in triple combination with metformin and a sulphonylurea (SU) for type 2 diabetes when diet and exercise plus dual therapy with vildagliptin and metformin do not provide adequate glycemic control. In 2017, Galvus was approved as an add-on to insulin and an add-on to SU treatment. Galvus and Eucreas are co-marketed by Merck KGaA as Jalra and Jalra M, respectively, in some countries in Latin America. • Diovan (valsartan), together with Diovan HCT/Co‑ Diovan (valsartan and hydrochlorothiazide), is an angio- tensin II receptor blocker (ARB). Diovan is the only agent in its class approved to treat all of the following: patients with high blood pressure (including children 6 to 18 years old), high-risk heart attack survivors, and patients with heart failure. Diovan first launched in 1996 and is available in more than 120 countries; Diovan HCT/ Co‑Diovan first launched in 1997 and is available in more than 100 countries. • Exforge (valsartan and amlodipine besylate) is a sin- gle-pill combination of the ARB Diovan and the calcium channel blocker amlodipine besylate. First approved for the treatment of high blood pressure in Switzerland in 2006, and in the US and EU in 2007, it is now 41 Item 4. Information on the Company available in more than 100 countries. Exforge HCT (val- sartan, amlodipine besylate and hydrochlorothiazide) is a single pill combining three widely prescribed high blood pressure treatments: an ARB, a calcium channel blocker and a diuretic (hydrochlorothiazide). Exforge HCT was approved in the EU and the US in 2009, and is now available in more than 75 countries. • Zortress/Certican (everolimus) is an oral inhibitor of the mTOR pathway. Zortress/Certican is approved in coun- tries including the US, EU member states and Japan for the prevention of organ rejection in adult patients at low to moderate immunological risk receiving an allo- geneic kidney or liver transplant. Additionally, it is approved in EU member states and Japan for adult patients receiving a heart transplant. First approved in July 2003, Zortress/Certican is now available in more than 80 countries worldwide and is the only mTOR inhibitor approved for liver and heart transplants. • Neoral (cyclosporine, USP Modified) is an immunosup- pressant to prevent organ rejection following a kidney, liver or heart transplant. It is approved for use in lung transplant in many countries outside the US. This micro-emulsion formulation of cyclosporine is also indi- cated for treating certain autoimmune disorders, such as psoriasis and rheumatoid arthritis. First launched in 1995, Neoral is marketed in approximately 100 coun- tries. Compounds in development The following table and paragraph summaries provide an overview of the key Innovative Medicines Division proj- ects currently in the Confirmatory Development stage and may also describe certain projects in the Exploratory Development stage. Projects include those seeking to develop potential uses of new molecular entities as well as potential additional indications or new formulations for already marketed products. Changes to the selected development projects table are highlighted in the table below entitled “Projects added to and subtracted from the development table since 2017.” Compounds and new indications in development are subject to required regulatory approvals and, in certain instances, contractual limitations. These compounds and indications are in various stages of development throughout the world. 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 any country or in every country. See “—Regulation” for fur- ther information on the approval process. The year that each project entered the current phase of development disclosed below reflects the year in which the decision to enter the phase was made. This may be different from the year in which the first patient received the first treatment in the related clinical trial. A reference to a project being in registration means that an application has been filed with a health authority for marketing approval. 42 Item 4. Information on the Company Selected development projects Project/ product Common name Mechanism of action Potential indication/ disease area Business franchise Formulation/ route of administration ABL001 asciminib BCR-ABL inhibitor Chronic myeloid leukemia, 3rd line Oncology Chronic myeloid leukemia, 1st line Oncology Oral Oral Year project entered current Planned filing development dates/current phase phase 2016 2017 2021/III ≥2023/I ACZ885 canakinumab Anti-interleukin-1 beta 2nd line non-small cell lung cancer Oncology Subcutaneous injection 2017 2021/III monoclonal antibody 1st line non-small cell lung cancer Oncology Subcutaneous injection 2017 Adjuvant non-small cell lung cancer Oncology Subcutaneous injection 2017 AVXS-101 onasemno- Survival motor neuron Spinal muscular atrophy type 1 (Zolgensma) gene abepar- (SMN) gene vovec-xxxx replacement therapy (IV formulation) Neuroscience Intravenous infusion 2018 2021/III 2022/III US/EU registration AVXS-201 TBD Methyl-CpG binding protein 2 (MECP2) gene replacement therapy Rett syndrome Neuroscience Intrathecal injection 2018 2022/I Spinal muscular atrophy type 2/3 (IT formulation) Neuroscience Intrathecal injection 2016 2020/I BAF312 (Mayzent) siponimod Sphingosine-1- phosphate receptor modulator BYL719 alpelisib PI3K-alpha inhibitor Secondary progressive multiple sclerosis Neuroscience Oral 2018 Hormone receptor-positive (HR+)/human Oncology epidermal growth factor receptor 2-negative (HER2-) advanced breast cancer (postmenopausal women), 2nd line (+ fulvestrant) Oral 2018 US/EU registration US/EU registration CAD106 amilomotide Beta-amyloid-protein therapy Alzheimer’s disease Neuroscience Intramuscular injection 2009 ≥2023/II/III CFZ533 iscalimab Blocking, non-depleting, Solid organ transplantation anti-CD40 monoclonal antibody Sjögren’s syndrome Immunology, Hepatology and Dermatology Immunology, Hepatology and Dermatology Intravenous infusion 2017 ≥2023/II Intravenous infusion 2018 ≥2023/II CNP520 TBD BACE inhibitor Alzheimer’s disease Neuroscience Oral 2016 ≥2023/II/III Cosentyx secukinumab Anti-interleukin-17 Non-radiographic axial spondyloarthritis monoclonal antibody Psoriatic arthritis head-to-head study versus Humira® (adalimumab) Immunology, Hepatology and Dermatology Immunology, Hepatology and Dermatology Ankylosing spondylitis head-to-head study Immunology, versus Sandoz biosimilar Hyrimoz (adalimumab) Hepatology and Dermatology Hidradenitis suppurativa Immunology, Hepatology and Dermatology Subcutaneous injection 2015 2019/III Subcutaneous injection 2015 2020/III Subcutaneous injection 2015 2022/III Intravenous infusion 2017 2022/III CSJ117 TBD Anti-thymic stromal lymphopoietin monoclonal antibody fragment Severe asthma Respiratory Inhalation 2018 ≥2023/II ECF843 TBD Boundary lubricant Dry eye Ophthalmology Eye drops EMA401 olodanrigan Angiotensin II type 2 Peripheral neuropathic pain Neuroscience Oral 2017 2015 2022/II ≥2023/II receptor antagonist Entresto valsartan and Angiotensin receptor/ Chronic heart failure with preserved sacubitril (as sodium salt complex) neprilysin inhibitor ejection fraction Cardio-Metabolic Oral 2012 2019/III Post-acute myocardial infarction Cardio-Metabolic Oral HDM201 TBD p53-HDM2 inhibitor Acute myeloid lymphoma INC280 capmatinib c-MET inhibitor Non-small cell lung cancer Non-small cell lung cancer (EGFR mutation) Oncology Oncology Oncology Jakavi ruxolitinib JAK1/2 inhibitor Acute graft-versus-host disease Oncology Chronic graft-versus-host disease Oncology KAE609 cipargamin PfATP4 inhibitor Malaria Established Medicines Oral Oral Oral Oral Oral Oral 2015 2017 2014 2016 2016 2016 2012 2020/III ≥2023/II 2019/II 2022/II 2020/III 2020/III ≥2023/II 43 Item 4. Information on the Company Project/ product Common name Mechanism of action Potential indication/ disease area KAF156 ganaplacide Imidazolopiperazines Malaria derivative Business franchise Established Medicines Formulation/ route of administration Year project entered current Planned filing development dates/current phase phase Oral 2014 ≥2023/II Kisqali ribociclib CDK4/6 inhibitor HR+/HER2- breast cancer (adjuvant) Oncology Oral 2018 ≥2023/III Kymriah tisagen- lecleucel CD19-targeted chimeric Relapsed/refractory follicular lymphoma Oncology antigen receptor T-cell immunotherapy Intravenous infusion 2017 2021/II Chronic lymphocytic leukemia Oncology Intravenous infusion 2017 2022/II Relapsed/refractory diffuse large B-cell Oncology lymphoma in 1st relapse Relapsed/refractory diffuse large B-cell Oncology lymphoma (+ pembrolizumab) Intravenous infusion 2018 2021/III Intravenous infusion 2017 ≥2023/I LAM320 clofazimine Mycobacterial Multidrug-resistant tuberculosis DNA binding Established Medicines Oral 2016 2021/III LCI699 osilodrostat Cortisol synthesis Cushing’s disease Oncology Oral 2018 EU registration US 2019/III LJC242 inhibitor tropifexor, FXR agonist and cenicriviroc CCR2/5 inhibitor (in fixed-dose combination) Nonalcoholic steatohepatitis LJN452 tropifexor FXR agonist Nonalcoholic steatohepatitis Immunology, Hepatology and Dermatology Oral Immunology, Hepatology and Dermatology Oral 2017 ≥2023/II 2015 ≥2023/II LMI070 branaplam SMN2 RNA splicing modulator Spinal muscular atrophy Neuroscience Oral 2017 ≥2023/II LNP023 TBD Factor B inhibitor IgA nephropathy Cardio-Metabolic Oral Membranous nephropathy Cardio-Metabolic Oral LOU064 TBD BTK inhibitor Chronic spontaneous urticaria Immunology, Hepatology and Dermatology Oral 2018 2018 2017 ≥2023/II ≥2023/II ≥2023/II 177Lu- PSMA-617 TBD Targeted DNA destruction via beta-particle radiation Metastatic castration-resistant prostate cancer Oncology Intravenous infusion 2018 2020/III Lucentis ranibizumab Anti-VEGF monoclonal Retinopathy of prematurity Ophthalmology Intravitreal injection 2018 EU registration antibody fragment Diabetic retinopathy Ophthalmology Intravitreal injection 2018 EU registration MOR106 TBD Anti-interleukin-17C monoclonal antibody Atopic dermatitis Immunology, Hepatology and Dermatology Subcutaneous injection 2018 ≥2023/II OMB157 ofatumumab Anti-CD20 monoclonal Relapsing multiple sclerosis Neuroscience Subcutaneous injection 2015 2019/III antibody PDR001 spartalizumab Anti-PD-1 monoclonal Metastatic BRAF V600+ Oncology Intravenous infusion 2017 2019/III antibody melanoma (w/ Tafinlar + Mekinist) Malignant melanoma (combo) Oncology Intravenous infusion 2017 2022/II Promacta/ eltrombopag Thrombopoietin receptor agonist Revolade Severe aplastic anemia, 1st line Oncology Oral 2018 US approved EU registration QAW039 fevipiprant DP2 antagonist (CRTH2 antagonist) Asthma Respiratory Oral 2015 2020/III QBW251 TBD CFTR potentiator Chronic obstructive pulmonary disease Respiratory Oral 2017 ≥2023/II QGE031 ligelizumab High-affinity anti-IgE monoclonal antibody Chronic spontaneous urticaria/ chronic idiopathic urticaria Immunology, Hepatology and Dermatology Subcutaneous injection 2017 2021/III QMF149 indacaterol, Long-acting beta2- mometasone adrenergic agonist and furoate (in fixed-dose combination) inhaled corticosteroid Asthma Respiratory Inhalation 2015 2019/III 44 Item 4. Information on the Company Project/ product Common name Mechanism of action Potential indication/ disease area Business franchise Formulation/ route of administration Year project entered current Planned filing development dates/current phase phase Asthma Respiratory Inhalation 2015 2019/III QVM149 indacaterol, Long-acting beta2- mometasone adrenergic agonist, furoate, glyco- pyrronium bromide (in fixed-dose combination) long-acting muscarinic antagonist and inhaled corticosteroid RTH258 brolucizumab Anti-VEGF single-chain Neovascular age-related macular Ophthalmology Intravitreal injection 2014 2019/III antibody fragment degeneration Diabetic macular edema Ophthalmology Intravitreal injection 2017 Retinal vein occlusion Ophthalmology Intravitreal injection 2018 Rydapt midostaurin Signal transduction Acute myeloid leukemia (FLT3 wild type) Oncology Oral 2016 inhibitor SEG101 crizanlizumab P-selectin inhibitor Sickle cell disease Oncology Intravenous infusion 2016 Presbyopia Ophthalmology Eye drops 2017 2020/III 2022/III 2022/III 2019/II 2022/II UNR844 TBD VAY736 lanalumab Reduction of disulfide bonds Anti-BAFF (B-cell- activating factor) monoclonal antibody Autoimmune hepatitis Primary Sjögren’s syndrome VAY785 emricasan Pan-caspase inhibitor Nonalcoholic steatohepatitis VPM087 TBD Interleukin-1 beta neutralization monoclonal antibody Colorectal cancer, 1st line; renal cell carcinoma, 1st line Immunology, Hepatology and Dermatology Immunology, Hepatology and Dermatology Immunology, Hepatology and Dermatology Subcutaneous injection 2016 ≥2023/II Subcutaneous injection 2015 ≥2023/II Oral 2017 ≥2023/II Oncology Intravenous infusion 2018 ≥2023/I Xolair omalizumab Anti-IgE monoclonal Nasal polyps Respiratory Subcutaneous injection 2017 2019/III antibody ZPL389 adriforant Histamine H4 receptor Atopic dermatitis antagonist Immunology, Hepatology and Dermatology Oral 2017 2022/II Key development projects • ACZ885 (canakinumab) was first approved as Ilaris in 2009 for cryopyrin-associated periodic syndromes. In 2017, data from CANTOS, a Phase III study evaluating quarterly injections of ACZ885 in people with a prior heart attack and inflammatory atherosclerosis, was presented at the European Society of Cardiology Con- gress and published simultaneously in The New England Journal of Medicine and The Lancet. A review of a blinded, pre-planned lung cancer safety analysis revealed a 77% reduction in lung cancer mortality and a 67% reduction in lung cancer cases in patients treated with 300 mg of ACZ885. As a result of these findings, Novartis has initiated three Phase III studies of ACZ885 in lung cancer, with data from primary anal- yses expected to report out in 2021. We received a complete response letter from the FDA in October 2018 regarding our supplemental Biologics License Application for ACZ885 in cardiovascular risk reduc- tion. • AVXS-101 (onasemnogene abeparvovec-xxxx, Zolgensma) is a gene replacement therapy candidate designed to address the genetic root cause of spinal muscular atrophy (SMA), a progressive neuromuscu- lar disease and the leading cause of genetic mortality in infants globally. In December 2018, we announced that the FDA accepted the Biologics License Applica- tion for Zolgensma for the treatment of SMA type 1, the most severe form of the disease. Delivered as a single, one-time infusion, Zolgensma works by replacing the missing or defective SMN1 gene with a functional copy that makes the SMN protein, thereby improving motor neuron function and survival. The Biologics License Application filing is supported by data from the Phase I START trial, which demonstrated an increase in sur- vival and improved achievement of developmental mile- stones compared to the natural history of SMA type 1. Zolgensma is currently being studied in a Phase III trial in patients with SMA type 1 in the US (STR1VE) and in Europe (STR1VE-EU), with a planned Phase III study in the Asia-Pacific region (STR1VE-AP). Zolgensma is also being studied in a Phase I trial in the US in patients with SMA type 2 (STRONG), and in a Phase III multinational trial in presymptomatic patients with SMA with two or three copies of the SMN2 gene (SPR1NT). A trial in pediatric patients with SMA types 1, 2 and 3 (REACH) is planned for 2019. Patients from the START trial had the option to voluntarily enroll in a long-term, 15-year observational follow-up study. The brand name Zolgensma has been provisionally approved by the FDA for AVXS-101, but the product itself has not received marketing authorization or Biologics License Applica- tion approval from any regulatory authorities. 45 Item 4. Information on the Company • BAF312 (siponimod, Mayzent) is an oral, second-gen- eration sphingosine-1-phosphate (S1P) receptor mod- ulator under development for the treatment of second- ary progressive multiple sclerosis (SPMS). It binds selectively to the S1P receptor subtypes 1 and 5, and penetrates effectively to the central nervous system, where it may impact central nervous system inflamma- tion and repair mechanisms. Results from the EXPAND Phase III study, evaluating efficacy and safety for SPMS, demonstrated that Mayzent reduced three- and six- month confirmed disability progression against pla- cebo, with a safety profile similar to other S1P1 recep- tor modulators. The full results from the Phase III EXPAND study of oral, once-daily Mayzent in SPMS were published in The Lancet in March 2018. Further analyses from the EXPAND study presented in April 2018 at the American Academy of Neurology showed that the efficacy of Mayzent on disability was largely independent from relapse activity in SPMS. The anal- yses also revealed positive data on cognitive decline. In October 2018, we announced that both the FDA and EMA had accepted our New Drug Application and Mar- keting Authorization Application, respectively, for review. Submissions are now also underway in Japan and China. If approved, label content will be subject to negotiation with regulatory authorities, but it is expected to reflect the typical SPMS population studied in the EXPAND trial. The brand name Mayzent has been pro- visionally approved by the FDA and EMA for BAF312, but the product itself has not been approved for sale in any country. • BYL719 (alpelisib) is an investigational, orally bioavail- able, alpha-specific PI3K inhibitor. In breast cancer cell lines harboring PIK3CA mutations, BYL719 has been shown to potentially inhibit the PI3K pathway and have antiproliferative effects. In addition, cancer cell lines with PIK3CA mutations were more sensitive to BYL719 than those without the mutation across a broad range of different cancers. At ESMO 2018, positive results from the global Phase III SOLAR-1 trial evaluating BYL719 in combination with fulvestrant were pre- sented. In patients with PIK3CA-mutated HR+/HER2- advanced breast cancer, BYL719 plus fulvestrant nearly doubled median progression-free survival compared to fulvestrant alone. Novartis is also conducting the Phase II open-label BYLieve trial evaluating BYL719 plus fulvestrant or letrozole in patients with PIK3CA- mutated HR+/HER2- advanced breast cancer who have progressed on prior therapy. The study investi- gates BYL719 in a broader patient population as com- pared with SOLAR-1, including two cohorts exclusively enrolling patients who have progressed on or after prior CDK4/6 inhibitor therapies. • Cosentyx (secukinumab) is a fully human monoclonal antibody that selectively neutralizes interleukin-17A (IL-17A). Cosentyx is in Phase III development in non-ra- diographic axial spondyloarthritis. We expect results from this trial in 2019. Cosentyx is also in a Phase III head-to-head clinical trial in psoriatic arthritis against Humira® (adalimumab), and a Phase III head-to-head clinical trial in ankylosing spondylitis against the Sandoz biosimilar Hyrimoz (adalimumab). • Entresto (sacubitril/valsartan) is a first-in-class angio- tensin receptor/neprilysin inhibitor approved and mar- keted for the treatment of chronic heart failure with reduced ejection fraction (HFrEF). Novartis is conduct- ing multiple studies of Entresto as part of the FortiHFy clinical program. FortiHFy includes studies to provide reinforcing evidence in HFrEF, such as PIONEER-HF and TRANSITION, which both read out in 2018 and confirmed safety as well as superiority of Entresto ver- sus enalapril, an angiotensin-converting enzyme inhib- itor (ACE inhibitor), in the hospital setting in a wide range of HFrEF patients hemodynamically stabilized after an acute decompensated heart failure event. For- tiHFy also includes studies to investigate Entresto use in novel indications and expanded patient populations. These include PARAGON-HF and PARALLAX-HF, Phase III trials of Entresto in patients with chronic heart failure with preserved ejection fraction (PARAGON-HF enrollment is completed and results are expected in 2019, while PARALLAX-HF enrollment is ongoing and results are expected in 2020); PARADISE-MI, a Phase III trial for patients at high risk for heart failure after an acute myocardial infarction (enrollment is ongoing and results are expected in 2020); PARALLEL-HF, a Phase III trial in Japan for patients with HFrEF (enrollment is completed and results are expected in 2019); and PAN- ORAMA-HF, a Phase III trial for pediatric patients with heart failure (enrollment is ongoing and results are expected in 2021). • INC280 (capmatinib) is an investigational, oral and selective MET inhibitor currently in a Phase II study in adult patients with advanced non-small cell lung can- cer harboring MET exon 14 skipping mutations, as well as additional early-stage studies in combination with other compounds. In October 2018, Novartis presented preliminary results of the Phase II study at the Euro- pean Society of Medical Oncology congress. INC280 is licensed by Novartis from Incyte Corporation. Under the licensing agreement, Incyte granted Novartis exclu- sive worldwide development and commercialization rights to this MET inhibitor compound. • KAF156 (ganaplacide) belongs to a novel class of anti- malarial compounds called imidazolopiperazines. It has the potential to clear malaria infection, including resis- tant strains, and to block the transmission of the malaria parasite. As demonstrated in a Phase IIa proof-of-con- cept trial, the compound is fast-acting and potent across multiple stages of the parasite’s lifecycle, rap- idly clearing both Plasmodium falciparum and Plasmo- dium vivax parasites. In August 2017, Novartis began a Phase IIb study to test multiple dosing combinations and dosing schedules of KAF156 and lumefantrine, including the feasibility of a single dose therapy in adults, adolescents and children. • Kisqali (ribociclib) is a selective cyclin-dependent kinase inhibitor that inhibits two proteins called cyclin-dependent kinase 4 and 6 (CDK4/6). Novartis is continuing to assess Kisqali through the MONA- LEESA clinical trial program, which includes MONA- LEESA-2, MONALEESA-3 and MONALEESA-7, as well as the NataLEE adjuvant trial. These trials are 46 Item 4. Information on the Company evaluating Kisqali in multiple endocrine therapy com- binations across a broad range of patients, including men and premenopausal women. Kisqali was devel- oped by Novartis as part of a drug discovery collabo- ration with Astex Pharmaceuticals. • Kymriah (tisagenlecleucel) is a CD19-directed geneti- cally modified autologous chimeric antigen receptor T-cell (CAR-T) therapy that uses the patient’s own immune system to fight certain types of cancer. CARs are engineered proteins that enable a patient’s own T-cells to seek out specific target proteins present on a patient’s cancerous cells. When these cells are rein- troduced into the patient’s blood, they demonstrate the potential to bind to the cancer cells and destroy them. Kymriah targets a protein called CD19, which is asso- ciated with a number of B-cell malignancies. Novartis is starting pivotal clinical studies of Kymriah in relapsed or refractory (r/r) follicular lymphoma, adult r/r acute lymphoblastic leukemia (ALL), first-line high-risk pedi- atric ALL, diffuse large B-cell lymphoma after first relapse, and r/r chronic lymphoblastic leukemia. Novartis and the University of Pennsylvania’s Perelman School of Medicine, which developed Kymriah, have a global collaboration to research, develop and commer- cialize CAR-T therapies, including Kymriah, for the investigational treatment of cancers. • LJN452 (tropifexor) is a potent, non-bile acid, farne- soid X receptor (FXR) agonist that is being developed for the treatment of nonalcoholic steatohepatitis (NASH). LJN452 has been shown to reduce steatosis, inflammation and fibrosis in animal models, alongside a favorable safety profile in first-in-human studies. This oral treatment is designed to break the cycle of fatty buildup in the liver and harness the body’s built-in mechanisms for coping with excess bile acid. Recruit- ment is underway for the first LJN452 clinical study with histological endpoints in NASH patients. • OMB157 (ofatumumab) is a fully human monoclonal antibody administered by subcutaneous injection. It is in development for multiple sclerosis (MS). OMB157 works by binding to the CD20 molecule on the B-cell surface and inducing B-cell depletion. Positive Phase IIb results in MS patients were presented in 2014 and showed significant reduction in the number of new brain lesions in the first 24 weeks after OMB157 admin- istration. Novartis initiated a Phase III program for OMB157 in relapsing MS in August 2016. The program is fully enrolled and is on track for completion in 2019. In addition, a registration study for Japan was initiated in March 2018. • PDR001 (spartalizumab) is an investigational PD-1 antagonist that may restore the ability of immune cells to induce cell death and fight cancer. PDR001 is being evaluated in a Phase III trial in combination with Tafinlar + Mekinist for metastatic BRAF V600+ melanoma, and in combination in other clinical trials across different tumor types. inflammatory cascade. By targeting the DP2 pathway, QAW039 blocks the asthma inflammatory cascade at multiple points. In asthma, this results in the reduction of eosinophil activation and migration; in the reduced release of pro-inflammatory cytokines IL-4, IL-5 and IL-13; and in the reduction of smooth muscle cell mass in the airways. Positive Phase II results showed improve- ment of lung function, reduction of sputum eosinophil levels, and improvement of asthma symptoms. Phase III studies are ongoing, measuring improvement of lung function and reduction of asthma attacks in moderate to severe patients with unresolved asthma despite treatment with inhaled therapies. Phase III develop- ment started in 2015, with first pivotal trial readouts expected this year. • QVM149 (indacaterol acetate, glycopyrronium bro- mide, mometasone furoate) is a fixed-dose combina- tion of indacaterol acetate (an inhaled long-acting beta2-adrenergic agonist), glycopyrronium bromide (an inhaled long-acting muscarinic antagonist), and mometasone furoate (an inhaled corticosteroid) deliv- ered once-daily via the Breezhaler device, a unit dose dry powder inhaler. It is in development as a mainte- nance treatment for poorly controlled asthmatic patients. All three mono-components have previously been developed as individual drugs for either chronic obstructive pulmonary disease or asthma. QVM149 is currently in Phase III clinical trials to support registra- tion outside the US. • RTH258 (brolucizumab) is a single-chain antibody frag- ment that acts as an anti-vascular endothelial growth factor (anti-VEGF) agent. RTH258 is currently in devel- opment for neovascular age-related macular degen- eration (nAMD) and diabetic macular edema. In nAMD, RTH258 met its primary endpoint of non-inferiority to aflibercept in mean change in best-corrected visual acuity in two Phase III clinical trials, HAWK and HAR- RIER. Additionally, superiority was shown in three sec- ondary endpoints that are considered key markers of nAMD disease: central subfield retinal thickness, reti- nal fluid (intraretinal and subretinal), and disease activ- ity. A majority of patients were maintained on a 12-week treatment schedule immediately following the loading phase to Week 48, also assessed by secondary end- points in the HAWK and HARRIER trials. Year Two data reaffirmed the Year One findings. We expect to make global regulatory filings for nAMD, starting in the US, the EU and Japan. • SEG101 (crizanlizumab) is an investigational humanized anti-P-selectin monoclonal antibody that is in late- stage development for the prevention of vaso-occlu- sive pain crises (VOCs) in patients with sickle cell dis- ease (SCD). SCD is a debilitating genetic blood disorder that affects the shape of red blood cells and can cause VOCs. In December 2018, the FDA granted SEG101 breakthrough therapy designation for the prevention of vaso-occlusive crises in sickle cell disease. • QAW039 (fevipiprant) is a once-daily oral therapy that blocks the DP2 pathway, a principal regulator of the • UNR844 is a potential first-in-class topical treatment in development for presbyopia. It is believed to work through the reduction of disulfide bonds, softening the 47 Item 4. Information on the Company crystalline lens. Presbyopia is a common age-related loss of near-distance vision characterized by a pro- gressive inability to focus on objects nearby, making everyday activities (such as reading) a challenge. In a Phase I/II masked, placebo-controlled proof-of-con- cept study, 50 patients were treated daily for 90 days with topical UNR844, and 25 patients were treated with placebo. UNR844 showed a statistically significant difference to placebo in distance-corrected near vision at all time points measured (from Day Eight). At Day 90, 82% of participants treated with UNR844 had 20/40 near vision (or 0.30 LogMAR) versus 48% in the pla- cebo group. Near vision of 20/40 allows for the major- ity of near-vision tasks in most people. UNR844 was acquired by Novartis through the acquisition of Encore Vision, Inc. in January 2017. Projects added to and subtracted from the development table since 2017 Project/product Potential indication/disease area Change ACZ885 Secondary prevention of cardiovascular events Removed Afinitor/Votubia Tuberous sclerosis complex seizures Commercialized AMG 334 Prophylaxis of migraine Commercialized as Aimovig Arzerra Refractory indolent non-Hodgkin’s lymphoma Removed AVXS-101 (Zolgensma) Spinal muscular atrophy type 1 (IV formulation) Added Spinal muscular atrophy type 2/3 (IT formulation) Added AVXS-201 Rett syndrome BYM338 Hip fracture recovery Sarcopenia CFZ533 Sjögren’s syndrome Cosentyx Hidradenitis suppurativa CSJ117 Severe asthma EGF816 Non-small cell lung cancer Gilenya Kisqali Pediatric multiple sclerosis HR+/HER2- advanced breast cancer (postmenopausal women), 1st/2nd line (+ fulvestrant) HR+/HER2- advanced breast cancer (premenopausal women), 1st line (+ tamoxifen + goserelin or NSAI + goserelin) Added Removed Removed Added Added Added Removed Commercialized Commercialized Commercialized Kymriah (CTL019) Pediatric/young adult acute lymphoblastic leukemia Commercialized Relapsed/refractory diffuse large B-cell lymphoma Commercialized LHW090 Resistant hypertension LIK066 LJC242 LNP023 Weight loss Nonalcoholic steatohepatitis IgA nephropathy Membranous nephropathy 177Lu-PSMA-617 Metastatic castration-resistant prostate cancer Lucentis Diabetic retinopathy MAA868 Stroke prevention in atrial fibrillation MOR106 Atopic dermatitis MTV273 Multiple myeloma Removed Removed Added Added Added Added Added Removed Added Removed Reason Development discontinued Development discontinued Acquired with acquisition of AveXis, Inc. Acquired with acquisition of AveXis, Inc. Acquired with acquisition of AveXis, Inc. Development discontinued Development discontinued Entered Confirmatory Development Entered Confirmatory Development Entered Confirmatory Development Development discontinued Development discontinued Development discontinued Entered Confirmatory Development Entered Confirmatory Development Entered Confirmatory Development Acquired with acquisition of Endocyte Entered Confirmatory Development Development discontinued Entered Confirmatory Development Development discontinued PDR001 Malignant melanoma (w/ Tafinlar + Mekinist) Now disclosed as metastatic BRAF V600+ melanoma (w/ Tafinlar + Mekinist) Endocrine neoplasm Malignant melanoma Removed Development discontinued Now disclosed as malignant melanoma (combo) RTH258 Retinal vein occlusion Signifor LAR Cushing’s disease Tafinlar + Mekinist BRAF V600+ melanoma (adjuvant) Added Commercialized Commercialized Entered Confirmatory Development VPM087 Colorectal cancer, 1st line; renal cell carcinoma, 1st line Added Entered Confirmatory Development 48 Item 4. Information on the Company Principal markets The Innovative Medicines Division sells products in approximately 155 countries worldwide. Net sales are gener- ally concentrated in the US, Europe, Japan and China. The following table sets forth the aggregate 2018 net sales of the Innovative Medicines Division by region: Innovative Medicines Europe United States Asia, Africa, Australasia Canada and Latin America Total Of which in Established Markets * Of which in Emerging Growth Markets * 2018 net sales to third parties USD millions 12 296 11 864 8 097 2 635 34 892 26 258 8 634 % 35 34 23 8 100 75 25 * Emerging Growth Markets comprise all markets other than the Established Markets of the US, Canada, Western Europe, Japan, Australia and New Zealand. Many of our Innovative Medicines Division products are used for chronic conditions that require patients to con- sume the product over long periods of time, ranging from months to years. However, certain of our marketed prod- ucts and development projects, such as gene therapies, are administered only once. 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 to ensure the uninterrupted, timely and cost-effective supply of products that meet all product specifications and quality standards. The manufacture of our products is heavily regulated by gov- ernmental health authorities around the world, including the FDA and EMA. In addition to regulatory requirements, many of our products involve technically complex man- ufacturing processes or require a supply of highly spe- cialized raw materials. We manufacture our products at facilities worldwide. See also “—Item 4.D Property, plants and equipment.” Active pharmaceutical ingredients are manufactured in our own facilities or purchased from third-party suppli- ers. We maintain state-of-the-art processes, with qual- ity as a primary goal within our own production network. Those processes include fermentation, chemical syn- theses and precipitation processes, such as sterile pro- cessing. Many biologic medicines are manufactured using recombinant DNA-derived technology, by which a gene is introduced into a host cell, which then produces a human protein. This manufacturing process requires sophisticated technical expertise. We are constantly working to improve current, and to develop new, manu- facturing processes, and to review and adapt our man- ufacturing network to meet the needs of our Innovative Medicines Division. Raw materials for the manufacturing process are either produced in-house or purchased from a number of third-party suppliers. Where possible, we 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 or other requirements. We monitor market developments that could have an adverse effect on the supply of essential materials. Our suppliers of raw mate- rials are required to comply with Novartis quality stan- dards. Because the manufacture of our products is complex and heavily regulated by governmental health authori- ties, supply is never guaranteed. If we or our third-party suppliers fail to comply with applicable regulations, then there could be a product recall or other shutdown or dis- ruption of our production activities. We have experienced supply interruptions for our products in the past, and there can be no assurance that supply will not be inter- rupted again in the future. We have implemented a global manufacturing strategy to maximize business continuity in case of such events. However, there can be no guar- antee that we will always be able to successfully man- age such issues when they arise. Marketing and sales The Innovative Medicines Division serves customers with 25 783 field force representatives, as of December 31, 2018, including supervisors and administrative person- nel. These trained representatives present the therapeu- tic risks and benefits of our products to physicians, phar- macists, hospitals, insurance groups, managed care organizations and other healthcare professionals. We continue to see increasing influence of customer groups beyond prescribers, and Novartis is responding by adapt- ing our business practices to engage appropriately with such constituencies. The marketplace for healthcare is also evolving, with patients becoming more informed stakeholders in their healthcare decisions and looking for solutions to meet their changing needs. Novartis seeks to support the 49 Item 4. Information on the Company patient, delivering innovative solutions to drive educa- tion, access and improved patient care. Additionally, in the US, certain products can be advertised by way of internet, television, newspaper and magazine advertis- ing. Although specific distribution patterns vary by coun- try, Novartis generally sells its prescription drugs primar- ily to wholesale and retail drug distributors, hospitals, clinics, government agencies and managed healthcare providers. The growing number of so-called “specialty” drugs in our portfolio has resulted in increased engage- ment with specialty pharmacies. In the US, specialty pharmacies continue to grow as a distribution channel for specialty products, with an increasing number of health plans mandating use of specialty pharmacies to monitor specialty drug utilization and costs. Novartis pursues co-promotion/co-marketing oppor- tunities as well as licensing and distribution agreements with other companies in various markets, when econom- ically attractive. As a result of continuing changes in healthcare eco- nomics and an aging population, the US Centers for Medicare & Medicaid Services (CMS) is the largest sin- gle payer for healthcare services in the US. In addition, both commercial and government-sponsored managed care organizations continue to be among the largest groups of payers for healthcare services in the US. In other countries, national health services are often the only significant payer for healthcare services. In an effort to control prescription drug costs, almost all managed care organizations and national health services use for- mularies that list specific drugs that may be reimbursed and/or the level of reimbursement for each drug. Man- aged care organizations and national health services also increasingly utilize various cost-benefit analyses to determine whether or not newly approved drugs will be added to a formulary and/or the level of reimbursement for that drug, and to determine whether or not to con- tinue to reimburse existing drugs. We have dedicated teams that actively seek to optimize patient access, including formulary positions, for our products. Recent trends have been toward continued consoli- dation among distributors and retailers of Innovative Medicines Division products, both in the US and interna- tionally. This has increased our customers’ purchasing leverage and resulted in increased pricing pressure on our products. Moreover, we are exposed to increased concentration of credit risk as a result of the consolida- tion among our customers. Competition The global pharmaceutical market is highly competitive, and we compete against other major international cor- porations that have substantial financial and other resources, as well as against smaller companies that operate regionally or nationally. Competition within the industry is intense and extends across a wide range of activities, including pricing, product characteristics, cus- tomer service, sales and marketing, and research and development. In addition, as is the case with other pharmaceutical companies selling patented pharmaceuticals, Novartis faces ever-increasing challenges from companies sell- ing products that compete with our products, including competing patented products and generic forms of our products following the expiry of intellectual property pro- tection. Generic companies may also gain entry to the market through successfully challenging our intellectual property rights, but we vigorously use legally permissi- ble measures to defend those rights. See also “—Intel- lectual property” below. We also may face competition from over-the-counter (OTC) products that do not require a prescription from a physician. See also “—Regulation— Price controls” below. There is ongoing consolidation in the pharmaceuti- cal industry. At the same time, new entrants are looking to use their expertise to establish or expand their pres- ence in healthcare, including technology companies hop- ing to benefit as data and data management become increasingly important in our industry. Research and development The discovery and development of a new drug is a lengthy process, usually requiring approximately 10 to 15 years from the initial research to bringing a drug to market, including approximately six to eight years from Phase I clinical trials to market entry. At each of these steps, there is a substantial risk that a compound will not meet the requirements to progress further. In such an event, we may be required to abandon a compound in which we have made a substantial investment. We manage our research and development expendi- tures across our entire portfolio in accordance with our strategic priorities. We make decisions about whether or not to proceed with development projects on a proj- ect-by-project basis. These decisions are based on the project’s potential to meet a significant unmet medical need or to improve patient outcomes, the strength of the science underlying the project, and the potential of the project (subject to the risks inherent in pharmaceutical development) to generate significant positive financial results for the Company. Once a management decision has been made to proceed with the development of a particular molecule, the level of research and develop- ment investment required will be driven by many factors, including the medical indications for which it is being developed, the number of indications being pursued, whether the molecule is of a chemical or biological nature, the stage of development, and the level of evi- dence necessary to demonstrate clinical efficacy and safety. Research program Our research program is conducted by the Novartis Insti- tutes for BioMedical Research (NIBR), which was estab- lished in 2002 and is the research and early develop- ment innovation engine of Novartis. NIBR is responsible for the discovery of new medicines for diseases with unmet medical need. We focus our work in areas where we believe we can have the most impact for patients. This requires the hiring and retention of extraordinary talent, a focus on fundamental disease mechanisms that are relevant across different disease areas, continuous improvement in technologies for drug discovery and 50 Item 4. Information on the Company potential therapies, close alliances with clinical col- leagues, and the establishment of strategic external alli- ances. At NIBR sites in Basel, Switzerland; Cambridge, Mas- sachusetts; East Hanover, New Jersey; San Diego, Cal- ifornia; Emeryville, California; and Shanghai, China, approximately 6 000 full-time equivalent scientists, phy- sicians and business professionals contribute to research into disease areas such as cardiovascular and metabolic diseases, neuroscience, oncology, muscle disorders, ophthalmology, autoimmune diseases and respiratory diseases. Research at the Friedrich Miescher Institute and the Genomics Institute of the Novartis Research Foundation focuses on basic genetic and genomic research, and the Novartis Institute for Tropical Diseases (NITD), located in Emeryville, California, focuses on dis- covering new medicines to fight tropical diseases, includ- ing malaria and cryptosporidiosis. All drug candidates are taken to the clinic via proof-of-concept trials to enable an early assessment of the safety and efficacy of the drug while collecting basic information on pharmacokinetics and tolerability, and adhering to the guidance for early clinical testing set forth by health authorities. Following proof of concept, our Global Drug Development unit conducts confirma- tory trials on the drug candidates. In July 2018, we announced the decision to exit anti- bacterial and antiviral research. While the science for these programs is compelling, we have decided to pri- oritize our resources in other areas where we believe we are better positioned to develop innovative medicines that will have a positive impact for patients. The San Fran- cisco Bay Area will continue to be home to NITD and global drug discovery teams focused on “undruggable” targets in collaboration with the Novartis-Berkeley Cen- ter for Proteomics and Chemistry Technologies. The need for new types of medicines to combat antimicro- bial resistance is clear, and following the announcement, we began to explore out-licensing opportunities for com- pounds within our infectious diseases portfolio. Development program Our Global Drug Development (GDD) organization over- sees drug development activities for our Innovative Medicines Division. GDD works collaboratively with NIBR to execute our overall pipeline strategy and takes an enterprise approach to pipeline portfolio management. The GDD organization includes centralized global func- tions such as Regulatory Affairs and Global Development Operations, and Global Development units aligned with our business franchises. GDD was created to improve resource allocation, technology implementation and pro- cess standardization to further increase innovation. GDD includes approximately 11 000 full-time equivalent asso- ciates worldwide. Under our Global Drug Development unit, the focus of our development program is to determine and then establish the safety and efficacy of a potential new med- icine in humans. The traditional model of development comprises three phases, which are defined as follows: Phase I: The first clinical trials of a new compound – generally performed in a small number of healthy human volunteers – to assess the drug’s safety profile, includ- ing the safe dosage range. These trials also determine how a drug is absorbed, distributed, metabolized and excreted, and the duration of its action. Phase II: Clinical studies performed with patients who have the target disease, with the aim of continuing the Phase I safety assessment in a larger group, assessing the efficacy of the drug in the patient population, and determining the appropriate doses for further evaluation. Phase III: Large-scale clinical studies with several hun- dred to several thousand patients, which are conducted to establish the safety and efficacy of the drug in spe- cific indications for regulatory approval. Phase III trials may also be used to compare a new drug against a cur- rent standard of care to evaluate the overall benefit-risk relationship of the new medicine. In each of these phases, physicians monitor volunteer patients closely to assess the potential new drug’s safety and efficacy. Though we use this traditional model as a platform, we have tailored the development process to be simpler, more flexible and efficient. We view the development pro- cess as generally consisting of Exploratory Development where proof of concept is established, and Confirmatory Development where this concept is confirmed in large numbers of patients. Exploratory Development consists of clinical proof-of-concept (PoC) studies, which are small clinical trials (typically involving five to 15 patients) that combine elements of traditional Phase I/II testing. These customized trials are designed to give early insights into issues such as safety, efficacy and toxicity for a drug in a given indication and are conducted by NIBR. Once a positive proof of concept has been estab- lished, the drug moves to the Confirmatory Development stage and becomes the responsibility of GDD. Confir- matory Development has elements of traditional Phase II/ III testing and includes trials aimed at confirming the safety and efficacy of the drug in the given indication, leading up to submission of a dossier to health authori- ties for approval. This stage can also include trials that compare the drug to the current standard of care for the disease in order to evaluate the drug’s overall risk-ben- efit profile. Further, with new treatment approaches such as gene therapy, elements of Exploratory and Confirma- tory Development may be combined. The vast amount of data that must be collected and evaluated makes clinical testing the most time-consum- ing and expensive part of new drug development. The next stage in the drug development process is to seek registration for the new drug. For more information, see “—Regulation.” At each phase of clinical development, our activities are managed by our Innovation Management Board (IMB). The IMB is responsible for oversight over all major aspects of our development portfolio and oversees our drug development budget. In particular, the IMB is responsible for the endorsement of proposals to com- mence the first clinical trials of a development com- pound, and of major project phase transitions and mile- stones following a positive proof-of-concept outcome, including transitions to full development and the decision to submit a regulatory application to the health authori- is also responsible for project ties. The IMB 51 Item 4. Information on the Company discontinuations, the endorsement of overall develop- ment strategy, and the endorsement of development project priorities. The IMB is chaired by our Chief Exec- utive Officer and has representatives from Novartis senior management with expertise spanning multiple fields, among its core members and extended member- ship. Alliances and acquisitions Our Innovative Medicines Division enters into business development agreements with other pharmaceutical and biotechnology companies and with academic and other institutions to develop new products and access new markets. We license products that complement our cur- rent product line and are appropriate to our business strategy. Therapeutic area strategies have been estab- lished to focus on alliances and acquisition activities for key disease areas and indications that are expected to be growth drivers in the future. We review products and compounds we are considering licensing, using the same criteria that we use for our own internally discovered drugs. On December 21, 2018, we completed our acquisi- tion of Endocyte, a US-based biopharmaceutical com- pany focused on developing targeted therapeutics for cancer treatment. This acquisition expanded our radioli- gand therapy platform and added 177Lu-PSMA-617 – a potential first-in-class radioligand therapy in Phase III development for metastatic, PSMA-positive castra- tion-resistant prostate cancer – as well as other investi- gational treatments. In December 2018, we announced an offer to acquire CellforCure, a French company that is one of the largest contract development and manufacturing organizations producing cell and gene therapies in Europe. This pro- posed acquisition builds on an existing agreement with CellforCure to produce CAR-T therapies, including Kymriah (tisagenlecleucel). If completed, the acquisition would bolster our CAR-T therapy manufacturing capac- ity with the potential to expand to other cell and gene therapies in the Novartis pipeline. This transaction is sub- ject to customary closing conditions, including regula- tory approval. For additional information, see “Item 18. Financial Statements—Note 2. Significant transactions— Significant pending transactions.” In October 2018, we licensed three of our infectious disease programs, with the potential to address the need for new approaches to treat antibiotic-resistant Gram-negative infections, to Boston Pharmaceuticals. This agreement is part of our strategy to collaborate with external innovators to further develop new medicines that fall outside of our strategic direction but have the potential to have a positive impact on the lives of patients. In August 2018, we closed an agreement with phar- maceutical company Mylan. Under the agreement, Mylan purchased the worldwide rights to commercialize our cystic fibrosis products TOBI solution and TOBI Podhaler. In July 2018, we announced an exclusive license agreement with biotech companies Galapagos NV and MorphoSys AG regarding their compound MOR106. Under the agreement, Novartis acquires the exclusive global development and marketing rights to MOR106 for atopic dermatitis and all other potential indications. This transaction became effective on September 10, 2018. In May 2018, we successfully completed the acqui- sition of AveXis, Inc., a US-based clinical stage gene ther- apy company. AveXis has several ongoing clinical stud- ies for the treatment of spinal muscular atrophy (SMA), an inherited neurodegenerative disease. The lead AveXis gene therapy candidate, AVXS-101, has the potential to be the first-ever one-time gene replacement therapy for SMA. For additional information, see “Item 18. Financial Statements—Note 2. Significant transactions—Signifi- cant transactions in 2018.” In March 2018, we announced a collaboration and licensing agreement with the Wyss Institute for Biologi- cally Inspired Engineering at Harvard University and the Dana-Farber Cancer Institute to develop biomaterial sys- tems for our portfolio of immuno-oncology therapies. The implantable and injectable systems aim to overcome barriers to success that have faced traditional cancer vaccines. The work will combine Harvard’s expertise in tumor biology and materials science with our diverse immuno-oncology pipeline. In March 2018, we announced a collaboration with Pear Therapeutics to develop novel prescription digital therapeutics for patients with schizophrenia and multi- ple sclerosis. Under the agreement, we are working with Pear Therapeutics to advance clinical development of the Pear-004 prescription digital therapeutic for patients with schizophrenia. We will also work together on the design and development of a new prescription digital therapeutic to address underserved mental health bur- den in multiple sclerosis patients. In January 2018, we announced a licensing agree- ment and a manufacturing and supply agreement with Spark Therapeutics covering development, registration and commercialization rights to Luxturna (voretigene neparvovec) in markets outside the US. Luxturna received FDA approval in December 2017 as a one-time gene ther- apy to restore functional vision in children and adult patients with biallelic mutations of the RPE65 gene, which typically lead to blindness. Luxturna was approved in the EU in November 2018. On January 19, 2018, we successfully completed a tender offer for all of the then-outstanding ordinary shares, including ordinary shares represented by Amer- ican Depositary Shares (ADSs), of Advanced Accelera- tor Applications S.A. (AAA). In addition, we commenced a subsequent offering period that expired on January 31, 2018. As of December 31, 2018, Novartis held 99.1% of the then outstanding fully-diluted ordinary shares, includ- ing ordinary shares represented by ADSs, which were validly tendered during the initial offering period, the sub- sequent offering period, and afterward. AAA is a radio- pharmaceutical company headquartered in Saint-Ge- nis-Pouilly, France, that develops, produces and commercializes nuclear medicines – including Lutathera (USAN: lutetium Lu 177 dotatate/INN: lutetium (177Lu) oxo- dotreotide), a first-in-class radioligand therapy for gas- troenteropancreatic neuroendocrine tumors – and diag- nostic products. For additional information, see “Item 18. Financial Statements—Note 2. Significant transactions— Significant transactions in 2018.” In November 2017, we announced an expanded col- laboration with Amgen Inc. and Banner Alzheimer’s Insti- tute to collaborate on a new Generation Study 2 to assess whether investigational BACE1 inhibitor CNP520 52 Item 4. Information on the Company can prevent or delay the symptoms of Alzheimer’s dis- ease in a high-risk population. development for atopic dermatitis. This acquisition was completed on January 20, 2017. In September 2017, we announced a collaboration agreement with the University of California, Berkeley, in the field of covalent chemoproteomics to establish the Novartis-Berkeley Center for Proteomics and Chemistry Technologies, based at Berkeley. The collaboration focuses on discovery of drug targets on proteins inac- cessible to conventional therapeutic molecules. In June 2017, we announced a clinical research col- laboration in which Bristol-Myers Squibb is to investigate the safety, tolerability and efficacy of Mekinist (trame- tinib) in combination with Opdivo® (nivolumab) and Opdivo® + Yervoy® (ipilimumab) regimen as a potential treatment option for metastatic colorectal cancer in patients with microsatellite stable tumors where the tumors are proficient in mismatch repair (MSS mCRC pMMR). In April 2017, we announced an expanded collabora- tion agreement with Amgen to co-commercialize Aimovig (erenumab) in the US. Aimovig, formerly known as AMG 334, was approved for the prevention of migraine. Under the agreement, Novartis retained exclusive rights to com- mercialize Aimovig in the rest of the world and gained commercialization rights in Canada. This agreement builds on the previously announced 2015 global collab- oration between Novartis and Amgen. In January 2017, we entered into a collaboration and option agreement with Ionis Pharmaceuticals, Inc. (Ionis) and its affiliate Akcea Therapeutics, Inc. (Akcea) to license two investigational treatments with the potential to significantly reduce cardiovascular risk in patients suf- fering from high levels of lipoproteins known as Lp(a) and ApoCIII. The two investigational antisense therapies developed by Ionis – called AKCEA-APO(a)-LRx and AKCEA-APOCIII-LRx – have the potential to lower both lipoproteins up to 90% and significantly reduce cardio- vascular risk in high-risk patient populations. In addition, Novartis entered into a stock purchase agreement with Ionis and Akcea. This transaction was completed on Feb- ruary 14, 2017. In December 2016, we entered into a definitive agree- ment for the acquisition of Encore Vision, Inc., a privately held company focused on the development of UNR844 (formerly EV06), an investigational, first-in-class, poten- tially disease-modifying topical treatment for presby- opia. This acquisition was completed on January 20, 2017. In December 2016, we signed an exclusive option, collaboration and license agreement with Conatus Pharmaceuticals Inc. for the global rights to VAY785 (emricasan), an investigational, first-in-class, oral, pan-caspase inhibitor for the treatment of nonalcoholic steatohepatitis with advanced fibrosis and cirrhosis of the liver. Novartis exercised the option on May 3, 2017. Novartis obtained an exclusive, worldwide license to develop and commercialize products containing emri- casan on July 5, 2017. In December 2016, we entered into a definitive agree- ment for the acquisition of Ziarco Group Limited, a pri- vately held company focused on the development of novel treatments in dermatology, including ZPL389 (adri- forant), a once-daily oral H4 receptor antagonist in In November 2016, we acquired Reprixys Pharmaceuticals Corporation and SEG101 (crizanli- zumab), an anti-P-selectin antibody being investigated in the reduction of vaso-occlusive pain crises in patients with sickle cell disease. In June 2016, we announced a collaboration and licensing agreement with Xencor for the development of bispecific antibodies for treating cancer. We are collab- orating with Xencor to co-develop its bispecific T-cell-en- gaging antibody targeting CD3xCD123 for the treatment of acute myeloid leukemia. As part of the agreement, Novartis also received the right to develop four additional bispecific antibodies and to use other Xencor proprietary antibody engineering technology for up to 10 additional biotherapeutic programs across the Novartis research and development portfolio. The original terms also included co-development of Xencor’s bispecific T-cell-engaging antibody targeting CD3xCD20 for the treatment of B-cell malignancies, which we have since agreed to revert to Xencor. In January 2016, we announced a collaboration and licensing agreement with Surface Oncology. Novartis obtained an exclusive worldwide license to develop and commercialize an anti-CD73 antibody. As part of the col- laboration, Novartis has options to license additional next-generation cancer immunotherapies. As part of our previously announced exclusive global research and development collaboration with the Uni- versity of Pennsylvania (Penn) to develop and commer- cialize targeted chimeric antigen receptor (CAR) immu- notherapies for the treatment of cancer, in February 2016 Penn opened the Center for Advanced Cellular Thera- peutics (CACT) at the Perelman School of Medicine cam- pus in Philadelphia, Pennsylvania. The CACT is a first- of-its-kind research and development center established specifically to develop and manufacture adoptive T-cell immunotherapies under the research collaboration guided by scientists and clinicians from NIBR and Penn. On March 2, 2015, we acquired a right of first nego- tiation over the co-development or commercialization of GSK’s current and future oncology R&D pipeline, exclud- ing oncology vaccines, which expires on September 2, 2027. We acquired this right with the completion of our acquisition of the oncology products of GSK and certain related assets. Regulation The international pharmaceutical industry is highly reg- ulated. Regulatory authorities around the world admin- ister numerous laws and regulations regarding the test- ing, approval, manufacturing, importing, labeling and marketing of drugs, and also review the safety and effi- cacy of pharmaceutical products. Extensive controls exist on the non-clinical and clinical development of pharmaceutical products. These regulatory require- ments, and the implementation of them by local health authorities around the globe, are a major factor in deter- mining whether a substance can be developed into a marketable product, and the amount of time and expense associated with that development. 53 Item 4. Information on the Company Health authorities, including those in the US, the EU and Japan, have high standards of technical evaluation. The introduction of new pharmaceutical products gen- erally entails a lengthy approval process. Products must be authorized or registered prior to marketing, and such authorization or registration must subsequently be main- tained. In recent years, the registration process has required increased testing and documentation for the approval 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 safety, effi- cacy and quality 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 and the specific requirements, including risk tolerance, of the local health authorities can vary significantly from country to country. It is pos- sible that a drug can be registered and marketed in one country while the registration authority in another coun- try may, prior to registration, request additional informa- tion from the 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 regis- tration authority’s procedures, and the nature of the product. Many countries provide for accelerated pro- cessing of registration applications for innovative prod- ucts of particular therapeutic interest. In recent years, 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 and other payers can substantially extend the time until a product may finally be available to patients. The following provides a summary of the regulatory processes in the principal markets served by Innovative Medicines Division affiliates: United States In the US, applications for drug registration are submit- ted to and reviewed by the FDA. The FDA regulates the testing, manufacturing, labeling and approval for market- ing of pharmaceutical products intended for commer- cialization in the US. The FDA continues to monitor the safety of pharmaceutical products after they have been approved for sale in the US market. The pharmaceutical development and registration process is typically inten- sive, lengthy and rigorous. When a pharmaceutical com- pany has gathered data that it believes sufficiently demonstrates a drug’s safety, efficacy and quality, then the company may file a New Drug Application (NDA) or Biologics License Application (BLA), as applicable, for the drug. The NDA or BLA must contain all the scientific information that has been gathered about the drug and typically includes information regarding the clinical expe- riences of patients tested in the drug’s clinical trials. A Supplemental New Drug Application (sNDA) or BLA amendment must be filed for new indications for a pre- viously approved drug. Once an application is submitted, the FDA assigns reviewers from its staff, including experts in biopharma- ceutics, chemistry, clinical microbiology, pharmacology/ toxicology, and statistics. After a complete review, these content experts provide written evaluations of the NDA or BLA. These recommendations are consolidated and are used by senior FDA staff in its final evaluation of the NDA or BLA. Based on that final evaluation, the FDA then provides to the NDA or BLA’s sponsor an approval, or a “complete response” letter if the NDA or BLA applica- tion is not approved. If not approved, the letter will state the specific deficiencies in the NDA or BLA that need to be addressed. The sponsor must then submit an ade- quate response to the deficiencies in order to restart the review procedure. Once the FDA has approved an NDA, BLA, sNDA or BLA amendment, 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 specified conditions. Throughout the life cycle of a product, the FDA requires compliance with standards relating to good lab- oratory, clinical and manufacturing practices. The FDA also requires compliance with rules pertaining to the manner in which we may promote our products. European Union In the EU, there are three main procedures for applica- tion for authorization to market pharmaceutical products in more than one EU member state at the same time: the centralized procedure, the mutual recognition procedure and the decentralized procedure. It is also possible to obtain a national authorization for products intended for commercialization in a single EU member state only, or for additional indications for licensed products. The pro- cedure used for first authorization must continue to be followed for subsequent changes, e.g., to add an indica- tion for a licensed product. Under the centralized procedure, applications are made to the EMA for an authorization that is valid for the European Union (all member states). The centralized pro- cedure is mandatory for all biotechnology products; new chemical entities in cancer, neurodegenerative disor- ders, diabetes, AIDS, autoimmune diseases and other immune dysfunctions; advanced therapy medicines, such as gene therapy, somatic cell therapy and tis- sue-engineered medicines; and orphan medicines (medicines for rare diseases). It is optional for other new chemical entities, innovative medicinal products, and medicines for which authorization would be in the inter- est of public health. When a pharmaceutical company has gathered data that it believes sufficiently demon- strates a drug’s safety, efficacy and quality, the company may submit an application to the EMA. The EMA then receives and validates the application, and the special- ized committee for human medicines, the CHMP, appoints 54 Item 4. Information on the Company 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 and co-rapporteur’s assessment report. When the compa- ny’s complete response is received by the EMA, the clock restarts on Day 121. If there are further aspects of the dossier requiring clarification, the CHMP will issue fur- ther questions at Day 180, and may also request an oral explanation, in which case the sponsor must not only response to the further questions but also appear before the committee to justify its responses. On Day 210, the CHMP will take a vote to recommend the approval or non-approval of the application, and their opinion is transferred to the European Commission (EC). The final EC decision under this centralized procedure is a deci- sion that is applicable to all member states. This deci- sion occurs 60 days, on average, after a positive CHMP recommendation. Under both the mutual recognition procedure (MRP) and the decentralized procedure (DCP), the assessment is led by one member state, called the reference mem- ber state (RMS) which then liaises with other member states, known as the concerned member states (CMSs). In the MRP, the company first obtains a marketing autho- rization in the RMS, which is then recognized by the CMSs in 90 days. In the DCP, the application is done simultaneously in the RMS and all CMSs. During the DCP, the RMS drafts an assessment report within 120 days. Within an additional 90 days, the CMSs review the appli- cation and can issue objections or requests for additional information. On Day 90, each CMS must be assured that the product is safe and effective, and that it will cause no risks to the public health. Once an agreement has been reached, each member state grants national mar- keting authorizations for the product. After the marketing authorizations have been granted, the company must submit periodic safety reports to the relevant health authority (EMA for the centralized pro- cedure, national health authorities for DCP or MRP). In addition, pharmacovigilance measures must be imple- mented and monitored, including the collection, evalua- tion and expedited reporting of adverse events, and updates to risk management plans. For some medica- tions, post-approval studies (Phase IV) may be imposed to complement available data with additional data to eval- uate long-term effects (called a Post-Approval Safety Study, or PASS) or to gather additional efficacy data (called a Post-Approval Efficacy Study, or PAES). European marketing authorizations have an initial duration of five years. The holder of the marketing autho- rization must actively apply for its renewal after this first five-year period. As part of the renewal procedure, the competent authority will perform a full benefit-risk review of the product. Should the authority conclude that the benefit-risk balance is no longer positive, the marketing authorization can be suspended or revoked. Once renewed, the marketing authorization is valid for an unlim- ited period. If the holder does not apply for renewal, the marketing authorization automatically lapses. Any mar- keting authorization that is not followed within three years of its granting by the actual placing on the market of the corresponding medicinal product ceases to be valid. Japan In Japan, applications for new products are made through the Pharmaceutical and Medical Devices Agency (PMDA). Once an NDA is submitted, a review team is formed, which consists of specialized officials of the PMDA, including chemistry/manufacturing, non-clinical, clinical and biostatistics. While a team evaluation is car- ried out, a data reliability survey and Good Clinical Prac- tice/Good Laboratory Practice/Good Manufacturing Practice inspection are carried out by the Office of Con- formity Audit and Office of GMP/GQP Inspection of the PMDA. Team evaluation results are passed to the 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); the MHLW makes a final determination for approval and refers this to the Council on Drugs and Foods Sanitation, which then advises the MHLW on final approvability. Mar- keting and distribution approvals require a review to determine whether or not the product in the application is suitable as a drug to be manufactured and distributed by a person who has obtained a manufacturing and dis- tribution business license for the type of drug concerned, and to confirm that the product has been manufactured in a plant compliant with Good Manufacturing Practices. Once the MHLW has approved the application, the company can make the new drug available for physicians to prescribe. After that, the MHLW lists its National Health Insurance price within 60 days (or 90 days) from the approval, and physicians can obtain reimbursement. For some medications, the MHLW requires additional post-approval studies (Phase IV) to further evaluate safety and/or to gather information on the use of the product under specified conditions. The MHLW also requires the drug’s sponsor to submit periodic safety update reports. Within three months from the specified re-examination period, which is designated at the time of the approval of the application for the new product, the company must submit a re-examination application to enable the drug’s safety and efficacy to be reassessed against approved labeling by the PMDA. 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 pro- grams with varying price control mechanisms. Due to increasing political pressure and governmental budget constraints, we expect these mechanisms to continue to remain robust – and to potentially even be strength- ened – and to have a negative influence on the prices we are able to charge for our products. Direct governmental efforts to control prices United States: • In the US, President Trump declared the reduction of drug prices as one of his key priorities to be addressed by his administration. In May 2018, the Trump adminis- tration unveiled its blueprint of potential actions that could be used to lower drug prices and reduce drug out-of-pocket costs for patients. In the second half of 2018, the Trump administration released a series of 55 Item 4. Information on the Company prescription drug-related proposals that may ultimately lead to new price restrictions and cost reduction solu- tions for pharmaceuticals. A key area of focus is Medi- care Part B, which includes prescription drugs dis- pensed by physicians in their offices or in outpatient clinics. The administration is also considering use of an international pricing comparison model for Medi- care Part B drugs that would reduce costs of select medications by aligning US drug reimbursements to prices in other countries. • In November 2018, the Democratic Party regained majority leadership of the US House of Representa- tives. Democratic Party leaders have outlined prescrip- tion drug costs as one of their priorities in the congres- sional session that began in January 2019. • The Independent Payment Advisory Board (IPAB), an entity created under the Patient Protection and Afford- able Care Act with authority to implement broad actions to reduce future costs of the Medicare program, was repealed in February 2018. • Additionally, seven states have passed legislation intended to impact pricing or requiring price transpar- ency reporting (California, Connecticut, Louisiana, Maine, Nevada, Oregon and Vermont). The California law requires 60-day advance notification of price increases for products exceeding a specific threshold over the past two years, as well as additional quarterly reporting requirements. Various formats of drug price reporting and disclosure are required in all seven states. It is expected in 2019 that state legislatures will continue to focus on drug pricing and that similar bills will be passed in more states. Europe: In Europe, our operations are subject to signif- icant price and marketing regulations. Many govern- ments are introducing healthcare reforms in a further attempt to curb increasing healthcare costs. In the EU, governments influence the price of pharmaceutical prod- ucts through their control of national healthcare systems that fund a large part of the cost of such products to patients. The downward pressure on healthcare costs in general in the EU, particularly with regard to prescription drugs, has become very intense. Increasingly strict anal- yses are applied when evaluating the entry of new prod- ucts, and as a result, access to innovative medicines is limited based on strict cost-benefit assessments. In addi- tion, prices for marketed products are referenced within member states and across member state borders, fur- ther impacting individual EU member state pricing. As an additional control for healthcare budgets, some EU coun- tries have passed legislation to impose further manda- tory rebates for pharmaceutical products and/or finan- cial claw-backs on the pharmaceutical industry. The calculation of these rebates and claw-backs may lack transparency in some cases and can be difficult to pre- dict. Japan: In 2018, the National Health Insurance price cal- culation method for new products and the price revision rule for existing products were reviewed by the Japanese government, and new drug tariffs became effective beginning April 2018. Also in 2018, the MHLW implemented a price maintenance scheme with a nar- rower scope and decreased number of products. The MHLW also increased the frequency of price cuts from every other year to annually beginning in 2021, and plans to introduce a cost-effectiveness assessment in 2019. The Japanese government is continuing deliberations regarding a healthcare reform initiative with a goal of sus- taining universal coverage under the National Health Insurance program, and is addressing the efficient use of drugs, including promotion of use of generic drugs. Rest of world: Many other countries around the world are also taking steps to control prescription drug prices. For example, China – one of our most important Emerg- ing Growth Markets – organized national price negotia- tions in 2017 for 36 patented drugs and in 2018 for 17 oncology drugs directly linked to national drug reim- bursement, which applied nationwide both in public and military hospitals, as well as a national procurement pilot on certain generic drugs at the end of 2018. These efforts resulted in drug price reductions of more than 50% on average for the drugs subject to these programs. Drug prices in China may further decline due to the national health reform, but meanwhile, reimbursement access is expected to accelerate, which aims to resolve the pub- lic issue of accessibility and the high cost of healthcare services. In addition, in 2016, the Colombian government took steps to unilaterally reduce the price of Glivec by up to 43% through a local procedural mechanism called a Declaration of Public Interest. While the government’s use of this exceptional mechanism as a tool to control the price of a prescription drug and to generally manage its healthcare budget is unprecedented, we continue to contest its appropriateness, as its use could become more widespread if upheld in this case, potentially lead- ing to a more systemic impact on drug pricing. In 2018, Canada proposed amendments to its patented medicines regulations to introduce three new economics-based price regulatory factors and the concept of affordability in price assessments; to update the schedule of com- parator countries to include 12 countries with similar con- sumer protection priorities, economic wealth and mar- keted medicines as Canada and to exclude Switzerland and the US; and to require reporting of all confidential discounts and rebates. Regulations favoring generics and biosimilars In response to rising healthcare costs, most govern- ments and private medical care providers 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 all states and permit or require the dispensing pharmacist to substitute a less expensive generic drug instead of an original patented drug. Other countries, including numerous European countries, have similar laws. We expect that the pressure for generic substitution will continue to increase. In addition, the US, EU and other jurisdictions are increasingly crafting laws and regulations encouraging the development of biosim- ilar versions of biologic drugs, which can also be expected to have an impact on pricing. 56 Item 4. Information on the Company 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 that we have sold to customers in coun- tries with stringent price controls can be legally resold to customers in other EU countries at a lower price than the price at which the product is otherwise available in the importing country (known as parallel trade). In North America, products that we have sold to customers in Canada – which has relatively stringent price controls – are sometimes resold 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 countries into the US are currently illegal. Given the increased focus on pharmaceutical prices in the US, the Trump administration, certain members of the US Congress, and select state legislators continue to explore legisla- tion to allow the safe importation of pharmaceutical prod- ucts into the US from select countries, including Canada. We expect that pressures on pricing will continue worldwide and will likely 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, would enable us to earn an adequate return on our investment in that product. Intellectual property We attach great importance to intellectual property – including patents, trademarks, copyrights, know-how and research data – in order to protect our investment in research and development, manufacturing and mar- keting. In general, we seek intellectual property protec- tion under applicable laws for significant product devel- opments in major markets. Among other things, patents may cover the products themselves, including the prod- uct’s active ingredient or ingredients and its formulation. Patents may cover processes for manufacturing a prod- uct, including processes for manufacturing intermediate substances used in the manufacture of the product. Pat- ents may also cover particular uses of a product, such as its use to treat a particular disease, or its dosage reg- imen. In addition, patents may cover assays or tests for certain diseases or biomarkers – which can improve patient outcomes when administered with certain drugs – as well as assays, research tools and other techniques used to identify new drugs. The protection offered by such patents extends for varying periods, depending on the grant and duration of patents in the various jurisdic- tions. The protection afforded, which may vary from country to country, depends upon the type of patent and its scope of coverage. In addition to patent protection, various countries offer data or marketing exclusivities for a prescribed period of time. Data exclusivity may be available that would preclude a potential competitor from filing a reg- ulatory application for a set period of time that relies on the sponsor’s clinical trial data, or the regulatory author- ity from approving the application. The data exclusivity period can vary depending upon the type of data included in the sponsor’s application. When it is available, market exclusivity, unlike data exclusivity, precludes a compet- itor from obtaining marketing approval for a product even if a competitor’s application relies on its own data. Data exclusivity and other regulatory exclusivity periods gen- erally run from the date a product is approved, and so their expiration dates cannot be known with certainty until the product approval date is known. In the US and other countries, pharmaceutical prod- ucts are eligible for a patent term extension for patent periods lost during product development and regulatory review. The law recognizes that product development and review by the FDA and other health authorities can take an extended period, and permits an extension of the patent term for a period related to the time taken for the conduct of clinical trials and for the health authori- ty’s review. However, the length of this extension and the patents to which it applies cannot be known in advance and can only be determined after the product is approved. United States Patents In the US, a patent issued for an application filed today will receive a term of 20 years from the earliest applica- tion filing date, subject to potential patent term adjust- ments for delays in patent issuance based upon certain delays in prosecution by the United States Patent and Trademark Office (USPTO). A US pharmaceutical patent that claims a product, method of treatment using a prod- uct, or method of manufacturing a product may also be eligible for a patent term extension based on the time the FDA took to approve the product. This type of exten- sion may only extend the patent term for a maximum of five years, and may not extend the patent term beyond 14 years from regulatory approval. Only one patent may be extended for any product based on FDA delay. In practice, however, it is not uncommon for signifi- cantly more than the five-year maximum patent exten- sion period to pass between the time that a patent appli- cation is filed for a product and the time that the product is approved by the FDA. As a result, it is rarely the case that, at the time a product is approved by the FDA, it will have the full 20 years of remaining patent life. Rather, in our experience, it is not uncommon that, at the date of approval, a product will have from 13 to 16 years of pat- ent protection remaining, including all extensions avail- able at that time. Data and market exclusivity In addition to patent exclusivities, the FDA may provide data or market exclusivity for a new chemical entity or an “orphan drug,” each of which runs in parallel to any patent protection. Regulatory data protection or exclu- sivity prevents a potential generic competitor from rely- ing on clinical trial data generated by the sponsor when establishing the safety and efficacy of its competing product. Market exclusivity prohibits any marketing of the same drug for the same indication. • A new small-molecule active pharmaceutical ingredi- ent shall have five years of regulatory data exclusivity, during which time a competitor generally may not sub- mit an application to the FDA based on a sponsor’s clinical data. 57 Item 4. Information on the Company • Orphan drug exclusivity provides seven years of mar- ket exclusivity for drugs designated by the FDA as “orphan drugs,” meaning drugs that treat rare diseases, as designated by the FDA. During this period, a poten- tial competitor may not market the same drug for the same indication even if the competitor’s application does not rely on data from the sponsor. • A new biologic active pharmaceutical ingredient shall have 12 years of market exclusivity, during which time a competitor may not market the same drug for the same indication. • The FDA may also request that a sponsor conduct pediatric studies, and in exchange, it will grant an addi- tional six-month period of pediatric market exclusivity if the FDA accepts the data, the sponsor makes a timely application for approval for pediatric treatment, and the sponsor has either a patent-based or regulato- ry-based exclusivity period for the product that can be extended. European community Patents Patent applications in Europe may be filed in the Euro- pean Patent Office (EPO) or in a particular country in Europe. The EPO system permits a single application to be granted for the EU plus other non-EU countries such as Switzerland and Turkey. When the EPO grants a pat- ent, it is then validated in the countries that the patent owner designates. The term of a patent granted by the EPO or a European country office is generally 20 years from the filing date of the patent application on which the patent is based, subject to potential patent term extensions. Pharmaceutical patents can be granted a further period of exclusivity under the Supplementary Protection Certificate (SPC) system. SPCs are designed to compensate the owner of the patent for the time it took to receive marketing authorization of a product by the European health authorities. An SPC may be granted to provide, in combination with the patent, up to 15 years of exclusivity from the date of the first European market- ing authorization. However, an SPC cannot last longer than five years. The SPC duration can additionally be extended by a further Pediatric Extension of six months if the product is the subject of an agreed pediatric inves- tigation plan. The post-grant phase of patents, including the SPC system, is currently administered on a coun- try-by-country basis under national laws that, while dif- fering, are intended to (but do not always) have the same effect. In practice, as in the US, it is not uncommon for pat- ent term extensions to not fully compensate the owner of a patent for the time it took to develop the product and receive marketing authorization by the European health authorities. Accordingly, it is not uncommon that a pharmaceutical product, at the date of approval, will have patent protection for 10 to 15 years, including exten- sions available at that time. Data and market exclusivity In addition to patent exclusivity, the EU provides a sys- tem of regulatory data exclusivity for authorized human medicines, which runs in parallel to any patent protec- tion. The system for drugs being approved today is usu- ally referred to as “8+2+1” because it provides: an initial period of eight years of data exclusivity, during which a competitor cannot rely on the relevant data; a further period of two years of market exclusivity, during which the data can be used to support applications for market- ing authorization but the competitive product cannot be launched; and a possible one-year extension of the mar- ket exclusivity period if, during the initial eight-year data exclusivity period, the sponsor registered a new thera- peutic indication with “significant clinical benefit.” This system applies both to national and centralized authori- zations. It has been in force since 2005; therefore, some medicines remain covered by the previous system in which EU member states provided either six or 10 years of data exclusivity. The EU also has an orphan drug exclusivity system for medicines similar to the US system. If a medicine is designated as an “orphan drug,” then it benefits from 10 years of market exclusivity after it is authorized, during which time a similar medicine for the same indication will not receive marketing authorization. Under certain cir- cumstances, this exclusivity can be extended with a two-year Pediatric Extension. Japan Patents In Japan, a patent can be issued for active pharmaceu- tical ingredients. Although methods of treatment – such as dosage and administration – are not patentable in Japan, pharmaceutical compositions for a specific dos- age or administration method are patentable. Processes to make a pharmaceutical composition are also patent- able. The patent term granted is generally 20 years from the filing date of the patent application on which the pat- ent is based, subject to potential patent term extensions and adjustments. A patent term extension can be granted for up to five years under the Japanese Patent Act to compensate for erosion against the patent term caused by the time needed to obtain marketing authorization from the MHLW. As in the US and EU, patent term exten- sions in Japan may not fully compensate for the time necessary to develop a product and obtain a marketing authorization. As a result, it is not uncommon for the effective term of patent protection for an active pharma- ceutical ingredient in Japan to be approximately 10 to 15 years, including available extensions. Data and market exclusivity Japan also has a regulatory data protection system called a “re-examination period” of eight years for new chemical entities and of four to six years for new indica- tions and formulations, and a 10-year orphan drug exclu- sivity system. Third-party patents and challenges to intellectual property Third parties can challenge our patents, patent term extensions and marketing exclusivities, including pedi- atric extensions and orphan drug exclusivity, through var- ious proceedings. For example, patents in the US can be challenged in the USPTO through various proceedings, including Inter Partes Review (IPR) proceedings. They 58 Item 4. Information on the Company may also be challenged through patent infringement lit- igation under the Abbreviated New Drug Application (ANDA) provisions of the Hatch-Waxman Act, or the Bio- logics Price Competition and Innovation Act (BPCIA). See generally “—Sandoz—Intellectual property.” In the EU, EU patents may be challenged through oppositions in the EPO, or national patents may be challenged in national courts or national patent offices. In Japan, pat- ents may be challenged in the Japanese patent office and in national courts. The outcomes of such challenges can be difficult to predict. In addition to directly challenging our intellectual property rights, in some circumstances a competitor may be able to market a generic version of one of our prod- ucts by, for example, designing around our intellectual property or marketing the generic product for non-pro- tected indications. Despite data exclusivity protections, a competitor could opt to incur the costs of conducting its own clinical trials and preparing its own regulatory application, and avoid our data exclusivity protection altogether. There is a risk that some countries may seek to impose limitations on the availability of intellectual property right protections for pharmaceutical products, or on the extent to which such protections may be enforced. For example, a review of several intellectual property rights is currently ongoing in the EU (orphan drug exclusivity, pediatric extensions, SPCs and regula- tory data protection), which could lead to legislative changes in the scope and/or term of protection under those rights. Also, even though we may own, co-own or in-license patents protecting our products, and conduct pre-launch freedom-to-operate analyses, a third party may nevertheless claim that one of our products infringes a third-party patent for which we do not have a license. As a result, there can be no assurance that our intel- lectual property will protect our products or that we will be able to avoid adverse effects from the loss of intel- lectual property protection or from third-party patents in the future. Intellectual property protection for certain key marketed products and compounds in development We present below certain additional details regarding intellectual property protection for certain Innovative Medicines Division products and compounds in devel- opment. For each product and compound in develop- ment below, we identify issued, unexpired patents by general subject matter and, in parentheses, years of expiry in, if relevant, the US, EU and Japan that are owned, co-owned or exclusively in-licensed by Novartis and that relate to the product or to the method of its use as it is currently approved and marketed or, in the case of a compound in development, as it is currently filed with the FDA and/or the EMA for approval. Identification of an EU patent refers to national patents in EU countries and/or to the national patents that have been derived from a patent granted by the EPO. Novartis may own or control additional patents relating to, for example, com- pound forms, methods of use, formulations, processes, synthesis, purification and detection. We identify unexpired regulatory data protection peri- ods and, in parentheses, years of expiry if the relevant marketing authorizations have been authorized or granted. The term “RDP” refers to regulatory data pro- tection, regulatory data exclusivity (which in the EU refers to the protections under “8+2+1” regulatory data exclu- sivity), and data re-examination protection systems. We identify certain unexpired patent term extensions and marketing exclusivities and, in parentheses, years of expiry if they are granted; their subject matter scope may be limited and is not specified. Marketing exclusivities and patent term extensions include orphan drug exclu- sivity (ODE), pediatric exclusivity (PE), patent term exten- sions (PTE) and SPCs. We designate them as “pending” if they have been applied for but not granted and years of expiry are estimable. Such pending applications may or may not ultimately be granted. In the case of the EU, identification of a patent, pat- ent term extension, marketing exclusivity or data protec- tion means grant, authorization and maintenance in at least one country and possibly pending or found invalid in others. For each product below, we indicate whether there is current generic competition – which in the case of products containing biologics, refers to biosimilar com- petition – for one or more product versions in one or more approved indications in each of the major markets for which intellectual property is disclosed. We identify ongoing challenges to the disclosed intellectual prop- erty that have not been finally resolved, including IPRs if instituted by the USPTO. Challenges identified as being in administrative entities, such as national patent offices, include judicial appeals from decisions of those entities. Resolution of challenges to the disclosed intellectual property, which in the EU may involve intellectual prop- erty of one or more EU countries, may include settlement agreements under which Novartis permits or does not permit future launch of generic versions of our products before expiration of that intellectual property. We iden- tify certain material terms of such settlement agree- ments where they could have a material adverse effect on our business. In other cases, such settlement agree- ments may contain confidentiality obligations restricting what may be disclosed. For additional information regarding commercial arrangements with respect to these products, see “— Key marketed products.” Novartis Oncology business unit Oncology • Tasigna. US: Patent on compound (2023), PE (2024); patents on salt forms (2026, 2027, 2028), three PEs (2027, 2028, 2029); patent on polymorph compound form (2026), PE (2027); patents on capsule form (2026, 2027), two PEs (2027, 2028) and patent on method of treatment (2032), PE (2032). EU: Patent on compound (2023); patent on salt form (2026); patent on poly- morph compound form (2026); patent on capsule form (2027); patent on method of treatment (2030); ODE (2017), PE (2019). Japan: Patent on compound (2023), PTE (2024); patent on salt form (2026); patent on poly- morph compound form (2026); patent on capsule form (2027); patent on method of treatment (2030). There is currently no generic competition in the US, EU or Japan. In the US, the salt form patents, the poly- morph patent, the capsule form patent and the method 59 Item 4. Information on the Company of treatment patent are being challenged in ANDA pro- ceedings against generic manufacturers. The EU method of treatment patent, the capsule form patent, and the polymorph compound patent are being opposed in the EPO. • Sandostatin SC and Sandostatin LAR. Sandostatin SC. There is no patent protection in the US, EU or Japan. There is generic competition in the US, EU and Japan. Sandostatin LAR. There is no patent protection in the US, EU or Japan. There is currently no generic compe- tition in the US, EU or Japan. • Gleevec/Glivec. US: Patent on polymorphic compound form (2019), PE (2019); patent on GIST method of use (2021), PE (2022). EU: Patent on GIST method of use (2021); patent on tablet formulation (2023). Japan: Pat- ent on polymorphic compound form (2019); patent on GIST method of use (2021); patent on tablet formula- tion (2023). There is generic competition in the US, EU and Japan. In the US and EU, Novartis has resolved patent litiga- tion with certain generic manufacturers. Novartis is tak- ing steps in some EU countries to enforce the tablet formulation patent and the GIST method of use patent. The EU GIST method of use patent is being challenged in one EU country. The EU tablet formulation patent is being challenged in the EPO and in the patent office of one EU country. • Afinitor/Votubia and Afinitor Disperz/Votubia dispers- ible tablets. US: Patent on compound (2014), PTE (2019), PE (2020); patent on dispersible tablet formu- lation (2022), PE (2023); patent on antioxidant (2019); patent on antioxidant (2019), PE (2020); patent on tuberous sclerosis complex (TSC)/subependymal giant cell astrocytoma (SEGA) use (2022), PE (2022); patent on breast cancer use (2022), PE (2022); patent on renal cell carcinoma use (2025), PE (2026); patent on pancreatic neuroendocrine tumor use (2028); RDP for neuroendocrine tumors of gastrointestinal or lung origin (2019), PE (2019); ODE for TSC/renal angiomy- olipoma (2019), PE (2019). EU: Patent on dispersible tablet formulation (2022); patent on antioxidant (2019); patent on breast cancer use (2022); patent on renal cell carcinoma use (2022); patent on TSC/SEGA use (2022); patent on use in neuroendocrine tumors of lung origin (2022); ODE (Votubia) (2021). Japan: Patent on dispersible tablet formulation (2022); patent on antiox- idant (2019); patent on breast cancer use (2022); pat- ent on pancreatic neuroendocrine tumor use (2026); patent on renal cell carcinoma use (2022); patent on gastrointestinal and lung neuroendocrine tumor use (2026), PTE (2027); patent on TSC/SEGA and TSC/ AML use (2027); ODE (tuberous sclerosis) (2022); ODE (dispersible tablet) (2022). cell carcinoma use patent are being challenged in ANDA proceedings against generic manufacturers. The US renal cell carcinoma use and pancreatic neu- roendocrine tumor use patents are being challenged in IPR proceedings in the USPTO. In the US, Novartis has resolved patent litigation with certain generic man- ufacturers which may result in limited generic compe- tition for Afinitor toward the end of 2019, and has resolved patent litigation relating to Afinitor Disperz. The EU breast cancer use patent, the EU TSC/SEGA use patent and the EU renal cell carcinoma use patent are being opposed in the EPO. The Japanese breast cancer use patent is being challenged in the Japanese Patent Office. • Promacta/Revolade. US: Patent on compound (2021), PTE (2022), PE (2023); patent on compound (2018), PE (2019); two patents on compound (2021, 2021), PEs (2021, 2021); patent on method of treating thrombocy- topenia (2021), PE (2021); patent on method of enhanc- ing platelet production (2021), PE (2021); patent on method of enhancing platelet production (2023), PE (2023); patent on salt form (2025); PE (2026); four pat- ents on formulation of different dose strengths (2027) (4), PE (2028) (4); ODE (2021), two PEs (2022, 2022). EU: Patents on compound (2021); patent on compound (2021), SPC (2025); patent on salt form (2023); patent on formulation (2027); RDP (2020). Japan: Patent on compound (2021), PTE (2025); patent on salt form (2023); PTE (2023), patent on formulation (2027); RDP (2020). There is currently no generic competition in the US, EU or Japan. In the US, generic manufacturers have filed ANDAs challenging certain patents other than the compound patents. The EU formulation patent is being opposed in the EPO. • Tafinlar and Mekinist. Tafinlar. US: Two patents on compound (2030; 2030); patent on method of use (2029); RDP (2018); ODE (2020). EU: Patent on compound (2029); RDP (2023). Japan: Patent on compound (2031). There is currently no generic competition in the US, EU or Japan. Mekinist. US: Patent on compound (2025), PTE (2027); patent on method of use (2025); three patents on for- mulation (2032) (3); RDP (2018); ODE (2020). EU: Pat- ent on compound (2025), SPC (2029); RDP (2025). Japan: Patent on compound (2025); patent on method of use (2025); patent on formulation (2031). There is currently no generic competition in the US, EU or Japan. Use of Mekinist with Tafinlar or Tafinlar with Mekinist. US: Patent on combination (2030); patent on method of use of combination (2030); RDP (2020); ODE on melanoma with certain mutations (2021), ODE on non-small cell lung cancer (2024). EU: RDP (2025). Japan: Patent on method of use of combination (2030). There is currently no generic competition in the US, EU or Japan. There is currently no generic competition in the US, EU or Japan. In the US, the compound patent and renal • Exjade and Jadenu. 60 Item 4. Information on the Company Exjade. US: Patent on compound (2017), PTE (2019), ODE for non-transfusion iron overload (2020). EU: Pat- ent on compound (2017), SPC (2021), PE (2022); pat- ent on dispersible tablet formulation (2023). Japan: Patent on compound (2017), PTE (2021); patent on dis- persible tablet formulation (2023). There is currently no generic competition in the US, EU or Japan. In the US, Novartis has resolved patent litigation with generic manufacturers relating to Exjade. Jadenu (marketed as Exjade FCT in EU and Japan). The compound patents for Exjade also protect Jadenu (US), and Exjade FCT (EU/Japan). US: Patent on film-coated tablet formulation (2034), ODE for non-transfusion iron overload (2020). EU: Patent on film-coated tablet for- mulation (2034). There is currently no generic compe- tition in the US, EU or Japan. In the US, the formulation patent is being challenged in ANDA proceedings against a generic manufacturer. Novartis has resolved patent litigation relating to the US formulation patent with a generic manufacturer. In the EU, the formulation patent is being opposed in the EPO. Novartis Pharmaceuticals business unit Ophthalmology • Lucentis. EU: Patent on compound (2018), SPC (2022). Japan: Patent on compound (2018), PTE for age-re- lated macular degeneration (2019), PTE for pathologic myopia (2021), PTE for retinal vein occlusion (2023). There is currently no generic competition in the EU or Japan. • Duotrav, Travatan and Travatan Z. Duotrav. EU: Six patents on formulations (2029) (6). Japan: Two patents on formulations (2029, 2029). Duotrav is not marketed in the US. There is generic competition in some EU countries. There is currently no generic competition in Japan. In the EU, the six for- mulation patents are being opposed in the EPO. Travatan. EU: Six patents on formulations (2029) (6). Travatan is not marketed in the US or Japan. There is generic competition in the EU. In the EU, the six formu- lation patents are being opposed in the EPO. • Jakavi. EU: Patent on compound (2026), SPC (2027); patent on salt (2028); RDP (2023). Japan: Patent on compound (2026), PTE (2028), PTE (2030); patent on salt (2028), PTE (2028), PTE (2030); patent on method of use (2026), PTE (2027); RDP (2022). There is cur- rently no generic competition in the EU or Japan. The EU salt patent is being opposed in the EPO. Travatan Z. US: Three patents on formulations (2027, 2027, 2029). Japan: Three patents on formulation (2027) (3). Travatan Z is not marketed in the EU. There is currently no generic competition in the US. There is generic competition in Japan. In the US, Novartis has resolved patent litigation with certain generic manu- facturers. • Votrient. US: Patent on compound (2021), PTE (2023), two patents on compound (2021, 2021), ODE (2019). EU: Patent on compound (2021), SPC (2025); RDP (2021). Japan: patent on compound (2021), two PTEs (2025, 2026); RDP (2020). There is currently no generic competition in the US, EU or Japan. • Kisqali. US: Three patents on compound (2028, 2030, 2031), pending PTE (2031); three patents on methods of use (2029, 2029, 2031); patent on salt (2031); RDP (2022). EU: Patent on compound (2027); patent on compound (2029), SPC (2032); patent on methods of use (2029); RDP (2027). Japan: Two patents on com- pound (2027, 2029). Kisqali is currently not marketed in Japan. There is currently no generic competition in the US or EU. • Kymriah. US: Seven patents on cells and/or pharma- ceutical compositions comprising the cells (2031) (7); four patents on methods of use (2031) (4); RDP (2029), PE (2030); ODE for r/r pedALL (2024); ODE for r/r DLBCL (2025), PE (2025). EU: Two patents on meth- ods of use (2031, 2031); RDP (2028); ODE (2028), PE (2030). Japan: One patent on pharmaceutical compo- sitions (2031); one patent on cells, pharmaceutical compositions and medical uses (2031). Kymriah is cur- rently not marketed in Japan. There is currently no generic competition in the US or Europe. • Lutathera. US: RDP (2023), ODE (2025); EU: RDP (2027), ODE (2027). Lutathera is currently not mar- keted in Japan. There is currently no generic competi- tion in the US or EU. • Luxturna. EU: ODE (2028). Immunology, Hepatology and Dermatology • Cosentyx. US: Patent on compound (2026), PTE (2029); patent on method of use (psoriasis) (2032); patent on method of use (ankylosing spondylitis) (2033); RDP (2027). EU: Patent on compound (2025), SPC (2030); patent on method of use (psoriasis) (2031); RDP (2026). Japan: Patent on compound (2025), PTE (2026, 2028, 2029); patent on method of use (psoria- sis) (2031), PTE (2032, 2033); patent on method of use (psoriatic arthritis) (2031); RDP (2022). There is cur- rently no generic competition in the US, EU or Japan. • Xolair. US: Two patents on syringe formulation (2021, 2024). EU: Two patents on syringe formulation (2021, 2024). Japan: Two patents on syringe formulation (2021, 2024). There is currently no generic competition in the US, EU or Japan. • Ilaris. US: Patent on compound (2024); patent on method of use in cryopyrin-associated periodic syn- dromes (CAPS) (2026), patent on method of use in familial Mediterranean fever (FMF) (2026), patent on method of use in systemic onset juvenile idiopathic arthritis (SJIA) (2027), patent on method of use in hyperimmunoglobulin D syndrome (HIDS) and tumor necrosis factor receptor-associated periodic syn- drome (TRAPS) (2028); patent on formulation (2029); RDP (2021). EU: Patent on compound (2021), SPC (2024), PE (2025); patent on method of use in SJIA (2026), patent on method of use in FMF (2026), patent 61 Item 4. Information on the Company on formulation (2029); RDP (2020). Japan: Patent on compound (2021), PTE for CAPS (2024), PTE for FMF, HIDS and TRAPS (2026); patent on method of use in familial cold urticaria, neonatal onset multisystem inflammatory disease, SJIA and FMF (2026), patent on method of use in Muckle Wells syndrome (2026), pat- ent on formulation (2029); ODE for CAPS (2021); ODE for FMF, HIDS and TRAPS (2026); ODE for SJIA (2028). There is currently no generic competition in the US, EU or Japan. Japan. The EU Eucreas formulation patent is being opposed in the EPO. • Diovan and Co‑Diovan/Diovan HCT. Diovan: There is generic competition in the US, EU and Japan. Co‑Dio‑ van/Diovan HCT: There is generic competition in the US, EU and Japan. • Exforge and Exforge HCT. Neuroscience • Gilenya. US: Patent on compound (2014), PTE (2019), PE (2019); patent on dosage regimen (2027). EU: RDP (2022); patent on formulation (2024), SPC (2026). Japan: RDP (2021); two patents on formulation (2024, 2024). There is currently no generic competition in the US, EU or Japan. In the US, the compound patent is being challenged in ANDA proceedings against generic manufacturers. The US dosage regimen patent is being challenged in an IPR proceeding in the USPTO. Novartis is taking steps to enforce the US dosage regimen pat- ent against generic manufacturers. • Aimovig (formerly AMG 334). US (co-commercialized with Amgen): Patent on compound (2031), RDP (2030). EU: Patent on compound (2029), RDP (2028). There is currently no generic competition in the US or EU. Respiratory • Xolair. The information set forth in the IP paragraph for Xolair under the “Immunology, Hepatology and Derma- tology” heading also applies to Xolair for respiratory indications. There is currently no generic competition in the US, EU or Japan. Cardio‑Metabolic • Entresto. US: Four patents on combination (2023) (4); two patents on complex (2026; 2027); RDP (2020). EU: Patent on combination (2023), SPC (2028); patent on complex (2026), SPC (2030); RDP (2025). Japan: Pat- ent on combination (2023); patent on complex (2026); patent on formulation (2028). There is currently no generic competition in the US, EU or Japan. The EU complex patent is being opposed in the EPO. Established Medicines • Galvus and Eucreas. EU: Patent on compound (2019), SPC (2022); patent on combination (2021), SPC (2022); patent on Galvus formulation (2025); patent on Eucreas formulation (2026). Japan: Patent on compound (2019), PTE on mono therapy and combinations with sulfo- nyureas (2024), PTE on combinations with other anti- diabetics (2022), PTE on Eucreas combination (2024); patent on combination (2021); patent on Galvus formu- lation (2025), PTE (2025); patent on Eucreas formula- tion (2026), PTE (2028); Eucreas RDP (2019). Galvus/ Eucreas is not marketed in the US. There is generic competition for Galvus and Eucreas in some EU coun- tries. There is currently no generic competition in Exforge. US: Patent on Exforge combination (2019). EU: Patent on Exforge combination/Exforge HCT combi- nation (2019), SPC (2021). There is generic competi- tion in the US, EU and Japan. The EU Exforge combi- nation/Exforge HCT combination patent is being challenged in the EPO and in the patent offices and courts of some EU countries. In the EU, Novartis has resolved patent litigation with certain generic manu- facturers. Novartis is taking steps to enforce the EU Exforge combination/Exforge HCT combination patent against generic manufacturers. Exforge HCT. US: Patent on Exforge HCT combination (2023); patent on formulation (2023). EU: patent on Exforge combination/Exforge HCT combination (2019), SPC (2021); RDP (2019). Japan: Patent on Exforge HCT combination (2023). There is generic competition in the US. There is currently no generic competition in the EU. Exforge HCT is not currently marketed in Japan. The EU Exforge combination/Exforge HCT combina- tion patent is being challenged in the EPO and in the patent offices and courts of some EU countries. In the EU, Novartis has resolved patent litigation with certain generic manufacturers. • Zortress/Certican. US: Patent on compound (2014), PTE (2019), PE (2020); patent on dispersible tablet for- mulation (2022), PE (2023); patent on antioxidant (2019); patent on antioxidant (2019), PE (2020); EU: Patent on dispersible tablet formulation (2022); patent on antioxidant (2019). Japan: Patent on dispersible tab- let formulation (2022); patent on antioxidant (2019). There is currently no generic competition in the US, EU or Japan. In the US, the compound patent is being chal- lenged in ANDA proceedings against generic manu- facturers. • Neoral. There is no patent protection for Neoral in the US, EU or Japan. There is generic competition in the US, EU and Japan. Compounds in development We provide the following information for non-marketed compounds in development that have been filed with the FDA and/or the EMA for registration but have not yet been approved by either agency for any indication. • AVXS-101 (onasemnogene abeparvovec-xxxx, Zolgensma). US: Patent on vector (2026). EU: Two pat- ents on vector (2024, 2028); patent on method of treat- ment (2028). Japan: Patent on vector (2024); two pat- ents on method of treatment (2028, 2028). 62 Item 4. Information on the Company • BAF312 (siponimod, Mayzent). US: Patent on com- pound (2024); patent on dosage regimen (2030). EU: Patent on compound (2024); patent on solid form (2029); patent on dosage regimen (2029). Japan: Pat- ent on compound (2024); patent on solid form (2029); patent on dosage regimen (2029); two patents on for- mulation (2032). • BYL719 (alpelisib). US: Patent on compound (2029); patent on compound and method of treatment (2030). EU: Patent on compound and method of treatment (2029). Japan: Patent on compound and method of treatment (2029). • LCI699 (osilodrostat). US: Patent on compound (2028), patent on method of treatment (2031), patent on tab- let form (2035). EU: Patent on compound (2026), pat- ent on method of treatment (2031); patent on poly- morph compound form (2033); patent on tablet form (2035). Japan: Patent on compound (2026), patent on method of treatment (2031); patent on polymorph com- pound form (2033). Sandoz Our Sandoz Division is a global leader in generic pharmaceuticals and biosimilars and sells products in well over 100 countries. In 2018, the Sandoz Division achieved consolidated net sales of USD 9.9 billion, rep- resenting 19% of the Group’s total net sales. Sandoz develops, manufactures and markets finished dosage form medicines as well as intermediary products includ- ing active pharmaceutical ingredients. Sandoz is organized globally into three franchises: Retail Generics, Anti-Infectives and Biopharmaceuticals. In Retail Generics, Sandoz develops, manufactures and markets active ingredients and finished dosage forms of pharmaceuticals to third parties. Retail Generics includes the areas of cardiovascular, central nervous system, der- matology, gastrointestinal and hormonal therapies, metabolism, oncology, ophthalmics, pain and respiratory, as well as finished dosage form anti-infectives sold to third parties. In Anti-Infectives, Sandoz manufactures and supplies active pharmaceutical ingredients and intermediates – mainly antibiotics – for internal use by Retail Generics and for sale to third-party customers. In Biopharmaceuticals, Sandoz develops, manufactures and markets protein- or other biotechnology-based products, including biosimilars, and provides biotechnol- ogy manufacturing services to other companies. The Sandoz strategic goal is to be a leader in off-pat- ent medicines, driving sustainable and profitable growth. The divisional strategy focuses simultaneously on two pillars: leading the development of an emerging segment of the healthcare market between innovation-driven orig- inator medicines and cost-driven commodity generic medicines, such as biosimilars, complex generics, val- ue-added medicines and digital therapeutics, and excel- lence in the development, manufacturing and marketing of medicines in selected parts of the standard generics segment. Sandoz executes on its divisional strategy by focus- ing on several key priorities, including investing in key markets and therapeutic areas where it is best positioned to make a real difference, increasing the performance of its small-molecule Development and Regulatory organi- zation, and maximizing opportunities in biosimilars. Sandoz also focuses on products that can add more value for patients, payers and healthcare professionals than standard generics, including seeking opportunities to leverage digital therapeutics. In 2018, in a key strategic step to evolve the Sandoz portfolio toward more differentiated products, Novartis announced an agreement to sell selected portions of its Sandoz US portfolio, specifically the Sandoz US derma- tology business and generic US oral solids portfolio, to Aurobindo Pharma USA Inc., for USD 0.9 billion in cash plus USD 0.1 billion in potential earn-outs. The Sandoz US portfolio to be sold to Aurobindo includes approxi- mately 300 products, as well as additional development projects. The sale includes the Sandoz US generic and branded dermatology businesses as well as its derma- tology development center. As part of the transaction, Aurobindo agreed to acquire the manufacturing facilities in Wilson, North Carolina, as well as Hicksville, New York, and Melville, New York. These businesses had net sales of approximately USD 1.2 billion in 2018. The transaction is expected to close in the course of 2019 following the satisfaction of customary closing conditions. Sandoz has a strong and continued strategic focus on biosimilars, which it began developing in 1996 and today sells in more than 80 countries. Sandoz is a mar- ket leader in biosimilars, with a total of eight approved and marketed products. Availability of our biosimilars var- ies by country. We launched Hyrimoz (biosimilar adalimumab) in the EU in October 2018, and Zessly (biosimilar infliximab) in the EU in November 2018. Hyrimoz was also approved in the US in October 2018. However, under the terms of our settlement with AbbVie, we are not entitled to launch Hyrimoz in the US until October 2023. Please see “—Item 4.B Business overview—Sandoz—Intellectual property” below for additional information. The FDA approved biosimilar Erelzi (etanercept-szzs) in 2016 to treat multiple inflammatory diseases. The launch of this biosimilar in the US is pending litigation with Amgen, which markets Enbrel®. Our biosimilar pegfilgrastim was approved and launched in the EU as Ziextenzo in November 2018, and we plan to submit additional data for biosimilar pegfil- grastim to the FDA in 2019 to address a complete response letter (CRL) received from the FDA in June 2016. We received a CRL from the FDA in May 2018 for our biosimilar rituximab, and subsequently announced in November 2018 that we do not plan to pursue our sub- mission for biosimilar rituximab in the US at this time. 63 Item 4. Information on the Company Separately, we received a CRL from the FDA in 2018 for our submission for a generic form of fluticasone pro- pionate and salmeterol inhalation powder, for oral inha- lation (GSK’s Advair®). According to IQVIA (formerly IMS Health), as of November 2018, Sandoz holds a leading global position in sales of biosimilars and of generic anti-infectives and oncology medicines. In addition, Sandoz holds leading global positions in key therapeutic areas, including generic cardiovascular, central nervous system, gastro- intestinal, metabolism, pain and respiratory medicines. In 2018 and January 2019, key Retail Generics prod- uct launches in the US included Glatopa 40 mg/mL (generic Copaxone® 40 mg/mL), palonesetron hydro- chloride injection (generic Aloxi®), generic bupropion XL, and SYMJEPI (epinephrine) 0.15 mg injection (pediatric formulation), as well as innovative digital therapeutics reSET and reSET-O (together with Pear Therapeutics). In 2018, Retail Generics product launches in various European countries included generic versions of rosu- vastatin film-coated tablets, ezetimide and simvastatin film-coated tablets, and ezetimide film-coated tablets, as well as buprenorphine and naloxone sublingual tab- lets. Following an internal reorganization announced on January 27, 2016, 19 mature products were transferred from our Innovative Medicines Division to the Retail Generics franchise of Sandoz. Sandoz also holds operational responsibility for the Novartis Social Business unit. Novartis Social Business aims to help improve public health in lower-income coun- tries by developing novel, sustainable business models that enable access to high-quality medicines against infectious and chronic diseases while also strengthen- ing healthcare capacity. Everything Novartis Social Busi- ness does is rooted in the local communities it serves and relies on its network of partners who share the same purpose. The unit comprises several legacy programs (Novartis Access, the Novartis Malaria Initiative, and Novartis Healthy Family) supported by digital enabling platforms, and has full responsibility for the entire Novartis product range for seven countries in Asia and Key marketed products Africa. For additional information, see “—Item 4.B Busi- ness overview—Overview—Corporate responsibility.” New products Sandoz launched a number of products in various coun- tries in 2018 and January 2019, including: • reSET (FDA-authorized prescription digital therapeu- tic for the treatment of patients with substance use disorder in the US) • reSET-O (FDA-cleared prescription digital therapeutic for the treatment of patients with opioid use disorder in the US) • Ziextenzo (biosimilar pegfilgrastim), approved in Europe in 2018 to reduce the duration of neutropenia and inci- dence of febrile neutropenia in adult patients treated with cytotoxic chemotherapy for malignancy with the exception of chronic myeloid leukemia and myelodys- plastic syndromes • Hyrimoz (biosimilar adalimumab), approved in Europe in 2018 to treat multiple inflammatory diseases • Zessly (biosimilar infliximab), approved in Europe in 2018 to treat multiple immunological diseases • Glatopa 40 mg/mL (generic Copaxone® 40 mg/mL) • Palonesetron hydrochloride injection • Bupropion XL • Rosuvastatin film-coated tablets • Ezetimide and simvastatin film-coated tablets • Ezetimide film-coated tablets • Buprenorphine and naxolone sublingual tablets Sandoz markets approximately 1 000 molecules in countries around the world. The following are some of the Sandoz key marketed products in each of its franchises (availability varies by market): Retail Generics Product Amoxicillin/clavulanic acid Cyclophosphamide Leuprorelin Levothyroxine sodium Potassium Zoledronic acid Originator drug Augmentin® Endoxan® Various Description Antibiotic Breast, ovarian and non-small cell cancer treatment Hormonal treatment Synthroid®; Levoxyl® Hypothyroidism treatment Klor-Con® Aclasta Hypokalemia treatment Osteoporosis treatment 64 Item 4. Information on the Company Anti-Infectives Active ingredients Oral and sterile penicillins Oral and sterile cephalosporins Description Anti-infectives Anti-infectives Clavulanic acid and mixtures with clavulanic acid ß-lactam inhibitors Classical and semisynthetic erythromycins Anti-infectives Intermediates Various cephalosporin intermediates Erythromycin base Description Anti-infectives Anti-infectives Various crude compounds produced by fermentation Cyclosporine, ascomysin, rapamycin, mycophenolic acid, etc. Biopharmaceuticals Product Omnitrope Originator drug Genotropin® Description Recombinant human growth hormone Binocrit and Epoetin alfa Hexal Eprex®/Erypo® Recombinant protein used for anemia Zarzio, Zarxio and Filgrastim Hexal Glatopa Erelzi Rixathon Hyrimoz Zessly Ziextenzo Neupogen® Copaxone® Enbrel® MabThera® Humira® Remicade® Neulasta® Recombinant protein used in oncology Treatment for multiple sclerosis (MS) Treatment for multiple inflammatory diseases Treatment for blood cancers and immunological diseases Treatment for multiple inflammatory diseases Treatment for gastroenterological, rheumatological and dermatological diseases Treatment to reduce duration of chemotherapy-induced neutropenia and incidence of chemotherapy-induced febrile neutropenia with the exception of chronic myeloid leukemia and myelodysplastic syndromes Biosimilars in Phase III development and registration The following table describes Sandoz biosimilar projects that are in Phase III clinical trials (including filing prepa- ration) and registration: Project/ product Route of administration Potential indication/indications Common name Mechanism of action Therapeutic areas Current phase GP2017 adalimumab TNF-α inhibitor Arthritides (rheumatoid arthritis, ankylosing spondylitis, psoriatic arthritis), plaque psoriasis and others (same as originator) Immunology Subcutaneous EU: Approved US: Registration LA-EP2006 pegfilgrastim Pegylated granulocyte colony-stimulating factor Chemotherapy-induced neutropenia and others Oncology (same as originator) Subcutaneous EU: Approved US1: Registration 1 Resubmission planned for 2019 to address FDA complete response letter received June 2016 Principal markets The two largest generics markets in the world – the US and Europe – are the principal markets for Sandoz. The following table sets forth the aggregate 2018 net sales of Sandoz by region: Sandoz Europe United States Asia, Africa, Australasia Canada and Latin America Total Of which in Established Markets * Of which in Emerging Growth Markets * 2018 net sales to third parties USD millions 4 963 2 754 1 363 779 9 859 7 233 2 626 % 50 28 14 8 100 73 27 * Emerging Growth Markets comprise all markets other than the Established Markets of the US, Canada, Western Europe, Japan, Australia and New Zealand. 65 Item 4. Information on the Company Many Sandoz products are used for chronic conditions that require patients to consume the product over long peri- ods of time, from months to years. Sales of our anti-infective products and over-the-counter cough and cold prod- ucts are subject to seasonal variation. Sales of the vast majority of our other products are not subject to material changes in seasonal demand. Production The primary goal of our manufacturing and supply chain management program is to ensure the uninterrupted, timely and cost-effective supply of products that meet all product specifications and quality standards. The manufacture of our products is heavily regulated by gov- ernmental health authorities around the world, including the FDA and EMA. In addition to regulatory requirements, many of our products involve technically complex man- ufacturing processes or require a supply of highly spe- cialized raw materials. We manufacture our products at facilities worldwide. See also “—Item 4.D Property, plants and equipment.” Active pharmaceutical ingredients are manufactured in our own facilities or purchased from third-party suppli- ers. We maintain state-of-the-art and cost-competitive processes, with quality as a primary goal within our own production network. Those processes include fermen- tation, chemical syntheses and precipitation processes, as well as sterile processing. Many biologic medicines are manufactured using recombinant DNA-derived tech- nology, by which a gene is introduced into a host cell, which then produces a human protein. This manufactur- ing process requires sophisticated technical expertise. We are constantly working to improve current, and develop new, manufacturing processes, and to review and adapt our manufacturing network to meet the needs of our Sandoz Division. Raw materials for the manufacturing process are either produced in-house or purchased from a number of third-party suppliers. Where possible, we 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 or other requirements. We monitor market developments that could have an adverse effect on the supply of essential materials. Our suppliers of raw mate- rials are required to comply with Novartis quality stan- dards. Because the manufacture of our products is complex and heavily regulated by governmental health authori- ties, supply is never guaranteed. If we or our third-party suppliers fail to comply with applicable regulations, then there could be a product recall or other shutdown or dis- ruption of our production activities. We have experienced supply interruptions for our products in the past, and there can be no assurance that supply will not be inter- rupted again in the future. We have implemented a global manufacturing strategy to maximize business continuity in case of such events. However, there can be no guar- antee that we will always be able to successfully man- age such issues when they arise. Due to impurities found in valsartan, losartan, and ibersartan active ingredient batches sourced from a third party manufacturer, we recalled Sandoz valsartan, losar- tan and ibersartan products in the third and fourth quar- ters of 2018 in several countries, in line with our quality standards for all of our marketed products, and in agree- ment with local health authorities. Marketing and sales Sandoz sells a broad portfolio of products, including the products of our Retail Generics franchise and biosimi- lars, to wholesalers, pharmacies, hospitals and other healthcare outlets. Sandoz adapts its marketing and sales approach to local decision-making processes, depending on the structure of the market in each coun- try. In response to rising healthcare costs, many govern- ments and private medical care providers, such as health maintenance organizations, have instituted reimburse- ment schemes that favor the substitution of bioequiva- lent generic versions of originator pharmaceutical prod- ucts, such as those sold by our Retail Generics franchise. In the US, statutes have been enacted by all states that permit or require pharmacists to substitute a less expen- sive generic product for the brand-name version of a drug that has been prescribed to a patient. Generic use is growing in Europe, but penetration rates in many EU countries (as a percentage of volume) remain well below those in the US. Recent trends have been toward continued consoli- dation among distributors and retailers of Sandoz prod- ucts, both in the US and internationally, which has increased our customers’ purchasing leverage. Legislative or regulatory changes can have a signifi- cant impact on our business in a country. In Germany, for example, healthcare reforms have increasingly shifted decision-making from physicians to insurance funds. Our Anti-Infectives franchise supplies active phar- maceutical ingredients and intermediates – mainly anti- biotics – for internal use by Retail Generics and for sale to the pharmaceutical industry worldwide. Our Biopharmaceuticals franchise operates in an emerging business environment, particularly in the US. Regulatory pathways for approving biosimilar products are either relatively new or still in development, and pol- icies have not yet been fully defined or implemented for the automatic substitution and reimbursement of biosim- ilars in many markets, including the US. As a result, in many of these markets, our biosimilar products are mar- keted as branded competitors to the originator products. Competition The market for generic products is characterized by increasing demand for high-quality pharmaceuticals that can be marketed at lower costs due to comparatively minimal initial research and development investments. Increasing pressure on healthcare expenditures and numerous patent and data exclusivity period expirations have encouraged more generic product launches, 66 Item 4. Information on the Company resulting in increased competition among the companies selling generic pharmaceutical products, leading to ongoing price pressure. In particular, Sandoz faces increased industrywide pressure on prices for generic products, particularly in the US, driven by factors includ- ing customer consolidation and growing competition from other manufacturers of generic medicines. These factors contributed to a decline in US sales that began in 2017 and continued in 2018. In addition, research-based pharmaceutical compa- nies are participating directly in the generic conversion process by licensing their patented products to generic companies (so-called “authorized generics”). Conse- quently, generic companies that were not otherwise in a position to launch a specific product may participate in the market using the innovator’s product authorization. Authorized generics serve as a business opportunity for Sandoz when the product of a research-based pharma- ceutical company loses patent protection and Sandoz secures a license from the research-based pharmaceu- tical company to launch the authorized generic of that product. Development and registration Development of Sandoz Biopharmaceuticals products is jointly overseen by Sandoz and by Novartis Global Drug Development. Development and registration activities for Retail Generics products, and certain registration activ- ities for Biopharmaceuticals products, continue to be overseen directly by Sandoz. Before a generic pharmaceutical may be marketed, intensive technical and clinical development work must be performed to demonstrate, in bioavailability studies, the bioequivalence of the generic product to the refer- ence product. Nevertheless, research and development costs associated with generic pharmaceuticals gener- ally are much lower than those of the originator pharmaceuticals, as no preclinical studies or clinical tri- als on dose finding, safety and efficacy must be per- formed by the generic company. As a result, generic pharmaceutical products can be offered for sale at prices often much lower than those of products pro- tected by patents and data exclusivity, which must recoup substantial research and development costs through higher prices over the life of the product’s pat- ent and data exclusivity period. While generic pharmaceuticals are follow-on ver- sions of chemically synthesized molecules, biosimilar products contain a version of the active substance of an already approved biological reference medicine. Due to the inherent variability and complexity of biologic prod- ucts, including batch-to-batch differences and variations following manufacturing changes, the development and the regulatory pathway of biosimilars differ significantly from that of generics. The development of a biosimilar product is much more technically challenging than the development of a typical generic pharmaceutical. While generic pharmaceuticals normally do not require clinical studies in patients, regulators worldwide do require such tar- geted studies for biosimilar products. Biosimilars are engineered to match the reference medicine in quality, safety and efficacy. This is achieved by systematically defining the target range of the reference medicine and then comparing the biosimilar to the reference medicine at various development stages to confirm biosimilarity and to establish that there are no clinically meaningful differences between the proposed biosimilar and the ref- erence biologic. Because the purpose of a biosimilar clin- ical development program is to confirm biosimilarity and not to establish efficacy and safety de novo, the clinical studies required are less than those required for a ref- erence biologic. Therefore, the cost of development for a biosimilar is usually less than that of a reference bio- logic. The Development and Registration staff employed by affiliates of the Sandoz Division are based worldwide, including at facilities in Holzkirchen, Germany; Rudol- stadt, Germany; Kundl, Austria; Ljubljana, Slovenia; Mel- ville, New York; and Hicksville, New York. In 2018, the divestment of the Boucherville, Canada, development (and associated manufacturing) facility to Avara Phar- maceutical Services was announced and subsequently completed, including a long-term agreement to secure supply of key products to the Canadian market. Also in 2018, Sandoz announced the planned opening of a new development center in Hyderabad, India, initially focused on oral solid medicines. Regulation Generics The Hatch-Waxman Act in the US (and similar legislation in the EU and in other countries) eliminated the require- ment that manufacturers of generic pharmaceuticals repeat the extensive clinical trials required for reference products, so long as the generic version could be shown in bioequivalence studies to be of identical quality and purity, and to be therapeutically equivalent to the refer- ence product. In the US, the decision on whether a generic phar- maceutical is bioequivalent to the original patented prod- uct is made by the FDA based on an Abbreviated New Drug Application (ANDA) filed by the generic product’s manufacturer. The process typically takes nearly two years 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-Wax- man Act requires a generic manufacturer to certify in certain situations that the generic product does not infringe on any current applicable patents on the prod- uct held by the holder of the marketing authorization for the reference product, or to certify that such patents are invalid or that the product is non-infringing. This certifi- cation often results in a patent infringement lawsuit being brought by the patent holder against the generic com- pany. In the event of such a lawsuit, the Hatch-Waxman Act imposes an automatic 30-month delay in the approval of the generic product to allow the parties to resolve the intellectual property issues. For generic applicants who are the first to file their ANDA containing a certification claiming non-infringement or patent invalidity, the Hatch-Waxman Act provides those applicants with 67 Item 4. Information on the Company 180 days of marketing exclusivity to recoup the expense of challenging the patents on the reference product. However, generic applicants must launch their products within certain timeframes or risk losing the marketing exclusivity that they had gained by being a first-to-file applicant. In the EU, decisions on the granting of a marketing authorization are made either by the European Commis- sion based on a positive recommendation by the EMA under the centralized procedure, or by a single member state under the national or decentralized procedure. See “—Innovative Medicines—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 following the expiration of the product’s data exclusivity period. In such cases, the generic company is able to submit its Abridged Applica- tion based on the data submitted by the innovator com- pany for the reference product, without the need to con- duct extensive Phase III clinical trials of its own. For all products that received a marketing authorization in the EU after late 2005, the Abridged Application can be sub- mitted throughout the EU. However, the data submitted by the innovator company in support of its application for a marketing authorization for the reference product will be protected for 10 years after the first grant of mar- keting authorization in all member states, and can be extended for an additional year if a further innovative indication has been authorized for that product, based on preclinical and clinical trials filed by the innovator company that show a significant clinical benefit in com- parison to the existing therapies. Biosimilars The regulatory pathways for approval of biosimilar medicines are still being developed and established in many countries of the world. A regulatory framework for the approval of biosimilars has been established in the EU, Japan, Canada and the US, while the World Health Organization (WHO) has issued guidance. Sandoz has successfully registered and launched the first biosimilar (or biosimilar-type) medicine in Europe, the US, Canada, Japan, Taiwan, Australia, and many countries in Latin America and Asia. Sandoz was the first company to secure approval for and launch a biosimilar under the US biosimilar pathway that was established as part of the Biologics Price Competition and Innovation Act (BPCIA). The approval of biosimilars in Europe follows a pro- cess similar to that followed for small molecules. How- ever, biosimilars usually have to be approved through the centralized procedure because they are manufactured using recombinant DNA technology. As part of the approval process in the EU, biosimilars have to demon- strate comparability to the reference medicine in terms of safety, efficacy and quality through an extensive com- parability exercise, based on strict guidelines set by the authorities. Regulators will only approve a biosimilar based on data that allows the regulators to conclude that there are no clinically meaningful differences between the reference medicine and the biosimilar. In the US, under the BPCIA, a biosimilar must be highly similar with no clinically meaningful differences compared to the reference medicine. Approval of a bio- similar in the US requires the submission of a BLA to the FDA, including an assessment of immunogenicity, and pharmacokinetics or pharmacodynamics. The BLA for a biosimilar can be submitted as soon as four years after the initial approval of the reference biologic, but can only be approved 12 years after the initial approval of the ref- erence biologic. This pathway is still relatively new, and some aspects remain untried and controversial. Intellectual property We take all reasonable steps to ensure that our products do not infringe valid intellectual property rights held by others. Nevertheless, competing companies commonly assert patent and other intellectual property rights. As a result, we can become involved in significant litigation regarding our products. If we are unsuccessful in defend- ing these suits, we could be subject to injunctions pre- venting us from selling our products and to potentially substantial damages. Wherever possible, our products are protected by our own patents. Among other things, patents may cover the products themselves, including the product’s formu- lation, or the processes for manufacturing a product. However, there can be no assurance that our intellectual property will protect our products or that we will be able to avoid adverse effects from the loss of intellectual prop- erty protection in the future. In October 2018, Sandoz announced a global reso- lution of all intellectual property-related litigation with AbbVie concerning adalimumab. Under the terms of the agreement, AbbVie grants Sandoz a non-exclusive license to AbbVie’s intellectual property relating to Humira®, beginning on certain dates in certain countries in which AbbVie has intellectual property. Sandoz will pay royalties to AbbVie for licensing its Humira® patents. AbbVie will make no payments to Sandoz. Alcon Our Alcon Division, a global leader in eye care, researches, develops, manufactures, distributes and sells eye care products. Its products are sold in more than 140 countries. In 2018, the Alcon Division had consolidated net sales of USD 7.1 billion, representing 14% of total Group net sales. To meet the needs of patients, ophthalmologists, sur- geons, optometrists, opticians and physician specialists, Alcon operates with two global business franchises: Sur- gical and Vision Care. Each business franchise operates with specialized sales forces and marketing support. In November 2018, Novartis announced that Alcon had filed an initial Form 20-F registration statement with the SEC in relation to the previously announced inten- tion of Novartis to spin off our Alcon Division as an 68 Item 4. Information on the Company independent, publicly traded company. An application will be made to list the shares in Alcon on SIX and the NYSE under the ticker symbol “ALC.” In addition to share- holder approval, completion of the proposed Alcon spin- off remains subject to certain conditions precedent, such as no material adverse events, receipt of necessary authorizations as well as tax rulings and opinions. If approvals are secured and conditions are met, the spin- off is expected to be completed in the first half of 2019. Effective January 1, 2018, we transferred our over-the-counter ophthalmic products and certain sur- gical diagnostic products from the Innovative Medicines Division to the Alcon Division. Our prescription ophthal- mic medicines business remains with the Innovative Medicines Division. In compliance with IFRS, beginning with our first-quarter 2018 results, Novartis updated its segment financial information to reflect this transfer, both for the current and prior years, to aid comparability of year-on-year results. The products of the Ophthalmic Pharmaceuticals franchise of Alcon had previously been transferred to our Innovative Medicines Division follow- ing an internal reorganization announced on January 27, 2016. In April 2016, Alcon entered into a strategic alliance with PowerVision to develop an accommodating intra- ocular lens (IOL) that has the potential to change focus via a fluid-driven shape-changing technology. In December 2018, Alcon acquired 100% of TrueVi- sion, the manufacturer of NGENUITY, a 3-D visualization system that combines a high-dynamic 3-D camera, advanced high-speed image optimization, polarizing sur- geon glasses, and an ultra-high-definition 4K OLED 3-D display to create a platform for digitally assisted vitreo- retinal surgery to help improve visualization of the deli- cate tissues in the back of the eye. Alcon has distributed NGENUITY since February 2016 under an exclusive agreement with TrueVision. In December 2018, Alcon acquired 100% of Tear Film Innovations, Inc., for its iLux Device, a therapeutic device used to treat meibomian gland dysfunction (MGD), a leading cause of dry eye. Alcon Division products Surgical Our Alcon Division’s Surgical franchise is the leader in global ophthalmic surgical product sales, offering implant- able products, consumables, instruments and equipment for use in surgical procedures to address cataracts, vit- reoretinal conditions, refractive errors and glaucoma. We also offer service on the equipment we sell. The Alcon Surgical portfolio includes IOLs and equip- ment for use in cataract procedures; equipment, instru- ments and devices for use in vitreoretinal surgeries; sur- gical equipment and diagnostic devices used in refractive surgical procedures; and devices for use in treating patients with glaucoma. Our IOL portfolio includes our Clareon and AcrySof IOL families, with options ranging from monofocal IOLs for basic cataract surgery to spe- cialized IOLs for the correction of presbyopia and astig- matism at the time of cataract surgery; as well as the UltraSert and AutonoMe innovative IOL delivery systems. The Cataract Refractive Suite by Alcon features the Centurion vision system for phacoemulsification and cat- aract removal; the Infiniti vision system for phacoemul- sification and cataract removal; the LenSx femtosecond laser used for specific steps in the cataract surgical pro- cedure; the LuxOR ophthalmic microscope; the ORA SYSTEM technology for cataract surgery planning and intra-operative guidance during surgery; and the Verion imaged guided system for use during cataract surgery. The Alcon vitreoretinal portfolio includes the NGENUITY 3D visualization system, designed to enhance visualiza- tion of the back of the eye, and the Constellation vision system and associated handpieces and instruments. Our WaveLight devices are used for LASIK and other vision-correcting refractive procedures, including topog- raphy-guided procedures marketed under the Contoura brand. For glaucoma surgery, Alcon offers the EX-PRESS glaucoma filtration device, and formerly distributed the CyPass Micro-Stent. However, in August 2018, Alcon vol- untarily withdrew the CyPass Micro-Stent from the global market based on analysis of five-year post-surgery data from the COMPASS-XT long-term safety study. In addi- tion, Alcon provides advanced viscoelastics, surgical solu- tions, diagnostic ophthalmic products, surgical packs, and other disposable products for cataract and vitreoretinal surgery. Vision Care Our Alcon Division’s Vision Care franchise develops and markets contact lenses and ocular health products. Alcon’s broad portfolio of silicone hydrogel, daily dispos- able and color contact lenses includes our Dailies, Air Optix and Freshlook brands. Our Dailies product line includes the Dailies Total1 lens, a first-of-its-kind water gradient contact lens that is also offered in a multifocal option for patients with presbyopia. Our Air Optix monthly replacement product line features silicone hydrogel con- tact lenses in monofocal, astigmatism-correcting and multifocal options, as well as Air Optix Colors and Air Optix plus HydraGlyde contact lenses. Our contact lens care solutions business includes the Opti‑Free line of multipurpose disinfecting solutions, as well as the Clear Care and AOSEPT Plus line of hydrogen peroxide lens care solutions. Over-the-counter ophthalmic products that have moved from our Innovative Medicines Division to the Alcon Vision Care franchise include artificial tear and related dry eye products marketed under the Systane, Tears Naturale and Genteal brands; Naphcon A and Zaditor eye drops for the temporary relief of ocular itching due to allergies; and vitamins for ocular health, marketed under the ICAPS and Vitalux brands. With the acquisition of Tear Film, the Alcon Vision Care portfolio also includes the iLux Device, a therapeutic device used to treat MGD, a leading cause of dry eye. 69 Item 4. Information on the Company New products We received a number of approvals and launched a number of products in 2018, including: • Systane Complete was launched in the US and EU. This addition to the Systane product line offers fast hydration and lasting relief, with nano droplet technology for enhanced coverage. • Air Optix plus HydraGlyde multifocal contact lenses launched in the US and EU. These lenses offer clear, seam- less vision at all distances and combine the innovative Air Optix multifocal design with lasting lens surface mois- ture provided by the HydraGlyde moisture matrix. Key marketed products The following tables set forth certain key marketed products in our Alcon Division. While we intend to sell our mar- keted products throughout the world, not all products and indications are currently available in every country. Surgical Cataract AcrySof family of IOLs, including: AcrySof IQ monofocal IOLs AcrySof IQ Toric astigmatism-correcting IOLs AcrySof IQ ReSTOR presbyopia-correcting IOLs AcrySof IQ ReSTOR Toric presbyopia- and astigmatism-correcting IOLs AcrySof IQ PanOptix presbyopia-correcting IOLs AcrySof IQ PanOptix Toric presbyopia- and astigmatism-correcting IOLs AutonoMe pre-loaded IOL delivery system Cataract Refractive Suite by Alcon, including: Centurion vision system for phacoemulsification and cataract removal Infiniti vision system for phacoemulsification and cataract removal LenSx femtosecond laser used for specific steps in the cataract surgical procedure LuxOR ophthalmic microscope ORA SYSTEM technology for cataract surgery planning and intra-operative guidance during surgery Verion imaged-guided system for use during cataract surgery Clareon monofocal IOLs UltraSert pre-loaded IOL delivery system Vitreoretinal Constellation vision system for vitreoretinal operations Grieshaber surgical instruments NGENUITY 3D visualization system Purepoint laser system and probes Ultravit vitrectomy probes Refractive WaveLight EX500 excimer laser for LASIK and other refractive correction procedures Glaucoma EX-PRESS glaucoma filtration device WaveLight FS200 femtosecond laser for refractive surgery In addition, Alcon provides advanced viscoelastics, surgical solutions, surgical packs, diagnostic ophthalmics, and other disposable products for cataract and vitreoretinal surgery. Vision Care Contact lenses Air Optix family of silicone hydrogel contact lenses (including Air Optix Colors and Air Optix plus HydraGlyde lenses) Dailies family of daily disposable contact lenses (including Dailies Total1 lenses) FreshLook family of color contact lenses Contact lens care Clear Care family of hydrogen peroxide lens care solution (AOSEPT Plus outside of North America) Opti‑Free family of multipurpose disinfecting solution Dry eye Genteal family of artificial tears Systane family of artificial tears and related dry eye products Tears Naturale lubricant eye drops iLux Device for the treatment of MGD, a leading cause of dry eye Allergy Naphcon A for the temporary relief of ocular redness and itching due to allergies Vitamins Zaditor for the temporary relief of ocular itching due to allergies ICAPS and Vitalux families of eye vitamin products 70 Item 4. Information on the Company Principal markets The principal markets for our Alcon Division include North America, Latin America, Japan, Asia and Europe. The following table sets forth the aggregate 2018 net sales of the Alcon Division by region: Alcon Europe United States Asia, Africa, Australasia Canada and Latin America Total Of which in Established Markets * Of which in Emerging Growth Markets * 2018 net sales to third parties USD millions 1 805 2 942 1 781 621 7 149 5 395 1 754 % 25 41 25 9 100 75 25 * Emerging Growth Markets comprise all markets other than the Established Markets of the US, Canada, Western Europe, Japan, Australia and New Zealand. Sales of the vast majority of our Alcon Division products are not subject to material changes in seasonal demand. However, sales of certain of our Vision Care products, including those for allergies and dry eye, are subject to sea- sonal variation. Research and development Production Alcon has made one of the largest commitments to research and development in the eye care devices mar- ket, with proven R&D capabilities in the areas of optical design, material and surface chemistry, automation and equipment platforms. Currently, our Alcon Division research and development organization employs over 1 200 individuals dedicated to its research and develop- ment efforts, including physicians, doctors of optometry, and Ph.Ds. Alcon researchers have extensive experience in the field of ophthalmology and frequently have aca- demic or practitioner backgrounds to complement their product development experience. Research and development activities for Alcon’s Sur- gical franchise are focused on expanding intraocular lens capabilities to further improve surgical and refractive out- comes, and on developing equipment and instrumenta- tion for cataract, vitreoretinal, refractive and glaucoma surgeries, as well as new platforms for diagnostics and visualization. The focus of the Vision Care franchise is on the research and development of new manufacturing platforms, novel contact lens materials, coatings and optical designs for various lens replacement schedules with the ultimate goal of improving patient outcomes, and novel delivery systems that safely deliver products that provide relief from symptoms of dry eye and ocular aller- gies. Alcon continues to seek opportunities to collaborate with third parties on advanced technologies for various ophthalmic conditions. These include the potential to provide accommodative contact and intraocular lenses for patients living with presbyopia. The manufacture of our products is heavily regulated by governmental health authorities around the world, includ- ing the FDA. In addition to regulatory requirements, many of our products involve technically complex manufactur- ing processes or require a supply of highly specialized raw materials. For some products and raw materials, we may also rely on a single source of supply. The combi- nation of these factors means that supply is never guar- anteed. Like some of our competitors, our Alcon Division faces manufacturing issues from time to time. If we or our third-party suppliers fail to comply fully with regula- tions, then there could be a product recall or other shut- down or disruption of our production activities. There can be no assurance that we will not experience supply interruptions for our products in the future. We have implemented a global manufacturing strategy to maxi- mize business continuity in case of such events. How- ever, there can be no guarantee that we will be able to successfully manage such issues if and when they arise. For additional information on Alcon production facilities, see “Item 4. Information on the Company—Item 4.D Prop- erty, plants and equipment.” Marketing and sales Our Alcon Division conducts sales and marketing activ- ities around the world, organized under five operating regions: Europe (including Russia)/Middle East/Africa, North America, Latin America/Caribbean, Asia and Japan. The Alcon Division’s global commercial capabil- ity is organized around sales and marketing organiza- tions dedicated to the Surgical and Vision Care fran- chises. 71 Item 4. Information on the Company Most of our global Alcon marketing efforts are sup- ported by advertising in trade publications and by mar- keting and sales representatives attending regional and national medical conferences. Marketing efforts are rein- forced by targeted and timely promotional materials and direct mail to eye care practitioners in the office, hospi- tal or surgery center setting. Technical service after the sale is provided, and an integrated customer relationship management system is in place in many markets. We also rely on direct-to-consumer marketing campaigns to pro- mote selected products. While our Alcon Division markets all of its products by calling on medical professionals, direct customers and distribution methods differ across business lines. Alcon Surgical products are sold directly to hospitals and ambulatory surgical centers, although Alcon sells through distributors in certain markets outside the US. In most countries, contact lenses are available only by prescription. Our contact lenses can be purchased from eye care professionals, optical chains and large retail- ers, subject to country regulation. Over-the-counter lens care, dry eye, allergy and ocular vitamin products can be found in major drugstore, food, mass merchandising and optical retail chains globally, subject to country regula- tions. Competition The eye care industry is highly competitive and subject to rapid technological change and evolving industry requirements and standards. Our Alcon Division com- petes with a number of different companies across its two franchises. Companies within this industry compete on technological leadership and innovation, quality and efficacy of their products, relationships with eye care professionals and healthcare providers, breadth and depth of product offerings, and pricing. The presence of these factors varies across our Alcon Division’s product offerings. Our principal competitors also sometimes form strategic alliances and enter into co-marketing agree- ments in an effort to better compete. Regulation Most of our Surgical products and many of our Vision Care products are regulated as medical devices in the US and the EU. These jurisdictions each have risk-based classification systems that determine the type of infor- mation that must be provided to the local regulatory bod- ies in order to obtain the right to market a product. In the US, safety and effectiveness information for Class II and III devices must be reviewed by the FDA. Our Class II and Class III devices typically are subject to one of the fol- lowing two pre-market review procedures: the Pre-Mar- ket Approval (PMA) process typically applies to Class III devices, and the Pre-Market Notification (510(k)) sub- mission process typically applies to Class II devices. Under a PMA, the manufacturer must submit to the FDA supporting evidence sufficient to prove the safety and effectiveness of the device. Under a 510(k) submission, the manufacturer notifies the FDA that it intends to com- mence marketing the product, with data that establishes the product as substantially equivalent to another already-marketed Class II product. In the EU, CE marking is required for all medical devices sold. By affixing the CE Mark, the manufacturer certifies that a product is in compliance with provisions of the EU’s Medical Device Directive. Most such prod- ucts are subject to a self-certification process by the manufacturer, which requires the manufacturer to con- firm that the product performs to appropriate standards. This allows the manufacturer to issue a Declaration of Conformity and to notify competent authorities in the EU that the manufacturer intends to market the product. In order to comply with European regulations, our Alcon Division maintains a full Quality Assurance system and is subject to routine auditing by a certified third party (a “notified body”) to ensure that this quality system is in compliance with the requirements of the EU’s Medical Device Directive as well as the requirements of ISO 13485. Many of our Vision Care dry eye and allergy products are regulated as over-the-counter pharmaceuticals in the US, and several Surgical diagnostic ophthalmic products are regulated as prescription pharmaceuticals in the US and the EU. In the US, over-the-counter pharmaceuticals that comply with the FDA over-the-counter monograph regulations may be marketed without prior FDA approval. Alcon’s prescription pharmaceutical products are sub- ject to the same regulatory approval procedures as the prescription pharmaceutical products of our Innovative Medicines Division. See “—Innovative Medicines—Reg- ulation.” Price controls The prices of our Surgical devices and our drugs that require a prescription are subject to reimbursement pro- grams and price control mechanisms that vary from country to country. Due to increasing political pressure and governmental budget constraints, we expect these programs and mechanisms to remain robust – and to potentially even be strengthened. As a result, such pro- grams and mechanisms could have a negative influence on the prices we are able to charge for our Surgical prod- ucts, particularly those used in cataract and vitreoretinal surgeries. For example, in India, the National Pharmaceutical Pricing Authority (NPPA) has imposed 75% to 85% price reductions on coronary stents (implantable medical devices intended to ensure an adequate flow of blood to the heart). The NPPA has begun to evaluate prices on other categories of medical devices, potentially includ- ing IOLs used in cataract surgeries. If the NPPA chooses to impose similar price reductions on IOLs from Alcon, this could have a negative impact on our Surgical fran- chise sales in India. It is also possible that regulatory agencies in other countries may consider applying sim- ilar price controls on IOLs and other Surgical products sold by Alcon. Intellectual property We strive to protect our investment in the research, development, manufacturing and marketing of our 72 Item 4. Information on the Company products through the use of patents, trademarks, copy- rights, trade secrets and other intellectual property. In general, we seek intellectual property protection under applicable laws for significant product developments in major markets. Among other things, patents may cover the products themselves, the processes for manufactur- ing a product, and particular uses of a product. The protection offered by our intellectual property extends for varying periods, depending on its legal life in the various countries. The protection afforded, which may also vary from country to country, depends upon the type of intellectual property and its scope of cover- age. We monitor infringements of our intellectual prop- erty and typically challenge such infringements. We also defend challenges through litigation and administrative proceedings to the validity of our intellectual property. However, because the outcomes of intellectual property challenges can be difficult to predict, there can be no assurance that we will be able to successfully protect our intellectual property rights in all cases. If we are unsuccessful in defending such challenges, we may face loss of exclusivity and increased competition in the affected territories. See generally “—Innovative Medicines—Intellectual property.” We take reasonable steps to ensure that our prod- ucts do not infringe valid intellectual property rights held by others. Nevertheless, third parties may assert patent and other intellectual property rights against our prod- ucts. As a result, we can become involved in significant intellectual property litigation regarding our products. If we are unsuccessful in defending these suits, we could be subject to injunctions preventing us from selling our products and to damages that may be substantial. In addition to our patents and pending patent appli- cations in the United States and selected non-US mar- kets, we rely on proprietary know-how and trade secrets in our businesses and work to ensure the confidentiality of this information, including through the use of confi- dentiality agreements with employees and third parties. In some instances, we also acquire, or obtain licenses to, intellectual property rights that are important to our businesses from third parties. All of our major Alcon Division products are sold under trademarks that we consider in the aggregate to be important to our Alcon Division business as a whole. We consider trademark protection to be particularly important to the protection of our investment in the sales and marketing of our Vision Care franchise. The scope and duration of trademark protection varies widely throughout the world. In some countries, trademark pro- tection continues only as long as the mark is used. Other countries require the registration of trademarks and the payment of registration fees. Trademark registrations are generally for fixed, but renewable, terms. We rely on copyright protection in various jurisdic- tions to protect the software and printed materials our business relies upon, including software used in our sur- gical and diagnostic equipment. The scope of copyright protection for computer software varies throughout the world, although it is generally for a fixed term that begins on the date of copyright registration. 73 Item 4. Information on the Company 4.C Organizational structure Organizational structure See “Item 4. Information on the Company—Item 4.A History and development of Novartis,” and “Item 4. Information on the Company—Item 4.B Business overview—Overview.” Significant subsidiaries See “Item 18. Financial Statements—Note 31. Principal Group subsidiaries and associated companies.” 4.D Property, plants and equipment Our principal executive offices are located in Basel, Swit- zerland. Our divisions operate through a number of affil- iates that have offices, research and development facil- ities, and production sites throughout the world. We generally own our facilities or have entered into long-term lease arrangements for them. Some of our principal facilities are subject to mortgages and other security interests granted to secure indebtedness to cer- tain financial institutions. Novartis Technical Operations manages the produc- tion and supply chains of our Innovative Medicines and Sandoz Division products through a network of 64 man- ufacturing sites, as well as through external suppliers, and warehouse and distribution centers. Our Alcon Sur- gical and Vision Care manufacturing sites continue to be managed by the Alcon Division. In addition, following the transition of our over-the-counter ophthalmic products and certain surgical diagnostics products to Alcon, and the overall strategic decision to create greater opera- tional autonomy for our Alcon Division, management of the manufacturing site in Fort Worth, Texas, was trans- ferred back to Alcon on July 1, 2018, and our aseptic manufacturing site in Singapore was transferred to Alcon on January 1, 2019. Our Puurs, Belgium, site will remain within Novartis Technical Operations, with the exception of Alcon Custom Pak production and warehousing, which was transferred to Alcon on January 1, 2019. AAA man- ages four sites for radioligand therapies production, and certain other small sites for diagnostics and enriched water production. AveXis manages five sites for research and development, production, warehousing, its head- quarters and administrative offices. Endocyte manages two sites for research and its headquarters and admin- istrative offices. 74 Item 4. Information on the Company The following table sets forth our major headquarters and most significant production, research and development, and administrative facilities. See also “—Item 4.B Business overview—Innovative Medicines—Production,” “—Item 4.B Business overview—Sandoz—Production” and “—Item 4.B Business overview—Alcon—Production” for a discussion of our manufacturing processes. Major facilities Location Size of site (in square meters) Major activity Basel, Switzerland – St. Johann 724 000 Global Group headquarters, global Innovative Medicines Division headquarters, research and development, production of drug substances and drug intermediates Kundl and Schaftenau, Austria 480 000 Production of biotechnological products, drug products and finished products, anti-infectives, active drug substances, product development East Hanover, New Jersey 391 000 Innovative Medicines Division US headquarters, research and development Barleben, Germany Fort Worth, Texas 340 000 Production of broad range of generics finished dosage forms 315 200 Alcon Division US headquarters; production, research and development for Alcon Vision Care and Surgical franchises; Novartis Finance Service Center Changshu (Suzhou), China 230 000 Technical research, development and manufacturing of drug substances and drug intermediates Cambridge, Massachusetts 205 000 Research and development Shanghai, China Ringaskiddy, Ireland Johns Creek, Georgia Ljubljana, Slovenia Hyderabad, India 106 500 Research and development 85 000 Production of drug substances and drug intermediates 84 100 Production, research and development for Alcon Vision Care franchise 83 000 Production of broad range of finished solid and sterile dosage forms 80 500 General administrative and development global service center Grosswallstadt, Germany 65 200 Production, research and development for Alcon Vision Care franchise Stein, Switzerland 64 700 Production of sterile vials, pre-filled syringes and ampoules, and of inhalation capsules, tablets and transdermals, and of active pharmaceutical ingredients Holzkirchen, Germany 64 200 Sandoz Division global headquarters, production of oral films, transdermal delivery systems, Grimsby, UK Menges, Slovenia Puurs, Belgium Kurtkoy, Turkey Stryków, Poland matrix patches, product development 64 000 Production of drug substances and drug intermediates 62 400 Production of drug substances and drug intermediates 55 000 Production for Innovative Medicines ophthalmic products and Alcon Surgical franchise 51 700 Production of Innovative Medicines solids 45 000 Production of broad range of bulk oral solid forms and packaging Rudolstadt, Germany 44 000 Development and production of respiratory technologies and ophthalmics Johor, Malaysia 43 900 Production for Alcon Vision Care franchise Rueil-Malmaison, France 43 700 Administrative offices for Innovative Medicines and Alcon Irvine, California Torre, Italy Houston, Texas Batam, Indonesia Huningue, France Singapore Barbera, Spain 40 800 Production, research and development for Alcon Surgical franchise 40 100 Production of Innovative Medicines solids 37 400 Production for Alcon Surgical franchise 35 000 Production for Alcon Vision Care franchise 35 000 Production of drug substances for clinical and commercial supply 35 000 Production for Alcon Vision Care franchise and Innovative Medicines solids and biologics 33 000 Production of tablets, capsules and inhalation products Basel, Switzerland – Schweizerhalle 31 700 Production of drug substances and drug intermediates Wehr, Germany 31 700 Production of tablets and packaging Huntington, West Virginia 27 500 Production for Alcon Surgical franchise Tokyo, Japan Sasayama, Japan 26 000 Administrative offices for Innovative Medicines, Sandoz and Alcon 23 300 Packaging site for Innovative Medicines Sinking Spring, Pennsylvania 21 800 Production for Alcon Surgical franchise Morris Plains, New Jersey 15 600 Production for Innovative Medicines Division cell and gene therapies Princeton, New Jersey 14 300 Sandoz Division US headquarters Cork, Ireland Libertyville, Illinois 13 600 Production for Alcon Surgical franchise 9 800 Production, warehouse, and administrative offices for AveXis Targu Mures, Romania 9 070 Production of solids for Innovative Medicines and Sandoz Schaffhausen, Switzerland 4 100 Production for Alcon Surgical franchise La Jolla, California Bannockburn, Illinois 3 300 Research and development, and quality control testing for AveXis 3 000 AveXis headquarters West Lafayette, Indiana 2 000 Headquarters, research laboratory and administrative offices for Endocyte Millburn, New Jersey 1 400 AAA primary production site for radioligand therapy Colleretto Giacosa/Ivrea, Italy 1 200 AAA primary production site for radioligand therapy Saint-Genis-Pouilly, France 600 AAA global headquarters 75 Item 4. Information on the Company To support the objectives of Novartis Technical Opera- tions, we are progressing with our network transforma- tion project, under which we are reviewing our manufac- turing network to ensure it can appropriately meet the future needs of the Group. Under this transformation plan, we have made the following announcements: • In May 2017, we announced the planned closure of one manufacturing building at each of our Basel, Switzer- land, and Schweizerhalle, Switzerland, sites by 2019. • In October 2017, we announced our plan to close com- mercial production operations at our Broomfield, Col- orado, site, with production anticipated to conclude during 2019. • In November 2017, we announced our plan to exit our packaging operations in Wehr, Germany, by 2022. • In April 2018, we announced the planned closure of our Kaminoyama, Japan, site and the transfer of all pack- aging activities to Sasayama, Japan, by 2020. • In May 2018, we announced an agreement with Avara Pharmaceutical Services to divest our Boucherville, Canada, plant. This divestment was completed on Sep- tember 1, 2018. • In September 2018, we announced that Aurobindo Pharma USA Inc. agreed to acquire our manufacturing facilities in Wilson, North Carolina; Hicksville, New York; and Melville, New York, as part of the divestment of the US dermatology business and generic US oral solids portfolio of our Sandoz Division. We expect this trans- action to be completed during the course of 2019. • In September 2018, we announced the acquisition of our Mahad, India, site by Olon S.p.A., which we expect to be completed in 2019. • Also in September 2018, we announced the proposed exit of manufacturing operations in Grimsby, United Kingdom, as well as the closure of a building in Sch- weizerhalle, Switzerland, by 2020 and the milling and blending center in Stein, Switzerland, by 2021. • In December 2018, we announced the transfer of the packaging and repackaging activities from our Can- delaria, Mexico, site to a local contract manufacturer in 2019. • In December 2018, we announced an offer to acquire CellforCure from LFB, including its cell and gene man- ufacturing facility located in Les Ulis, France. If this transaction closes as planned, CellforCure is expected to become a wholly owned Novartis manufacturing site managed by NTO. We expect this transaction to be completed during the first half of 2019. • In December 2018, we completed the exit of our site in Turbhe, India. In 2012, Novartis announced the construction of a new state-of-the-art production facility to produce solid dos- age form medicines for the Innovative Medicines Division in Stein, Switzerland. We expect our investment in this facility to exceed USD 0.6 billion. The new facility is planned to replace an older facility. In addition, Novartis is investing in new technologies and packaging facilities for pharmaceuticals at Stein. Stein is a technological competence center for both sterile and solid dosage form drugs. Through December 31, 2018, the total amount paid and committed to be paid on this project is equivalent to approximately USD 0.6 billion. In 2012, we announced the planned construction of a new state-of-the-art biotechnology production site in Singapore, with a planned investment of over USD 0.8 bil- lion. The new facility will focus on drug substance man- ufacturing based on cell culture technology. Ground was broken in February 2013, and construction was com- pleted in the third quarter of 2015 for phase one of the project. Phase one of this project is now operational, and we expect phase two to be operational in 2019. The facil- ity is co-located with the pharmaceutical production site based in Tuas, Singapore. In the future, Singapore is expected to be a technological competence center for both biotechnology and pharmaceutical manufacturing at Novartis. Through December 31, 2018, the total amount paid and committed to be paid on this project is equiva- lent to USD 0.7 billion. An expansion of our Alcon Division’s Johns Creek, Georgia, facility was approved in 2017 to add three pro- duction lines of Dailies Total1 contact lenses. This proj- ect is still in progress. We expect to pay a total amount of approximately USD 0.1 billion on this project. Through December 31, 2018, the total amount paid and commit- ted to be paid on this project is approximately USD 0.1 billion. In March 2018, the second phase of expansion of the Grosswallstadt, Germany, and Singapore facilities relat- ing to the production of contact lenses was approved. We expect to pay a total amount of approximately USD 0.4 billion on the Grosswallstadt project and approxi- mately USD 0.1 billion on the Singapore project, in each case for both the first and second phases of expansion. Through December 31, 2018, the total amount paid and committed to be paid on the Grosswallstadt project is equivalent to approximately USD 0.3 billion, and the total amount paid and committed to be paid on the Singapore project is equivalent to approximately USD 0.1 billion. In July 2018, AveXis initiated construction of a new 15 800-square-meter state-of-the-art gene therapy manufacturing facility in Durham, North Carolina. The new facility is expected to complement the existing AveXis site in Libertyville, Illinois, and allow for produc- tion of multiple gene therapy products simultaneously. The site is expected to be fully operational in 2020. We expect to pay a total amount of USD 0.2 billion. Through December 31, 2018, the total amount paid and commit- ted to be paid on this project is approximately USD 0.1 billion. In August 2018, Novartis Technical Operations announced its plan to establish a European cell and gene therapy hub in Stein, Switzerland. We expect our invest- ment in this project to exceed USD 0.1 billion. Through December 31, 2018, the total amount paid and commit- ted to be paid on this project is equivalent to USD 22 mil- lion. 76 Item 4. Information on the Company In November 2018, Novartis announced the construc- tion of a new state-of-the-art advanced integrated bio- logics manufacturing facility in Schaftenau, Austria. We expect our investment in this facility to exceed USD 0.2 billion. We expect phase one of this project to be oper- ational in 2020. Through December 31, 2018, the total amount paid and committed to be paid on this project is equivalent to approximately USD 0.1 billion. Environmental matters We integrate core values of environmental protection into our business strategy to protect the environment, add value to the business, manage risk and enhance our rep- utation. For example, our Executive Committee recently endorsed new targets for environmental sustainability related to our carbon footprint, waste production and water sustainability, and we announced a virtual power purchase agreement for renewable energy. We are subject to laws and regulations concerning the environment, safety matters, regulation of chemicals, and product safety in the countries where we manufac- ture and sell our products or otherwise operate our busi- ness. These requirements include regulation of the han- dling, 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 haz- ardous substances into the environment that could cause environmental or property damage or personal injuries, and that could require remediation of contami- nated soil and groundwater – in some cases over many years – regardless of whether the contamination was caused by us or by previous occupants of the property. See “Item 3. Key Information—Item 3.D Risk factors— Environmental, social and governance matters may impact our business and reputation,” and “Item 3. Key Information—Item 3.D Risk factors—Environmental lia- bilities may adversely impact our financial results.” See also “Item 4. Information on the Company—Item 4.B Busi- ness overview—Overview—Corporate responsibility,” and “Item 18. Financial Statements—Note 19. Provisions and other non-current liabilities.” 77 Item 4A. Unresolved Staff Comments Item 4A. Unresolved Staff Comments Not applicable. 78 Item 5. Operating and Financial Review and Prospects Item 5. Operating and Financial Review and Prospects 5.A Operating results This operating and financial review should be read together with the Group’s consolidated financial state- ments in this Annual Report, which have been prepared in accordance with International Financial Reporting Standards (IFRS) as published by the International Accounting Standards Board (see “Item 18. Financial Statements”). “Item 5 Operating and Financial Review and Prospects” together with the sections on com- pounds in development and key development projects of our divisions (see “Item 4. Information on the Compa- ny-Item 4.B Business overview”) constitute the Operat- ing and Financial Review (“Lagebericht”), as defined by the Swiss Code of Obligations. Overview As a leading global medicines company, we use innovative science and digital technologies to create transforma- tive treatments in areas of great medical need. Our pur- pose is to reimagine medicine to improve and extend people’s lives. Our vision is to be a trusted leader in changing the practice of medicine. Our strategy is to focus Novartis as a leading medicines company powered by advanced therapy platforms and data science. The Group comprises three global operating divisions and we separately report the results of Corporate activ- ities: • Innovative Medicines: innovative patent protected pre- scription medicines • Sandoz: generic pharmaceuticals and biosimilars • Alcon: surgical and vision care products • Corporate activities The financial results of our Corporate activities include the costs of the Group headquarters and those of corporate coordination functions in major countries. In addition, Corporate includes other items of income and expense that are not attributable to specific seg- ments such as certain revenues from intellectual prop- erty rights and certain expenses related to post employ- ment benefits, environmental remediation liabilities, charitable activities, donations and sponsorships. In June 2018, we announced that we plan to spin off Alcon into a separately-traded standalone company. As two distinct publicly traded companies, we believe Novartis and Alcon will be better positioned to capital- ize on significant growth opportunities and focus resources on their respective businesses and strategic priorities. Our divisions are supported by the following cross-di- visional organizational units: the Novartis Institutes for BioMedical Research, Global Drug Development, Novartis Technical Operations and Novartis Business Services. The financial results of these organizational 79 units are included in the results of the divisions for which their work is performed. As part of the planned spin-off of Alcon, efforts are being undertaken to prepare for the separation of Alcon from Novartis and to enable Alcon to operate as a standalone public company. As part of these efforts, Alcon is forming its own supporting func- tions and service organizations. As part of the long-term strategy to build a leading, focused medicines company powered by advanced ther- apy platforms and data science, we announced and/or completed several acquisitions and divestments during 2018, 2017 and 2016. For a description of these acqui- sitions and divestments and other significant transac- tions, refer to “Item 4.A History and development of Novartis – Important Corporate developments 2016 – 2018”, and “Item 18. Financial Statements – Note 2. Sig- nificant transactions” and “Note 30. Events subsequent to the December 31, 2018, consolidated balance sheet date – proposal to the Annual General Meeting of Share- holders to approve a spin-off transaction of the Alcon Division”. During 2018 and 2017 Novartis announced several new nominations to the Executive Committee of Novartis including the appointment of Vasant (Vas) Narasimhan, M.D., Global Head of Drug Development and Chief Med- ical Officer, as CEO of Novartis, effective February 1, 2018. For a more detailed description of these nomina- tions please refer to “Item 4. Information on the Com- pany – Item 4.B Business overview”. In 2018, Novartis achieved net sales of USD 51.9 bil- lion, of which USD 13.0 billion, or 25%, came from Emerg- ing Growth Markets, and USD 38.9 billion, or 75%, came from Established Markets. Emerging Growth Markets comprise all markets other than the Established Markets of the US, Canada, Western Europe, Japan, Australia and New Zealand. Innovative Medicines accounted for USD 34.9 billion, or 67%, of Group net sales, and for USD 7.9 billion, or 87%, of Group operating income (excluding Corporate income and expense, net). Sandoz accounted for USD 9.9 billion, or 19%, of Group net sales, and for USD 1.3 billion, or 15%, of Group operating income (excluding Corporate income and expense, net). Alcon accounted for USD 7.1 billion, or 14%, of Group net sales, and an increased operating loss of USD 0.2 billion. Effective January 1, 2018, following the internal reor- ganization, announced on October 24, 2017, and Janu- ary 24, 2018, we transferred our over-the-counter oph- thalmic products and certain surgical diagnostic products with sales in 2017 of USD 747 million (2016: USD 731 mil- lion) from the Innovative Medicines Division to the Alcon Division. Our prescription Ophthalmic medicines busi- ness remains with the Innovative Medicines Division. As Item 5. Operating and Financial Review and Prospects the Innovative Medicines Division will discontinue its use of the Alcon brand name, the intangible asset has been transferred from corporate to the Alcon Division. In com- pliance with IFRS, we updated our segment reporting to reflect this transfer, both for the current and prior years, to aid comparability of year-on-year results. This restate- ment had no impact on the reported financial results of the Sandoz Division or the total Group. Opportunity and risk summary Our financial results are affected to varying degrees by external factors. The healthcare industry is entering a phase of significant progress and change. Over the next two decades, we believe biomedical innovation will con- tinue to accelerate – potentially spawning new treat- ments that could have unparalleled impact on humanity, including in areas such as cancer and heart disease. The digital revolution that is now gaining momentum in health- care is likely to transform everything from drug research and development to how doctors diagnose and treat dis- eases. These trends could help society address the chang- ing healthcare needs of aging populations and produce better health outcomes for patients. At the same time, loss of market exclusivity and the introduction of branded and generic competitors could significantly erode sales of our innovative products. Our ability to grow depends on the success of our research and development efforts to replenish our pipeline, as well as on the commercial acceptance of our products in the markets. Increased pricing pressure could impact our ability to generate returns and invest for the future. We have a significant global compliance program in place, but any failure to comply with local laws could lead to substantial liabilities. Our manufacturing processes are technically complex and subject to strict regulatory requirements, which introduce a greater chance for dis- ruptions and liabilities. Our dependence on information technology puts us at risk of information security threats and losses of per- sonal data. We may also fail to take advantage of rapid progress in digital technologies and in the development of new business models, and third parties may enter the healthcare field and could supplant portions of our busi- ness We carry a significant amount of goodwill and other intangible assets on our consolidated balance sheet, and may incur significant impairment charges in the future. We pay taxes in numerous countries, and tax authorities around the world have increased their scrutiny of com- pany tax filings. In addition, tax reform initiatives by the OECD, the EU, Switzerland and the US will require us to continually assess our organizational structure against tax policy trends, could lead to an increased risk of inter- national tax disputes and an increase in our effective tax rate, and could adversely affect our financial results. For more details on these trends and how they could impact our results, see “—Factors affecting results of operations” starting on page 105. 80 Item 5. Operating and Financial Review and Prospects Results of operations 2018 compared to 2017 Key figures (USD millions unless indicated otherwise) Net sales to third parties Other revenues Cost of goods sold Gross profit Selling, general and administration Research and development Other income Other expense Operating income Return on net sales (%) Income from associated companies Interest expense Other financial income and expense Income before taxes Taxes Net income Attributable to: Shareholders of Novartis AG Non-controlling interests Basic earnings per share (USD) Net cash flows from operating activities Free cash flow 1 Year ended Year ended Dec 31, 2018 Dec 31, 2017 Change in USD % Change in constant currencies % 51 900 49 109 1 266 1 026 – 18 407 – 17 175 34 759 32 960 – 16 471 – 14 997 – 9 074 – 8 972 1 690 1 969 – 2 735 – 2 331 8 169 8 629 15.7 6 438 – 957 185 17.6 1 108 – 777 39 13 835 8 999 – 1 221 – 1 296 12 614 7 703 12 611 7 703 3 0 5.44 3.28 14 272 12 621 11 717 10 428 6 23 – 7 5 – 10 – 1 – 14 – 17 – 5 nm – 23 nm 54 6 64 64 nm 66 13 12 5 23 – 6 5 – 9 0 – 15 – 16 – 5 nm – 27 nm 54 5 64 64 nm 66 1 For an explanation of non-IFRS measures and reconciliation tables, see “ —Item 5.A Operating results—Non-IFRS measures as defined by Novartis.” nm = not meaningful Group overview Novartis delivered strong performance in 2018 driven by continued sales momentum from our key growth prod- ucts and the successful acquisition of Advanced Accel- erator Applications (AAA). Net sales for Novartis were USD 51.9 billion, up 6% in reported terms and up 5% measured in constant cur- rencies (cc) to remove the impact of exchange rate move- ments. The strong sales growth was driven by volume growth of 9 percentage points (cc), mainly driven by Cosentyx, AAA and four additional drugs reaching block- buster status (Promacta/Revolade, Tafinlar + Mekinist, Entresto and Xolair). The strong volume growth was partly offset by the negative impacts of pricing (-2 per- centage points) and generic competition (-2 percentage points). Cosentyx, our treatment for psoriasis and other auto- immune diseases, grew strongly across all indications, with sales rising 37% (+36% cc), to USD 2.8 billion. Entresto, our product for heart failure has now more than doubled sales reaching USD 1.0 billion. Our treatments for certain cancer and related rare diseases continued to grow, driven by strong demand. Promacta/Revolade, a treatment for blood disorders, grew 35% (+35% cc) to USD 1.2 billion. Tafinlar + Mekinist, a combination treatment for skin and lung cancers, had sales of USD 1.2 billion, up 32% (+31% cc). Jakavi, a treat- ment for rare blood cancers, grew 26% (+24% cc) to USD 977 million. Sales of the products from AAA, including Lutathera, a radioligand therapy for a rare type of can- cer in the pancreas or gut, amounted to USD 355 million. By division, Innovative Medicines sales grew 8% (+8% cc). Alcon sales grew 6% (+5% cc), reflecting the sec- ond consecutive year of growth, mainly as a result of improved operations and customer relationships. Sandoz sales declined 2% (–3% cc), mainly due to lower retail generics, which was impacted by continued US indus- try-wide pricing pressures, partly offset by growth in Bio- pharmaceuticals including the continued uptake of Rix- athon and Erelzi in Europe. Operating income in 2018 was USD 8.2 billion (–5%, –5% cc), mainly due to the impacts from M&A transac- tions, higher restructuring and net impairment charges, and growth investments, partly offset by higher sales. Operating income margin in constant currencies decreased 1.6 percentage points; currency had a nega- 81 Item 5. Operating and Financial Review and Prospects tive impact of 0.3 percentage points resulting in a net decrease of 1.9 percentage points to 15.7% of net sales. Net income was USD 12.6 billion compared to USD 7.7 billion in the prior year, mainly benefiting from a USD 5.7 billion net gain from the divestment of our stake in the GSK consumer healthcare joint venture. Earnings per share were USD 5.44 compared to USD 3.28 in the prior year, driven by higher net income and the lower number of shares outstanding. Free cash flow grew 12% to USD 11.7 billion compared to USD 10.4 billion in the prior year driven by higher cash flows from operating activities, which includes the receipt of a GSK sales milestone from the divested Vaccines business, partly offset by higher net investments in intan- gible assets. We also present our core results, which exclude the impact of amortization, impairments, disposals, acquisi- tions, restructurings and other significant one-time items, to help investors understand our underlying perfor- mance. Core operating income was USD 13.8 billion (+8%, +8% cc) driven by higher sales and gross margin, which were partly offset by growth investments, including AveXis. Core operating income margin in constant cur- rencies increased 0.7 percentage points; currency had a negative impact of 0.3 percentage points resulting in a net increase of 0.4 percentage points to 26.6% of net sales. Core net income was USD 11.9 billion (+5%, +5% cc), driven by growth in core operating income, which was partly offset by the discontinuation of core income from the GSK consumer healthcare joint venture from April 1, 2018. Core earnings per share were USD 5.15 (+6%, +6% cc), driven by growth in core net income and the lower number of shares outstanding. Net sales by segment The following table provides an overview of net sales to third parties by segment: (USD millions) Innovative Medicines Sandoz Alcon Net sales to third parties 1 Restated to reflect the product transfers between divisions that was effective as of January 1, 2018. Year ended Year ended Dec 31, 2017 restated 1 Dec 31, 2018 Change in USD % 34 892 32 278 9 859 10 060 7 149 6 771 51 900 49 109 8 – 2 6 6 Change in constant currencies % 8 – 3 5 5 Innovative Medicines Following the internal reorganization announced on October 24, 2017, and January 24, 2018, that was effec- tive January 1, 2018, we transferred our over-the-counter ophthalmic products and certain surgical diagnostic products with sales in 2017 of USD 747 million (2016: USD 731 million) from the Innovative Medicines Division to the Alcon Division. Our prescription Ophthalmic medicines business remains with the Innovative Medicines Division. In compliance with IFRS, we updated our segment reporting to reflect this transfer, both for the current and prior years, to aid comparability of year- on-year results. For details on the Innovative Medicines net sales by business franchise see also “Item 18. Finan- cial Statement – Note 3. Segmentation of key figures 2018, 2017 and 2016.” In addition to this, the former Immunology and Der- matology franchise was reorganized into Immunology, Hepatology and Dermatology, and certain products were transferred to Established Medicines. Innovative Medicines Division delivered net sales of USD 34.9 billion in 2018, up 8% in reported terms and in constant currencies (cc). The Pharmaceuticals Business Unit grew 7% (cc), driven by Cosentyx reaching USD 2.8 billion and Entresto reaching USD 1.0 billion. Oncology Business Unit grew 9% (cc), driven by AAA, including Luthathera, Promacta/Revolade and Tafinlar + Mekinist both reaching USD 1.2 billion and Jakavi reaching USD 977 million. Volume contributed 11 percentage points to sales growth. Generic competition had a negative impact of 2 percentage points. Pricing had a negative impact of 1 percentage point. Regionally, in the US (USD 11.9 billion, +9%), the strong performance was driven by Cosentyx, Entresto, Promacta/Revolade and Lutathera. Europe sales (USD 12.3 billion, +8% cc) were driven by Cosentyx, Entresto and Jakavi. Japan sales (USD 2.4 billion, –3% cc) declined mainly due to the biennial price cut and generic compe- tition. Emerging Growth Markets sales increased 10% (cc) to USD 8.6 billion, mainly driven by strong growth in China. 82 Item 5. Operating and Financial Review and Prospects The following table provides an overview of net sales to third parties by franchise of the Innovative Medicines Divi- sion: (USD millions) Total Oncology business unit Total Pharmaceuticals business unit Ophthalmology Neuroscience Immunology, Hepatology and Dermatology Respiratory Cardio-Metabolic Established Medicines Total Innovative Medicines Year ended Year ended Dec 31, 2018 Dec 31, 2017 1 13 428 12 274 21 464 20 004 4 558 3 429 3 392 1 767 1 050 7 268 4 621 3 287 2 474 1 617 524 7 481 34 892 32 278 Change in USD % Constant currencies change % 9 7 – 1 4 37 9 100 – 3 8 9 7 – 2 4 37 8 100 – 3 8 1 Restated to reflect the product transfers between divisions that was effective as of January 1, 2018, and the new franchise structure of Immunology, Hepatology and Dermatology The following table provides the top 20 Innovative Medicines Division product net sales – 2018 US Rest of world Total Business franchise Indication % change USD m USD/cc 2 % % change change cc 2 USD USD m % % change change cc 2 USD USD m Neuroscience Relapsing multiple sclerosis 1 765 3 1 576 7 5 3 341 5 4 Brands Gilenya Cosentyx Lucentis Tasigna Xolair 1 Entresto Jakavi Votrient Ilaris Immunology, Hepatology and Dermatology Ophthalmology Psoriasis, ankylosing spondylitis and psoriatic arthritis Age-related macular degeneration 1 674 31 1 163 46 44 2 837 37 36 Oncology Chronic myeloid leukemia 806 0 1 068 2 046 8 4 7 3 2 046 1 874 8 2 7 1 Sandostatin Oncology Gleevec/Glivec Oncology Carcinoid tumors and acromegaly Chronic myeloid leukemia and GIST 817 – 2 770 – 1 – 1 1 587 – 2 – 2 440 – 30 1 121 – 15 – 16 1 561 – 20 – 20 Afinitor/Votubia Oncology Breast cancer/TSC 929 13 627 – 11 – 12 1 556 Galvus Group Established Medicines Diabetes 1 284 4 6 1 284 Promacta/Revolade Oncology Immune thrombocytopenic purpura Tafinlar + Mekinist Oncology Melanoma Exjade/Jadenu Oncology Chronic iron overload 581 457 521 30 35 1 593 698 578 41 31 6 40 29 1 174 1 155 5 1 099 2 4 35 32 4 Respiratory Asthma 1 039 13 12 1 039 13 Cardio-Metabolic Chronic heart failure 556 87 472 125 124 1 028 103 102 Diovan Group Established Medicines Hypertension Exforge Group Established Medicines Hypertension 84 – 3 19 – 32 939 983 8 5 8 5 1 023 1 002 7 4 Oncology Oncology Myelofibrosis 977 26 24 977 26 Renal cell carcinoma 404 – 1 424 6 5 828 2 Immunology, Hepatology and Dermatology Auto-inflammatory (CAPS, TRAPS, HIDS/MKD, FMF, SJIA, AOSD and gout) 262 34 292 42 44 554 38 39 2 6 35 31 3 12 7 4 24 2 Travoprost Group Ophthalmology Reduction of elevated intraocular pressure 194 – 10 323 – 13 – 13 517 – 12 – 12 Zortress/Certican Established Medicines Transplantation 145 12 319 Top 20 products total Rest of portfolio Total division sales 9 654 11 17 292 2 210 4 5 736 11 864 9 23 028 12 10 0 8 12 464 9 26 946 0 7 946 7 34 892 12 10 1 8 12 10 1 8 1 Net sales reflect Xolair sales for all indications (e.g., including Xolair SAA and Xolair CSU, which is managed by the Immunology, Hepatology and Dermatology franchise). 2 Constant currencies (cc) is a non-IFRS measure. For an explanation of non-IFRS measures, see “ —Item 5.A Operating results—Non-IFRS measures as defined by Novartis.” For information about the approved indications for the products described, see “Item 4. Information on the Com- pany—Item 4.B Business overview—Innovative Medicines—Key marketed products”. 83 Item 5. Operating and Financial Review and Prospects Novartis Oncology business unit Oncology sales were USD 13.4 billion (+9% cc) driven by AAA, including Luthathera, Promacta/Revolade, Tafinlar + Mekinist and Jakavi. Tasigna (USD 1.9 billion, +1% cc) was broadly in line focused global campaign and strong retina market growth. Travoprost Group (USD 517 million, −12% cc) sales declined mainly due to generic competition in Europe and increased competition in the US. with prior year across most regions. Sandostatin (USD 1.6 billion, −2% cc) sales declined slightly, due to competitive pressure across most regions. Gleevec/Glivec (USD 1.6 billion, −20% cc) continued to decline due to generic competition in most major mar- kets. Afinitor/Votubia (USD 1.6 billion, +2% cc) sales grew slightly mainly driven by the tuberous sclerosis complex (TSC) and neuroendocrine tumor (NET) indications in the US. Promacta/Revolade (USD 1.2 billion, +35% cc) sales grew at a strong double-digit rate across all regions. Tafinlar + Mekinist (USD 1.2 billion, +31% cc) contin- ued strong double-digit growth due to increased demand in metastatic melanoma and NSCLC across all regions, with strong uptake in the adjuvant melanoma indication also contributing in the US and Europe. Exjade/Jadenu (USD 1.1 billion, +3% cc) grew driven by continued uptake in Europe and Japan as well as the FCT (film-coated tablets) formulation launch in Europe. Jakavi (USD 977 million, +24% cc) continued strong double-digit growth across all regions driven by both the myelofibrosis and polycythemia vera indications. Votrient (USD 828 million, +2% cc) sales grew slightly driven by growth in Japan and Emerging Growth Mar- kets partially offset by competitive pressures in the US and Europe. Kisqali (USD 235 million, +210% cc) continues to build momentum with growth in the US and launches in sev- eral European and Emerging Growth Markets. In July 2018, the US FDA approved two new indications for Kisqali based on the MONALEESA 3/7 trials, also approved in Europe in December 2018. Lutathera (USD 167 million) launch in the US is pro- gressing well, with over 100 centers actively treating. Sales from all AAA brands (including Lutathera and radio- pharmaceutical diagnostic products) were USD 355 mil- lion in 2018. The US FDA approved Lutathera in late Jan- uary 2018, shortly following the acquisition of AAA. In Europe, full reimbursement for Lutathera has been achieved in several countries during 2018. European authorities approved Lutathera in late September 2017. Kymriah sales were USD 76 million. In May, the US FDA approved Kymriah for a second indication – in relapsed/refractory (r/r) DLBCL. Approval of Kymriah was also granted by the European Commission, Health Canada and Swissmedic for the r/r pediatric and young adult ALL and r/r DLBCL indications. Novartis Pharmaceuticals business unit Ophthalmology Sales in the Ophthalmology franchise were USD 4.6 bil- lion (–2% cc), with increased sales of Lucentis partially offsetting the impact of generic competition for glau- coma and anti-infective portfolios mainly in the US and Europe, as well as price erosion. Lucentis (USD 2.0 billion, +7% cc) sales delivered strong growth benefitting from the implementation of a Neuroscience Sales in the Neuroscience franchise were USD 3.4 bil- lion (+4% cc), mainly driven by Gilenya. Gilenya (USD 3.3 billion, +4% cc) with approximately 267,000 treated patients worldwide, continued solid growth, driven by increased demand in Europe and US. Gilenya was approved by the FDA in May 2018 and by the European Commission in November 2018 as the first disease-modifying therapy for pediatric relapsing multi- ple sclerosis addressing the strong unmet clinical need of younger patients. Aimovig received FDA approval in May 2018 and European Commission approval in July 2018 and is now available in 25 countries as the first novel treatment designed specifically for migraine prevention. Aimovig was successfully launched in the US and ex-US launches are now underway, including local reimbursement pro- cedures. Additional regulatory filings are pending with other health authorities worldwide. Aimovig is co-com- mercialized with Amgen in the US, where Amgen records sales, and Novartis has exclusive commercialization rights for all territories excluding the US and Japan. More than 165,000 patients have been treated with Aimovig worldwide since launch. Immunology, Hepatology and Dermatology Sales in the Immunology, Hepatology & Dermatology franchise reached USD 3.4 billion (+37% cc), of which Cosentyx delivered USD 2.8 billion. Cosentyx (USD 2.8 billion, +36% cc) delivered strong volume growth across all indications in the US and EU. In October, Novartis presented five-year data in psori- atic arthritis and ankylosing spondylitis confirming the efficacy and safety benefits of Cosentyx. This adds to the results of a Phase III psoriasis study reported in 2017, demonstrating that Cosentyx delivers high and long-last- ing skin clearance in patients with moderate-to-severe plaque psoriasis, with high response rates essentially maintained from year one to year five. These scientific data are reinforcing Cosentyx’s unique position as a long-lasting comprehensive treatment across PsO, PsA and AS. Ilaris (USD 554 million, +39% cc) sales were driven by strong double-digit growth across most regions driven by volume. Respiratory Sales in the Respiratory franchise were USD 1.8 billion (+8% cc). Xolair sales amounted to USD 1.0 billion and our chronic obstructive pulmonary disease (COPD) port- folio including Onbrez Breezhaler, Seebri Breezhaler and Ultibro Breezhaler achieved sales of USD 703 million (+2% cc). Xolair (USD 1.0 billion, +12% cc) continued to grow in both indications, Severe Allergic Asthma (SAA) and in Chronic Spontaneous Urticaria (CSU, also known as CIU), a severe skin disease, driven by increasing disease 84 Item 5. Operating and Financial Review and Prospects awareness. The asthma indication is managed by the Respiratory franchise which reports all Xolair sales. Ultibro Breezhaler (USD 454 million, +8% cc) contin- ued to grow driven by positive FLAME and CLAIM study results as well as the GOLD Strategy 2018 Report and further supported by the published SUNSET study results. Cardio-Metabolic Sales in the Cardio-Metabolic franchise were USD 1.1 bil- lion (+100% cc). Entresto (USD 1.0 billion, +102% cc) sales doubled year on year driven by growing adoption by physicians and strong volume in all markets (US +87%, rest of world +124% cc). New data from the landmark PIONEER-HF trial presented at AHA 2018 and published in the NEJM reconfirms the superiority of Entresto over enalapril as demonstrated in PARADIGM-HF. Established Medicines The Established Medicines franchise had sales of USD 7.3 billion (−3% cc). Galvus Group (USD 1.3 billion, +6% cc) continues to grow driven by solid performance in Emerging Growth Markets including China. Diovan Group (USD 1.0 billion, +7% cc) saw increased demand mainly due to the recall of generic products in many markets. Exforge Group (USD 1.0 billion, +4% cc) saw increased sales mainly in Emerging Growth Markets. Zortress/Certican (USD 464 million, +12% cc) sales were driven by strong double-digit growth across all regions. Neoral/Sandimmun(e) (USD 463 million, −6% cc) declined due to generic competition and mandatory price reductions. Voltaren/Cataflam (USD 445 million, −3% cc) declined due to generic competition. Sandoz Sandoz net sales in 2018 were USD 9.9 billion, down 2% in reported terms. In constant currencies, or cc, sales declined 3%, as 8 percentage points of price erosion, mainly in the US, were partially offset by volume growth of 5 percentage points. In the US, sales were USD 2.8 billion (−16%), down mainly due to continued indus- try-wide pricing pressure. Sales in Europe were USD 5.0 billion (+5% cc) with growth in biosimilars mainly in Ger- many, France, UK and Italy. Sales in Asia, Africa and Aus- tralasia were USD 1.4 billion, down 2% (cc). Sales in Can- ada and Latin America were USD 779 million (+8% cc). Excluding the US, net sales grew 4% (cc). (USD millions) Year ended Year ended Dec 31, 2018 Dec 31, 2017 Retail Generics1 7 880 Biopharmaceuticals 1 436 8 409 1 135 Anti-Infectives (partner label/API) 543 516 Total 9 859 10 060 Change in USD % Constant currencies change % – 6 27 5 – 2 – 7 24 3 – 3 1 Of which USD 826 million (2017: USD 880 million) represents anti-infectives sold under the Sandoz name Retail Generics Sandoz markets active ingredients, intermediates and finished dosage forms of pharmaceuticals. The Retail Generics franchise includes products in the therapeutic areas of cardiovascular, central nervous system, derma- tology, gastrointestinal and hormonal therapies, metab- olism, oncology, ophthalmics, pain and respiratory, plus finished dosage forms of anti-infectives sold under the Sandoz name. Retail Generics sales in 2018 were USD 7.9 billion (–7% cc), due to the decline in the US (–22%). Biopharmaceuticals The Biopharmaceuticals business comprises biosimilars, contract biologics supplied to third parties, and Glatopa, a generic version of Copaxone®, which treats relapsing forms of multiple sclerosis and is marketed in the US. Global sales of Biopharmaceuticals grew 24% (cc) to USD 1.4 billion driven by both Europe and the US. By region, Europe continued double-digit growth driven by Rixathon (rituximab) and Erelzi (etanercept). In the US, growth was mainly driven by Zarxio (now the leading fil- grastim in the US market). Anti-Infectives Sandoz sells pharmaceutical ingredients and intermedi- ates (mainly antibiotics) to third-party customers, as well as finished dosage forms. Anti-infectives sold to third parties for sale under their own name were USD 543 mil- lion, up 3% (cc). Total Anti-Infectives sales were USD 1.4 billion (–3% cc), and included USD 826 million sales of finished dosage forms sold under the Sandoz name. 85 Item 5. Operating and Financial Review and Prospects Alcon Sales in Alcon were restated for 2017 to reflect the prod- uct transfer between the Innovative Medicines Division and Alcon Division, announced on October 24, 2017, and January 24, 2018, that was effective as of January 1, 2018. In 2017, these sales transferred from the Innovative Medicines Division to Alcon Division amounted to USD 747 million. Alcon net sales in 2018 were USD 7.1 billion (+6%, +5% cc), compared to USD 6.8 billion in the prior year. Alcon’s results reflect the second consecutive year of net sales growth mainly as a result of improved opera- tions and customer relationships. Surgical Surgical sales were USD 4.0 billion (+7% cc), with growth across all key product categories, driven mainly by advanced technology intraocular lenses (AT-IOLs) and consumables. Vision Care Vision Care sales were USD 3.2 billion (+3% cc), driven by growth in contact lenses with continued double-digit growth of Dailies Total1. Year ended Year ended Dec 31, 2017 restated 1 Dec 31, 2018 Change in USD % Constant currencies change % (USD millions) Surgical Consumables Implantables 2 227 1 136 2 097 1 034 594 Equipment/other 636 Total 3 999 3 725 Vision Care Contact lenses Ocular health Total 1 928 1 222 3 150 1 833 1 213 3 046 Total net sales 7 149 6 771 6 10 7 7 5 1 3 6 6 11 8 7 4 1 3 5 1 Restated to reflect the product transfers between divisions that was effective as of January 1, 2018. Operating income The following table provides an overview of operating income by segment: (USD millions) Innovative Medicines Sandoz Alcon Corporate Operating income Year ended Dec 31, 2018 Year ended % of Dec 31, 2017 restated 1 net sales 7 871 1 332 – 194 – 840 8 169 22.6 13.5 – 2.7 15.7 7 595 1 368 – 3 – 331 8 629 % of net sales 23.5 13.6 0.0 Change in USD % 4 – 3 nm Change in constant currencies % 4 – 2 nm – 154 – 148 17.6 – 5 – 5 nm = not meaningful 1 Restated to reflect the product transfers between divisions that was effective as of January 1, 2018. Operating income in 2018 was USD 8.2 billion (–5%, –5% cc), mainly due to the impacts from M&A transactions, higher restructuring and net impairment charges, and growth investments, partly offset by higher sales. Oper- ating income margin in constant currencies decreased 1.6 percentage points; negative currency impact was 0.3 percentage points, resulting in a net decrease of 1.9 per- centage points to 15.7% of net sales. 86 Item 5. Operating and Financial Review and Prospects Core operating income key figures1 (USD millions unless indicated otherwise) Core gross profit Selling, general and administration Research and development Other income Other expense Core operating income As % of net sales Year ended Year ended Dec 31, 2018 Dec 31, 2017 39 418 36 578 – 16 429 – 15 000 – 8 681 – 8 313 596 778 – 1 081 – 1 193 13 823 12 850 26.6 26.2 Change in USD % Change in constant currencies % 8 – 10 – 4 – 23 9 8 7 – 9 – 4 – 24 11 8 1 For an explanation of non-IFRS measures and reconciliation tables, see “ —Item 5.A Operating results—Non-IFRS measures as defined by Novartis.” The adjustments made to operating income to arrive at core operating income amounted to USD 5.7 billion (com- pared to USD 4.2 billion in 2017), increasing mainly due to higher restructuring and net impairment charges. Core operating income was USD 13.8 billion (+8%, +8% cc) driven by higher sales and gross margin, partly offset by growth investments, including AveXis. Core operating income margin in constant currencies increased by 0.7 percentage points; currency had a neg- ative impact of 0.3 percentage points, resulting in a net increase of 0.4 percentage points to 26.6% of net sales. The following table provides an overview of core operating income by segment: (USD millions) Innovative Medicines Sandoz Alcon Corporate Year ended Dec 31, 2018 Year ended % of Dec 31, 2017 restated 1 net sales 11 151 2 002 1 279 – 609 32.0 20.3 17.9 10 019 2 080 1 168 – 417 % of net sales 31.0 20.7 17.3 Core operating income 13 823 26.6 12 850 26.2 1 Restated to reflect the product transfers between divisions that was effective as of January 1, 2018. Change in USD % 11 – 4 10 – 46 8 Change in constant currencies % 11 – 3 10 – 43 8 Innovative Medicines Operating income was USD 7.9 billion (+4%, +4% cc) mainly driven by higher sales, partly offset by increased growth and launch investments, and higher restructur- ing charges and net impairment charges. Operating income margin in constant currencies decreased 0.8 percentage points; currency had a negative impact of 0.1 percentage points, resulting in a net decrease of 0.9 per- centage points to 22.6% of net sales. Core adjustments amounted to USD 3.3 billion, including USD 2.2 billion of amortization of intangible assets. Prior year core adjustments were USD 2.4 billion. Core adjustments increased compared to prior year mainly due to higher restructuring and net impairment charges. Core operating income was USD 11.2 billion (+11%, +11% cc) mainly driven by strong sales growth and gross margin expansion, partly offset by higher growth investments. Core operating income margin in constant currencies increased by 1.0 percentage points; currency had a negligible impact, resulting in a net increase of 1.0 percentage points to 32.0% of net sales. Core gross margin as a percentage of net sales increased by 0.9 percentage points (cc). Core R&D expenses decreased by 0.8 percentage points (cc). Core SG&A expenses increased by 0.7 percentage points (cc) due to launch investments and AveXis and AAA acquisi- tions. Core Other Income and Expense, net, was in line with prior year. Sandoz Operating income was USD 1.3 billion (–3%, –2% cc) mainly driven by impairment charges related to the Sandoz US dermatology business and generic US oral solids portfolio and lower sales partly offset by contin- ued gross margin expansion and lower amortization. Operating income margin was broadly in line with prior year. Core adjustments amounted to USD 670 million, including USD 363 million of amortization. Prior year core adjustments were USD 712 million. Core adjustments declined compared to prior year driven by net changes in legal provisions and lower amortization partially offset by impairment charges related to the Sandoz US derma- tology business and generic US oral solids portfolio. Core operating income was USD 2.0 billion (–4%, –3% cc), mainly due to the sales decline, ex-US M&S invest- ments, partially offset by continued core gross margin expansion. Core operating income margin decreased by 0.1 percentage points, currency had a negative impact 87 Item 5. Operating and Financial Review and Prospects of 0.3 percentage points, resulting in a net decrease of 0.4 percentage points to 20.3% of net sales. Core gross margin as a percentage of net sales increased by 2.4 percentage points (cc), mainly driven by productivity gains and favorable product and geo- graphic mix. Core R&D expenses increased by 0.4 per- centage points (cc). Core SG&A expenses increased by 2.2 percentage points (cc), mainly due to higher M&S investments in key ex-US markets. Core Other Income and Expense increased the margin by 0.1 percentage points (cc). Alcon Operating loss was USD 194 million for the full year, com- pared to a loss of USD 3 million in prior year, as higher sales were more than offset by the voluntary withdrawal of CyPass (USD 0.3 billion) and higher investments in growth drivers. Operating income margin in constant cur- rencies decreased 2.5 percentage points; currency had a negative impact of 0.2 percentage points, resulting in a net decrease of 2.7 percentage points to negative 2.7% of net sales. Core adjustments increased to USD 1.5 billion com- pared to USD 1.2 billion in the prior year, primarily due to the voluntary withdrawal of CyPass. Core operating income was USD 1.3 billion (+10%, +10% cc) as higher sales and improved gross margin were partly offset investments in growth drivers. Core operating income margin in constant currencies increased by 0.8 percent- age points; currency had a negative impact of 0.2 per- centage points, resulting in a net increase of 0.6 percent- age points to 17.9% of net sales. Core gross margin as a percentage of net sales increased by 1.4 percentage points (cc). Core R&D expenses decreased 0.2 percentage points (cc). Core SG&A expenses increased by 0.9 percentage points (cc) reflecting higher growth and operational investments. Core Other Income and Expense increased the margin by 0.1 percentage points (cc). Corporate income and expense, net Corporate income and expense, which includes the cost of Group management and central services, amounted to an expense of USD 840 million in 2018 compared to USD 331 million in prior year. The increase in net expense compared to prior year was mainly due to lower contri- butions from the Novartis Venture Fund, lower income from retained vaccines intellectual property, higher NBS restructuring costs and an income from a sales milestone in the prior year related to the Vaccines divestment. Research and development of Innovative Medicines Division The following table provides an overview of the reported and core research and development expense of the Innovative Medicines Division: (USD millions unless indicated otherwise) Research and exploratory development Confirmatory development Total Innovative Medicines Division research and development expense As % of Innovative Medicines net sales to third parties Core research and exploratory development2 Core confirmatory development2 Total core Innovative Medicines Division research and development expense As % of Innovative Medicines net sales to third parties Year ended Year ended Dec 31, 2017 restated 1 Dec 31, 2018 Change in USD % Change in constant currencies % – 2 770 – 2 729 – 4 905 – 4 886 – 7 675 – 7 615 22.0 23.6 – 2 665 – 2 603 – 4 675 – 4 431 – 7 340 – 7 034 21.0 21.8 – 2 0 – 1 – 2 – 6 – 4 – 1 0 0 – 2 – 5 – 4 1 2017 figures are restated to reflect the product transfers between divisions that was effective as of January 1, 2018, and in addition for certain amounts that were reclassified from research and exploratory development to confirmatory development for comparative purposes. 2 Core excludes impairments, amortization and certain other items. For an explanation of non-IFRS measures and reconciliation tables, see “ —Item 5.A Operating results—Non-IFRS measures as defined by Novartis.” Innovative Medicines Division research and explor- atory development expense increased by 2% (–1% cc) to USD 2.8 billion in 2018, and confirmatory development expense amounted to USD 4.9 billion, broadly in line with prior year. This was mainly due to higher pipeline invest- ments, including AveXis, which were offset by lower net impairment charges (mainly prior-year RLX030) and pro- ductivity. Total core research and development expense in the Innovative Medicines Division as a percentage of sales decreased by 0.8 percentage points in constant curren- cies mainly driven by continued resource allocation and productivity efforts, and the higher net sales. The impact from currency exchange rates was negligible, yielding a net decrease of 0.8 percentage points to 21.0% of net sales. 88 Item 5. Operating and Financial Review and Prospects Non-operating income and expense The following table provides an overview of non-operating income and expense: (USD millions unless indicated otherwise) Operating income Income from associated companies Interest expense Other financial income and expense Income before taxes Taxes Net income Basic EPS (USD) nm = not meaningful Year ended Year ended Dec 31, 2018 Dec 31, 2017 8 169 6 438 – 957 185 8 629 1 108 – 777 39 13 835 8 999 – 1 221 – 1 296 12 614 7 703 5.44 3.28 Change in USD % Change in constant currencies % – 5 nm – 23 nm 54 6 64 66 – 5 nm – 27 nm 54 5 64 66 Income from associated companies Income from associated companies increased to USD 6.4 billion from USD 1.1 billion in prior year, an increase of USD 5.3 billion. This increase was mainly due to the pre-tax gain of USD 5.8 billion recognized on the divest- ment of the 36.5% stake in the GSK consumer health- care joint venture. Excluding this divestment gain, income from associated companies amounted to USD 648 mil- lion compared to USD 1.1 billion in prior year. The share of income from Roche was USD 526 mil- lion compared to USD 456 million in prior year. The higher estimated income for Roche of USD 130 million in 2018, was partly offset by the net impacts from a negative prior year adjustment of USD 125 million recognized in 2018, compared to a negative prior year adjustment of USD 67 million recognized in 2017. The share of income from the GSK consumer healthcare joint venture decreased by USD 509 million compared to prior year, due to the dis- continuation of the recognition of income from April 1, 2018 (see “Item 18. Financial Statements—Note 2. Sig- nificant transactions”). Interest expense and other financial income and expense Interest expense was USD 957 million compared to USD 777 million in prior year, an increase of USD 180 million due to higher interest expense of USD 134 million relat- ing to the level of outstanding debt, and higher interest expense of USD 46 million on discounting of long term liabilities. Other financial income and expense amounted to an income of USD 185 million compared to an income of USD 39 million in prior year, mainly due to higher inter- est income of USD 294 million compared to USD 110 mil- lion in prior year, partly offset by higher currency losses of USD 65 million compared to currency losses of USD 58 million in prior year and higher other financial expenses, net of USD 44 million compared to USD 13 million in prior year. Taxes The tax rate in 2018 was 8.8% compared to 14.4% in prior year, due to the impact on taxes of the divestment of the 36.5% stake in the GSK consumer healthcare joint ven- ture. Excluding the impact of the divestment, the tax rate in 2018 would have been 14.4% in line with the 14.4% in prior year, as the benefit from favorable profit mix was offset by the impact from the discontinuation of the rec- ognition of the income from associated companies related to the GSK consumer healthcare joint venture from April 1, 2018 (see “Item 18. Financial Statements— Note 2. Significant transactions”). Net income Net income was USD 12.6 billion, compared to USD 7.7 billion in prior year, mainly benefiting from a USD 5.7 bil- lion net gain from the divestment of our stake in the GSK consumer healthcare joint venture, in the second quar- ter of 2018. EPS Basic earnings per share (EPS) in 2018 was USD 5.44, compared to USD 3.28 in the prior year, driven by higher net income and lower number of shares outstanding. 89 Item 5. Operating and Financial Review and Prospects Core non-operating income and expense1 The following table provides an overview of core non-operating income and expense: (USD millions unless indicated otherwise) Core operating income Core income from associated companies Core interest expense Core other financial income and expense Core income before taxes Core taxes Core net income Core basic EPS (USD) Year ended Year ended Dec 31, 2018 Dec 31, 2017 13 823 12 850 1 113 – 957 185 1 335 – 777 39 14 164 13 447 – 2 226 – 2 056 11 938 11 391 5.15 4.86 Change in USD % Change in constant currencies % 8 – 17 – 23 nm 5 – 8 5 6 8 – 17 – 27 nm 5 – 8 5 6 1 For an explanation of non-IFRS measures and reconciliation tables, see “ —Item 5.A Operating results—Non-IFRS measures as defined by Novartis.” nm = not meaningful Core income from associated companies Core income from associated companies amounted to USD 1.1 billion compared to USD 1.3 billion in prior year. The core income contribution from Roche amounted to USD 970 million compared to USD 832 million in prior year, an increase of USD 138 million, mainly due to the higher estimated contribution from core income. The share of core income from GSK consumer healthcare joint venture decreased by USD 338 million compared to prior year, due to the discontinuation of core income from April 1, 2018 (see “Item 18. Financial Statements— Note 2. Significant transactions”). Core interest expense and other financial income and expense Core interest expense was USD 957 million compared to USD 777 million in prior year. Core other financial income and expense amounted to a net income of USD 185 million, compared to USD 39 million in 2017. Core taxes The core tax rate (core taxes as a percentage of core pre-tax income) increased to 15.7% from 15.3% in the prior year. Core net income Core net income was USD 11.9 billion (+5%, +5% cc) driven by growth in core operating income, partly offset by the discontinuation of core income from the GSK con- sumer healthcare joint venture from April 1, 2018. Core EPS Core earnings per share were USD 5.15 (+6%, +6% cc), driven by growth in core net income and the lower num- ber of shares outstanding. 90 Item 5. Operating and Financial Review and Prospects 2017 compared to 2016 Key figures (USD millions unless indicated otherwise) Net sales to third parties Other revenues Cost of goods sold Gross profit Selling, general and administration Research and development Other income Other expense Operating income Return on net sales (%) Income from associated companies Interest expense Other financial income and expense Income before taxes Taxes Net income Attributable to: Shareholders of Novartis AG Non-controlling interests Basic earnings per share (USD) Net cash flows from operating activities Free cash flow 1 Year ended Year ended Dec 31, 2017 Dec 31, 2016 Change in USD % Change in constant currencies % 49 109 48 518 1 026 918 – 17 175 – 17 520 32 960 31 916 – 14 997 – 14 192 – 8 972 – 9 039 1 969 1 927 – 2 331 – 2 344 8 629 8 268 17.6 1 108 – 777 39 8 999 17.0 703 – 707 – 447 7 817 – 1 296 – 1 119 7 703 6 698 7 703 6 712 0 3.28 – 14 2.82 12 621 11 475 10 428 9 455 1 12 2 3 – 6 1 2 1 4 58 – 10 nm 15 – 16 15 15 nm 16 10 10 2 11 2 4 – 7 1 1 0 7 58 – 12 nm 12 – 13 12 12 nm 14 1 For an explanation of non-IFRS measures and reconciliation tables, see “ —Item 5.A Operating results—Non-IFRS measures as defined by Novartis.” nm = not meaningful Group overview Novartis had solid performance in 2017, as strong sales of our growth drivers – including Cosentyx (secuki- numab), Entresto (sacubitril/valsartan) and other recently launched products – continued to offset the impact of generic competition for our cancer treatment Gleevec/ Glivec, which lost patent protection in the US and Europe during 2016. Our results underscore the breadth and strength of our product portfolio and highlight our suc- cess at steering through the patent expiration of one of our biggest selling drugs. Our divisions had varied results. Sales increased in the Innovative Medicines Division, and the Alcon eye care division returned to growth in 2017. Sandoz Division sales declined, as the effects of increased price competition in the US more than offset growth in the rest of the world. Net sales in 2017 for Novartis were USD 49.1 billion, up 1% in reported terms and up 2% measured in constant currencies (cc) to remove the impact of exchange rate movements. Sales volumes increased 7%, as growth drivers – such as Cosentyx (USD 2.1 billion; +84%, +82% cc), Entresto (USD 507 million; +198%, +195% cc), Promacta/Revolade (USD 867 million; +37%, +37% cc), and Tafinlar + Mekinist (USD 873 million; +30%, +29% cc) – more than offset the impact of patent expirations for Gleevec/Glivec (USD 1.9 billion; −42%, −41% cc). The impact of currency exchange headwinds eased in 2017 compared to what we have seen for several years, particularly in 2015 when currency fluctuations had a negative 10% impact on sales. To help investors assess the impact of exchange rates on our performance, we continue to also indicate growth rates in constant cur- rencies. Operating income in 2017 was USD 8.6 billion (+4%, +7% cc), mainly driven by higher sales, productivity improvements and lower amortization, which were partly offset by generic competition and higher marketing investments to support product launches. Net income in 2017 was USD 7.7 billion (+15%, +12% cc), benefiting from growth in operating income and higher income from our stake in GSK Consumer Health- care Holdings Ltd. Basic earnings per share were USD 3.28 (+16%, +14% cc), benefiting from higher net income and our share buy- back program. Free cash flow rose 10% to USD 10.4 billion, driven mainly by improved cash flow from operating activities. 91 Item 5. Operating and Financial Review and Prospects Net sales by segment The following table provides an overview of net sales to third parties by segment: (USD millions) Innovative Medicines Sandoz Alcon Net sales to third parties 1 Restated to reflect the product transfers between divisions that was effective as of January 1, 2018. Year ended Year ended Dec 31, 2017 Dec 31, 2016 restated 1 restated 1 Change in USD % Change in constant currencies % 32 278 31 831 10 060 10 144 6 771 6 543 49 109 48 518 1 – 1 3 1 2 – 2 4 2 Innovative Medicines Following changes to the divisional structure of Novartis effective January 1, 2018, the sales and results of Innovative Medicines in 2017 and 2016 were restated and exclude the sales of the over-the-counter ophthalmic products and certain surgical diagnostic products, which were transferred to the Alcon Division. In 2017, these sales amounted to USD 747 million, and in 2016, they amounted to USD 731 million. In both years, they were reported under the Ophthalmology franchise. In addition to this, the former Immunology and Der- matology franchise was reorganized into Immunology, Hepatology and Dermatology, and certain products were transferred to Established Medicines. For details on the Innovative Medicines net sales by business franchise, see also “Item 18. Financial Statements—Note 3. Seg- mentation of key figures 2018, 2017 and 2016.” Innovative Medicines Division sales in 2017 were USD 32.3 billion, up 1% in reported terms. In constant curren- cies (cc), sales grew 2%. An 8% increase in volume more than offset the impact of generic competition (−5 per- centage points) and price declines (−1 percentage point). Products contributing to sales growth included Cosentyx, Entresto, Promacta/Revolade, Tafinlar + Mekinist, and Jakavi. Regionally, sales performance was mixed. In the US, sales rose 2% to USD 10.9 billion, overcoming the impact of generic competition, mainly for Gleevec. Sales in Europe were USD 11.1 billion, up 1% in reported terms and in line with the prior year in constant currencies, as growth drivers offset the impact of patent loss for Gleevec/Glivec. Sales rose 3% (+7% cc) in Emerging Growth Markets to USD 8.1 billion. Sales in Japan were USD 2.4 billion, a decline of 4% in reported terms and in line with the prior year in constant currencies. The following table provides an overview of net sales to third parties by franchise of the Innovative Medicines Divi- sion: (USD millions) Total Oncology business unit Total Pharmaceutical business unit Ophthalmology Neuroscience Immunology, Hepatology and Dermatology Respiratory Cardio-Metabolic Established Medicines Total Innovative Medicines Year ended Year ended Dec 31, 2017 1 Dec 31, 2016 1 12 274 12 790 20 004 19 041 4 621 3 287 2 474 1 617 524 4 733 3 233 1 412 1 521 184 7 481 7 958 32 278 31 831 Change in USD % Constant currencies change % – 4 5 – 2 2 75 6 185 – 6 1 – 3 6 – 2 2 74 8 182 – 4 2 1 Restated to reflect the product transfers between divisions that was effective as of January 1, 2018, and the new franchise structure of Immunology, Hepatology and Dermatology 92 Item 5. Operating and Financial Review and Prospects The following table provides the Top 20 Innovative Medicines Division product net sales—2017 US Rest of world Total Brands Business franchise Indication Gilenya Cosentyx Neuroscience Immunology, Hepatology and Dermatology Gleevec/Glivec Oncology Lucentis Ophthalmology Tasigna Oncology Sandostatin Oncology Relapsing multiple sclerosis Psoriasis, ankylosing spondylitis and psoriatic arthritis Chronic myeloid leukemia and GIST Age-related macular degeneration Chronic myeloid leukemia Carcinoid tumors and acromegaly Afinitor/Votubia Oncology Breast cancer/TSC Galvus Group Cardio-Metabolic Diabetes Exjade/Jadenu Oncology Chronic iron overload Exforge Group Established Medicines Hypertension % change USD m USD/cc 3 % % change change cc 3 USD USD m % % change change cc 3 USD USD m 1 709 2 1 476 4 3 3 185 2 2 1 275 67 796 119 115 2 071 84 82 627 – 48 1 316 – 38 – 37 1 943 – 42 – 41 1 888 3 4 1 888 810 12 1 031 1 6 1 841 3 6 4 9 832 – 2 819 6 780 706 – 2 – 5 515 15 28 180 1 233 544 932 3 7 2 5 8 2 1 1 612 – 2 – 1 – 3 1 525 1 233 1 3 1 059 11 960 4 2 5 11 4 Diovan Group Established Medicines Hypertension 87 – 41 870 – 6 – 4 957 – 11 – 9 Xolair 1 Respiratory Tafinlar + Mekinist Oncology Asthma Melanoma 339 14 920 534 10 43 11 41 Promacta/Revolade Oncology Votrient Jakavi Oncology Oncology Travoprost Group Ophthalmology Immune thrombocytopenic purpura Renal cell carcinoma Myelofibrosis Reduction of elevated intraocular pressure 446 407 44 14 421 30 31 401 8 7 777 34 32 Entresto Cardio-Metabolic Chronic heart failure 297 161 210 275 262 507 198 195 Immunology, Hepatology and Neoral/Sandimmun(e) Dermatology Transplantation 38 – 7 450 – 5 Voltaren/Cataflam Established Medicines Inflammation/pain 465 – 11 – 4 – 4 488 – 5 465 – 11 216 2 373 – 9 – 9 589 – 5 – 5 920 873 867 808 777 10 30 37 11 34 11 29 37 10 32 8 445 6 16 123 2 3 24 568 4 2 412 – 11 5 298 – 2 0 7 710 – 5 – 4 10 857 2 21 421 1 2 32 278 1 2 – 4 – 4 4 Top 20 products total Rest of portfolio2 Total division sales2 1 Net sales reflect Xolair sales for all indications (e.g. including Xolair SAA and Xolair CSU, which are managed by the Immunology, Hepatology and Dermatology franchise). 2 Restated to reflect the product transfers between the Innovative Medicines and Alcon Divisions that was effective as of January 1, 2018 3 Constant currencies (cc) is a non-IFRS measure. For an explanation of non-IFRS measures, see “ —Item 5.A Operating results—Non-IFRS measures as defined by Novartis.” For information about the approved indications for the products described below, see “Item 4. Information on the Company—Item 4.B Business overview—Innovative Medicines—Key marketed products.” Novartis Oncology business unit Oncology sales in 2017 were USD 12.3 billion (−3% cc), as strong performance of existing products and the launch of new products, including Kisqali, Rydapt and Kymriah, helped to partially offset the effects of generic competition on Gleevec/Glivec. Significant gains on key hematology products, such as Tasigna, Promacta/ Revolade and Jakavi, were complemented by Tafinlar + Mekinist, which was approved for advanced non-small cell lung cancer in addition to the existing use in mela- noma. Gleevec/Glivec (USD 1.9 billion, −41% cc) continued to decline this year, driven by generic competition pri- marily across Europe and the US. Tasigna (USD 1.8 billion, +9% cc) continued to grow this year, primarily in the US and Emerging Growth Mar- kets, despite some impact of generic imatinib in Europe for patients with previously untreated Philadelphia chro- mosome-positive (Ph+) chronic myeloid leukemia. Sandostatin (USD 1.6 billion, −1% cc) declined slightly this year, driven by increased competitive pressure pri- marily in the US and Japan, which was partially offset by growth in Latin America and Emerging Growth Markets. Afinitor/Votubia (USD 1.5 billion, +2% cc) grew slightly this year as the neuroendocrine tumors and tuberous sclerosis complex indications compensated for compet- itive pressure in the breast cancer and renal cell carci- noma indications. Exjade/Jadenu (USD 1.1 billion, +11% cc) sales growth was primarily driven by solid growth in the US in addition to continued uptake of the film-coated tablet formulation in Europe. 93 Item 5. Operating and Financial Review and Prospects Tafinlar + Mekinist (USD 873 million, +29% cc) sales growth was primarily driven by combination uptake across Europe in addition to launch uptake in the US for the non-small cell lung cancer indication. Promacta/Revolade (USD 867 million, +37% cc) con- tinued to deliver solid double-digit growth across all regions. Votrient (USD 808 million, +10% cc) worldwide growth was driven primarily by the advanced renal cell carci- noma indication both in the US and in Emerging Growth Markets, specifically China and Asia-Pacific countries. Jakavi (USD 777 million, +32% cc) delivered strong double-digit growth across all regions, driven by contin- ued momentum in the myelofibrosis indication in addi- tion to reimbursement and launch uptake in the polycy- themia vera indication across Europe. Novartis Pharmaceuticals business unit Ophthalmology Sales in the Ophthalmology franchise were restated for 2017 and 2016 to reflect the product transfers between the Innovative Medicines and Alcon Divisions, announced on October 24, 2017, and January 24, 2018, that was effective January 1, 2018. Total sales for 2017 amounted to USD 4.6 billion (−2% cc), with increased sales of Lucentis helping to partially offset the impact of generic competition. Lucentis (USD 1.9 billion, +4% cc) sales continued to grow, driven by market expansion in Europe, Japan and Emerging Growth Markets, and reimbursement listing in China for neovascular age-related macular degenera- tion. Travoprost Group (USD 589 million, −5% cc) sales declined mainly due to loss of exclusivity in Europe. Neuroscience Neuroscience franchise sales in 2017 were USD 3.3 bil- lion (+2% cc), driven by increased sales for Gilenya (USD 3.2 billion, +2% cc) which continued to grow across regions, mainly driven by volume. Immunology, Hepatology and Dermatology Sales in 2017 in the Immunology, Hepatology and Der- matology franchise reached USD 2.5 billion ( +74% cc). Cosentyx saw continued strong growth across all indi- cations, particularly in the US and Europe, reaching USD 2.1 billion (+82% cc). Ilaris also continued to deliver strong gains (+42% cc). Respiratory Respiratory franchise sales in 2017 were USD 1.6 billion (+8% cc). Our chronic obstructive pulmonary disease (COPD) portfolio – including Onbrez Breezhaler, Seebri Breezhaler and Ultibro Breezhaler – achieved sales of USD 674 million (+5% cc). Sales of Xolair, for moder- ate-to-severe or severe, persistent asthma, as well as for chronic hives, reached USD 920 million (+11% cc) and showed balanced growth across all regions. Cardio-Metabolic Sales for the franchise in 2017 were USD 524 million (+182% cc). Entresto – which has been launched in nearly 60 countries and used to treat more than 420 000 heart failure patients worldwide – continued to grow, and sales reached USD 507 million (+195% cc). Entresto perfor- mance was driven by growing adoption by physicians in the US and EU, and continued market access improve- ment. Established Medicines The Established Medicines franchise had sales in 2017 of USD 7.5 billion (−4% cc). Increased sales of Galvus Group and Exforge Group were more than offset by declines for products such as Diovan Group, Neoral/San- dimmun(e) and Exelon/Exelon Patch (−14% cc) due to generic competition. Galvus Group (USD 1.2 billion, +5% cc) continued to grow, driven by solid performance in Japan and Emerg- ing Growth Markets. Exforge Group (USD 960 million, +4% cc) grew despite ongoing generic competition in the US and Japan, and new generic competition in Europe in 2017. Growth was driven by Emerging Growth Markets. Diovan Group (USD 957 million, −9% cc) saw sales decline due to loss of exclusivity including in the US, EU and Japan, while sales continued to grow in China and some Emerging Growth Markets. Neoral/Sandimmun(e) (USD 488 million, –4% cc) sales declined slightly due to generic competition and mandatory price reductions, mainly in Europe and Japan. Voltaren/Cataflam (USD 465 million, −4% cc) sales were impacted by increased generic competition. Sandoz Sandoz net sales in 2017 were USD 10.1 billion, down 1% in reported terms. In constant currencies, or cc, sales declined 2%. A 6 percentage-point increase in volume was more than offset by the negative 8 percentage-point effect of price erosion. Sales rose +4% (cc) in Europe to USD 4.6 billion. In the US, where we continue to see cus- tomer consolidation and greater competition, sales were USD 3.3 billion (−12%), mainly due to increased industry- wide pressure on prices in generics. Sales in Asia, Africa and Australasia were USD 1.4 billion, up 1% in constant currencies. (USD millions) Year ended Year ended Dec 31, 2017 Dec 31, 2016 Retail Generics1 8 409 Biopharmaceuticals 1 135 8 623 1 002 Anti-Infectives (partner label/API) 516 519 Total 10 060 10 144 Change in USD % Constant currencies change % – 2 13 – 1 – 1 – 3 12 – 2 – 2 1 Of which USD 880 million (2016: USD 860 million) represents Anti-infectives sold under Sandoz name 94 Item 5. Operating and Financial Review and Prospects Retail Generics Sandoz markets active ingredients, intermediates, and finished dosage forms of pharmaceuticals. The Retail Generics franchise includes products in the therapeutic areas of cardiovascular, central nervous system, derma- tology, gastrointestinal and hormonal therapies, metab- olism, oncology, ophthalmics, pain and respiratory, plus finished dosage forms of anti-infectives sold under the Sandoz name. Franchise sales in 2017 were USD 8.4 bil- lion, down 3% (cc). Declines in the US (−14%) more than offset increased sales in the rest of the world (+3% cc). Biopharmaceuticals The Biopharmaceuticals business comprises biosimilars; contract biologics supplied to third parties; and a generic version of Copaxone® 20 mg, Glatopa, which treats relapsing forms of multiple sclerosis and is marketed in the US. Global sales in 2017 of Biopharmaceuticals grew 12% (cc) to USD 1.1 billion, driven by Zarxio (filgrastim), Binocrit (epoetin alfa), and the launch of Rixathon (ritux- imab) and Erelzi (etanercept) in several European coun- tries. Anti-Infectives Sandoz sells pharmaceutical ingredients and intermedi- ates (mainly antibiotics) to third-party customers, as well as finished dosage forms. Anti-infectives sold to third parties for sale under their own name were USD 516 mil- lion, down 2% (cc) due to the discontinuation of some low-margin products. Total Anti-Infectives sales in 2017 were USD 1.4 billion, in line with the prior year in constant currencies, and included sales of finished dosage forms sold under the Sandoz name of USD 880 million, up 2% (cc). Surgical Surgical sales in 2017 grew 5% (cc) to USD 3.7 billion, mainly driven by the by the consumables portfolio (+5% cc), particularly for cataract and vitreoretinal surgery. Implantables grew 4% (cc) as strong performance of new products, including the UltraSert pre-loaded IOL deliv- ery system, the AcrySof IQ PanOptix trifocal IOL and AcrySof IT ReSTOR +2.5D Toric IOL , was partly offset by declines in monofocal IOLs which continued to face competitive pressures. Sales of equipment grew 5% (cc), mainly driven by sales of vitreoretinal equipment. Vision Care Vision Care sales in 2017 grew 2% (cc) to USD 3.0 bil- lion driven by contact lens sales (+4% cc). Contact lens sales growth was driven by continued double-digit growth of Dailies Total1, the world’s first and only water gradient lens, and was partly offset by declines in reus- able lenses as the market continues to shift to daily dis- posable lenses. Ocular health sales remained broadly in line with the prior year (0% cc), as dry eye growth was offset by a decline in contact lens care product sales impacted by the continued market shift to daily dispos- able lenses. Alcon Sales in Alcon were restated for 2017 and 2018 to reflect the product transfer between the Innovative Medicines Division and Alcon Division, announced on October 24, 2017, and January 24, 2018, that was effective as of Jan- uary 1, 2018. In 2017, these sales transferred from the Innovative Medicines Division to Alcon Division amounted to USD 747 million and in 2016 USD 731 million. Alcon continued to implement its growth plan in 2017, with a focus on strengthening customer relationships, improving operations, and accelerating innovation and sales. In the US, Alcon launched the AcrySof IQ ReSTOR +2.5 D Multifocal Toric intraocular lens (IOL) with ACTIVE- FOCUS optical design, which aims to improve distance vision in cataract patients with astigmatism. Other prod- uct launches in 2017 include the CyPass Micro-Stent in the EU to treat glaucoma. Alcon also received European approval for the Clareon IOL with AutonoMe pre-loaded delivery system, the first and only automated, disposable IOL delivery system for cataract surgery. Year ended Year ended Dec 31, 2017 Dec 31, 2016 restated 1 restated 1 (USD millions) Surgical Consumables Implantables 2 097 1 034 2 007 1 007 565 Equipment/other 594 Total 3 725 3 579 Vision Care Contact lenses Ocular health Total 1 833 1 213 3 046 1 762 1 202 2 964 Total net sales 6 771 6 543 Change in USD % Constant currencies change % 4 3 5 4 4 1 3 3 5 4 5 5 4 0 2 4 1 Restated to reflect the product transfers between divisions that was effective as of January 1, 2018. 95 Item 5. Operating and Financial Review and Prospects Operating income The following table provides an overview of operating income by segment: (USD millions) Innovative Medicines Sandoz Alcon Corporate Operating income Year ended Dec 31, 2017 restated 1 Year ended % of Dec 31, 2016 restated 1 net sales % of net sales 7 595 1 368 – 3 – 331 8 629 23.5 13.6 0.0 17.6 7 255 1 445 39 – 471 8 268 22.8 14.2 0.6 17.0 Change in USD % Change in constant currencies % 5 – 5 nm 30 4 7 – 7 nm 27 7 nm = not meaningful 1 Restated to reflect the product transfers between divisions that was effective as of January 1, 2018. Operating income in 2017 was USD 8.6 billion (+4%, +7% cc), as growth drivers, productivity, lower amortization, and a gain from the achievement of a sales milestone related to the 2015 Vaccines divestment to GSK more than offset generic erosion. Operating income margin in constant currencies increased 0.8 percentage points compared to the prior year; currency had a negative impact of 0.2 percentage points, resulting in an increase of 0.6 percentage points to 17.6% of net sales. Core operating income key figures1 (USD millions unless indicated otherwise) Core gross profit Selling, general and administration Research and development Other income Other expense Core operating income As % of net sales Year ended Year ended Dec 31, 2017 Dec 31, 2016 36 578 35 806 – 15 000 – 14 111 – 8 313 – 8 402 778 753 – 1 193 – 1 059 12 850 12 987 26.2 26.8 Change in USD % Change in constant currencies % 2 – 6 1 3 – 13 – 1 3 – 6 1 2 – 13 0 1 For an explanation of non-IFRS measures and reconciliation tables, see “ —Item 5.A Operating results—Non-IFRS measures as defined by Novartis.” The adjustments made to operating income to arrive at core operating income in 2017 amounted to USD 4.2 bil- lion (2016: USD 4.7 billion), less than in the prior year due to lower amortization and a gain from the achievement of a sales milestone related to the 2015 Vaccines divest- ment to GSK. Core operating income in 2017 was USD 12.9 billion (−1%, 0% cc). Core operating income margin in constant currencies decreased 0.3 percentage points, mainly due to generic competition for Gleevec/Glivec, and higher launch investments, which were partially offset by expanded gross margin and productivity improvements. Currency exchange rates had an additional negative impact of 0.3 percentage points, yielding a net decrease of 0.6 percentage points to 26.2% of net sales. The following table provides an overview of core operating income by segment: (USD millions) Innovative Medicines Sandoz Alcon Corporate Year ended Dec 31, 2017 restated 1 Year ended % of Dec 31, 2016 restated 1 net sales 10 019 2 080 1 168 – 417 31.0 20.7 17.3 10 054 2 071 1 150 – 288 % of net sales 31.6 20.4 17.6 Core operating income 12 850 26.2 12 987 26.8 1 Restated to reflect the product transfers between divisions that was effective as of January 1, 2018. Change in USD % 0 0 2 – 45 – 1 Change in constant currencies % 2 – 1 5 – 53 0 96 Item 5. Operating and Financial Review and Prospects Innovative Medicines Operating income in 2017 was USD 7.6 billion (+5%, +7% cc), mainly driven by higher sales, productivity improve- ments and lower amortization, which offset the impact of generic competition and investments in growth driv- ers. Core operating income, which excludes certain items, in 2017 was USD 10.0 billion (0%, +2% cc). Core operat- ing income margin decreased 0.2 percentage points in constant currencies, and fluctuations in exchange rates had a further negative impact of 0.4 percentage points, resulting in a net decrease of 0.6 percentage points to 31.0% of net sales. Sandoz Operating income in 2017 was USD 1.4 billion (−5%, −7% cc), down mainly due to pressure on prices in the US, investments in marketing and sales in key markets out- side the US, and higher manufacturing restructuring charges. These negative impacts were partly offset by favorable changes in product mix. Core operating income, which excludes certain items, in 2017 was USD 2.1 billion (0%, −1% cc). Core operating income margin in constant currencies increased 0.1 per- centage points, and an additional 0.2 percentage point increase from exchange rates yielded a result of 20.7% of net sales. Alcon Operating loss in 2017 was USD 3 million, compared to an operating income of USD 39 million the year before, as higher sales were offset by continued investment in the division’s growth plan and charges related to busi- ness development activities. Core operating income, which excludes certain items, in 2017 was USD 1.2 billion (+2%, +5% cc). Core operat- ing income margin in constant currencies increased by 0.2 percentage points, offset by negative currency impact of 0.5 percentage points, yielding a net decrease of 0.3 percentage points to 17.3% of net sales. Corporate income and expense, net Corporate income and expense, which includes the cost of Group management and central services, amounted to a net expense of USD 331 million (+30%, +27% cc) in 2017, compared to a net expense of USD 471 million in the prior year. The favorable decrease in expense was mainly due to a gain from the achievement of a sales milestone related to the 2015 Vaccines divestment to GSK, partly offset by lower gains from divestment in real estate and lower contributions from the captive insur- ance companies. Research and development of Innovative Medicines Division The following table provides an overview of the reported and core research and development expense of the Innovative Medicines Division: (USD millions unless indicated otherwise) Research and exploratory development Confirmatory development Total Innovative Medicines Division research and development expense As % of Innovative Medicines net sales to third parties Core research and exploratory development2 Core confirmatory development2 Total core Innovative Medicines Division research and development expense As % of Innovative Medicines net sales to third parties Year ended Year ended Dec 31, 2017 Dec 31, 2016 restated 1 restated 1 – 2 729 – 2 720 – 4 886 – 4 976 – 7 615 – 7 696 23.6 24.2 – 2 603 – 2 618 – 4 431 – 4 482 – 7 034 – 7 100 21.8 22.3 Change in USD % Change in constant currencies % 0 2 1 1 1 1 0 2 1 1 1 1 1 2017 and 2016 figures are restated to reflect the product transfers between divisions that was effective as of January 1, 2018, and in addition for certain amounts that were reclassified from research and exploratory development to confirmatory development for comparative purposes. 2 Core excludes impairments, amortization and certain other items. For an explanation of non-IFRS measures and reconciliation tables, see “ —Item 5.A Operating results—Non-IFRS measures as defined by Novartis.” Innovative Medicines Division research and exploratory development expense amounted to USD 2.7 billion in 2017, in line with the prior year. Confirmatory develop- ment expense decreased by 2% (+2% cc) to USD 4.9 bil- lion, compared to USD 5.0 billion in 2016, driven by resource allocation and continued productivity efforts, including the benefit of the creation of the Novartis Global Drug Development (GDD) organization. Total core research and development expense in the Innovative Medicines Division as a percentage of sales decreased by 0.7 percentage points in constant curren- cies, mainly due to resource allocation and continued productivity efforts. Currency exchange rates had a neg- ative impact of 0.2 percentage points, yielding a net decrease of 0.5 percentage points to 21.8% of net sales. 97 Item 5. Operating and Financial Review and Prospects Non-operating income and expense The following table provides an overview of non-operating income and expense: (USD millions unless indicated otherwise) Operating income Income from associated companies Interest expense Other financial income and expense Income before taxes Taxes Net income Total basic EPS (USD) nm = not meaningful Year ended Year ended Dec 31, 2017 Dec 31, 2016 8 629 1 108 – 777 39 8 268 703 – 707 – 447 8 999 7 817 – 1 296 – 1 119 7 703 6 698 3.28 2.82 Change in USD % Change in constant currencies % 4 58 – 10 nm 15 – 16 15 16 7 58 – 12 nm 12 – 13 12 14 Income from associated companies Income from associated companies in 2017 increased to USD 1.1 billion, compared to USD 703 million in the prior year. The increase was due to higher income rec- ognized from our investment in GSK Consumer Health- care Holdings Ltd. (GSK Consumer Healthcare). The estimated income from our investment in GSK Consumer Healthcare in 2017 amounted to USD 629 mil- lion, compared to USD 234 million in 2016. The increase is due to improved operational results of USD 89 million; an estimate of a one-time deferred tax income of USD 237 million, arising from a change in a Swiss cantonal statutory tax rate; and a positive prior-year adjustment of USD 47 million based on the actual audited results for 2016, compared to a negative prior-year adjustment of USD 22 million recognized in 2016 for 2015. The estimated income from our investment in Roche in 2017 amounted to USD 456 million (2016: USD 464 million). This reflected our estimated share of income for 2017 of USD 523 million (2016: USD 532 million), offset by the negative prior-year adjustment of USD 67 million, based on actual 2016 results (2016: negative prior-year adjustment of USD 68 million, based on actual 2015 results). Interest expense and other financial income and expense Interest expense in 2017 increased to USD 777 million from USD 707 million in the prior year due to higher out- standing debt. Other financial income and expense amounted to an income of USD 39 million, compared to an expense of USD 447 million in the prior year, mainly on account of exceptional charges related to Venezuela of USD 305 million in 2016, as well as higher currency losses in 2016. Taxes The tax rate in 2017 increased to 14.4% from 14.3% in the prior year. On December 22, 2017, the US enacted tax reform legislation (Tax Cuts and Jobs Act), which – among other provisions – reduced the US corporate tax rate from 35% to 21%, effective January 1, 2018. This required a revaluation of the deferred tax assets and lia- bilities, and a portion of current tax payables to the newly enacted tax rate at the date of enactment, which resulted in a net tax expense of USD 61 million (0.7%). In addition, a change in a Swiss cantonal statutory tax rate resulted in a one-time income from our share in GSK Consumer Healthcare, the impact of which decreased the tax rate by 0.4%. Excluding the impact of these rate changes, the reported tax rate for 2017 would have been 14.1%, com- pared to 14.3% in the prior year. Net income Net income in 2017 was USD 7.7 billion (+15%, +12% cc), benefiting from growth in operating income and higher income from our stake in GSK Consumer Healthcare Holdings Ltd. The prior year also included the excep- tional charges related to Venezuela. EPS Basic earnings per share in 2017 were USD 3.28 (+16%, +14% cc), up more than net income in constant curren- cies, benefiting from our share buyback program. 98 Item 5. Operating and Financial Review and Prospects Core non-operating income and expense1 The following table provides an overview of core non-operating income and expense: (USD millions unless indicated otherwise) Core operating income Core income from associated companies Core interest expense Core other financial income and expense Core income before taxes Core taxes Core net income Core basic EPS (USD) Year ended Year ended Dec 31, 2017 Dec 31, 2016 12 850 12 987 1 335 – 777 39 1 134 – 707 – 99 13 447 13 315 – 2 056 – 2 001 11 391 11 314 4.86 4.75 Change in USD % Change in constant currencies % – 1 18 – 10 nm 1 – 3 1 2 0 18 – 12 nm 2 – 4 2 3 1 For an explanation of non-IFRS measures and reconciliation tables, see “ —Item 5.A Operating results—Non-IFRS measures as defined by Novartis.” nm = not meaningful Core income from associated companies Core income from associated companies in 2017 increased to USD 1.3 billion from USD 1.1 billion in the pri- or-year period. The core income contribution from GSK Consumer Healthcare Holdings Ltd. increased to USD 479 million in 2017 from USD 369 million in the prior-year period, and the core income contribution from Roche increased to USD 832 million from USD 760 million. Core interest expense and other financial income and expense Core other financial income and expense in 2017 amounted to an income, net of USD 39 million, compared to an expense, net of USD 99 million in 2016, mainly on account of lower currency losses. In the prior year, the exceptional charges of USD 0.3 billion related to Vene- zuela were excluded from the 2016 core other financial expense. Core taxes The core tax rate in 2017 (core taxes as a percentage of core pre-tax income) increased to 15.3% from 15.0% in the prior year. Core net income Core net income in 2017 was USD 11.4 billion (+1%, +2% cc), benefiting from higher core income from associated companies. Core EPS Core earnings per share in 2017 were USD 4.86 (+2%, +3% cc), reflecting the benefit of our share buyback pro- gram. Factors affecting comparability of year-on-year results of operations Significant transactions in 2018, 2017, 2016 and significant pending transactions The comparability of the year-on-year results of our operations for the total Group can be significantly affected by acquisitions and divestments. As part of the long-term strategy to focus Novartis as a leading medicines company, we announced and/or completed several acquisitions and divestments during 2018, 2017 and 2016. A detailed description of the significant transactions of 2018, 2017, 2016 and significant pending transactions can be found in “Item 4.A History and development of Novartis – Important Corporate developments 2016 – 2018”, and “Item 18. Financial Statements—Note 2 Sig- nificant transactions”. 99 Item 5. Operating and Financial Review and Prospects Critical accounting policies and estimates Our significant accounting policies are set out in “Item 18. Financial Statements—Note 1. Significant accounting policies,” which are prepared in accordance with Inter- national Financial Reporting Standards (IFRS) as issued by the International Accounting Standards Board (IASB). Given the uncertainties inherent in our business activ- ities, we must make certain estimates and assumptions that require difficult, subjective and complex judgments. Because of uncertainties inherent in such judgments, actual outcomes and results may differ from our assump- tions and estimates, which could materially affect the Group’s consolidated financial statements. Application of the following accounting policies requires certain assumptions and estimates that have the potential for the most significant impact on our consolidated financial statements. New accounting pronouncements Novartis implemented IFRS 9 Financial Instruments as of January 1, 2018, which substantially changes the clas- sification and measurement of financial instruments. The new standard requires impairments to be based on a for- ward-looking model, changes the approach to hedging financial exposures and related documentation, changes the recognition of certain fair value changes, and amends disclosures requirements. Novartis implemented the new standard IFRS 15 Rev- enue from Contracts with Customers as of January 1, 2018. The new standard amends revenue recognition requirements and establishes principles for reporting information about the nature, amount, timing and uncer- tainty of revenue and cash flows arising from contracts with customers. The standard replaces IAS 18 Revenue and IAS 11 Construction contracts and related interpre- tations. The Group applied the modified retrospective method upon adoption of IFRS 9 and IFRS 15 on January 1, 2018. This method requires the recognition of the cumulative effect of initially applying IFRS 9 and IFRS 15 to retained earnings and not to restate prior years. As a result, the critical accounting policies related to revenue and trade receivables described below are applicable to the prepa- ration of the 2018 consolidated financial statements. The accounting policies for revenue and trade receivables that are applicable to the preparation of the 2017 and 2016 consolidated financial statements are described in Note 1; see “Item 18. Financial Statements—Note 1. Sig- nificant accounting policies.” Deductions from revenues As is typical in the pharmaceutical industry, our gross sales are subject to various deductions, which are pri- marily composed of rebates and discounts to retail cus- tomers, government agencies, wholesalers, health insur- ance companies and managed healthcare organizations. These deductions represent estimates of the related obligations, requiring the use of judgment when estimat- ing the effect of these sales deductions on gross sales for a reporting period. These adjustments are deducted from gross sales to arrive at net sales. The following summarizes the nature of some of these deductions and how the deduction is estimated. After recording these, net sales represent our best esti- mate of the cash that we expect to ultimately collect. The US market has the most complex arrangements related to revenue deductions. United States-specific healthcare plans and program rebates The United States Medicaid Drug Rebate Program is administered by state governments, using state and fed- eral funds to provide assistance to certain vulnerable and needy individuals and families. Calculating the rebates to be paid related to this program involves inter- preting relevant regulations, which are subject to chal- lenge or change in interpretative guidance by govern- ment authorities. Provisions for estimating Medicaid rebates are calculated using a combination of historical experience, product and population growth, product pricing, and the mix of contracts and specific terms in the individual state agreements. The United States Federal Medicare Program, which funds healthcare benefits to individuals age 65 and older, and to people with certain disabilities, provides prescrip- tion drug benefits under the Part D section of the pro- gram. This benefit is provided and administered through private prescription drug plans. Provisions for estimating Medicare Part D rebates are calculated based on the terms of individual plan agreements, product sales and population growth, product pricing, and the mix of con- tracts. We offer rebates to key managed healthcare and pri- vate plans in an effort to sustain and increase the mar- ket share of our products, and to ensure patient access to our products. These programs provide a rebate after the plans have demonstrated they have met all terms and conditions set forth in their contract with us. These rebates are estimated based on the terms of individual agreements, historical experience, product pricing, and projected product growth rates, and are recorded as a deduction from revenue at the time, the related revenues are recorded. These provisions are adjusted based on established processes and experiences from filing data with individ- ual states and plans. There is often a time lag of several months between the recording of the revenue deduc- tions and the final accounting for them. Non-United States-specific healthcare plans and program rebates In certain countries other than the US, we provide rebates to governments and other entities. These rebates are often mandated by laws or government regulations. In several countries, we enter into innovative pay- for- performance arrangements with certain healthcare pro- viders. Under these agreements, we may be required to make refunds to the healthcare providers or to provide additional medicines free of charge if anticipated treat- 100 Item 5. Operating and Financial Review and Prospects ment outcomes do not meet predefined targets. Poten- tial refunds or the delivery of additional medicines at no cost are estimated and recorded as a deduction from revenue at the time the related revenues are recorded. Estimates are based on historical experience and clini- cal data. In cases where historical experience and clini- cal data are not sufficient for a reliable estimation of the outcome, revenue recognition is deferred until such his- tory is available. In addition, we offer global patient assistance pro- grams. There is often a time lag of several months between us recording the revenue deductions and our final accounting for them. Non-healthcare plans and program rebates, returns and other deductions We offer rebates to purchasing organizations and other direct and indirect customers to sustain and increase market share and to ensure patient access to our prod- ucts. Since rebates are contractually agreed upon, the related provisions are estimated based on the terms of the individual agreements, historical experience, and projected product sales growth rates. Chargebacks occur where our subsidiaries have arrangements with indirect customers to sell products at prices that are lower than the price charged to whole- salers. A chargeback represents the difference between the invoice price to the wholesaler and the indirect cus- tomer’s contract price. We account for vendor charge- backs by reducing revenue by the estimate of charge- backs attributable to a sales transaction. Provisions for estimated chargebacks are calculated using a combina- tion of factors, such as historical experience, product growth rates, product pricing, level of inventory in the distribution channel and the terms of individual agree- ments. When we sell a product providing a customer the right to return it, we record a provision for estimated sales returns based on our sales return policy and historical return rates. Other factors considered include actual product recalls, expected marketplace changes, the remaining shelf life of the product, and the expected entry of generic products. In 2018, sales returns amounted to approximately 1% of gross product sales. If sufficient experience is not available, sales are only recorded based on evidence of product consumption or when the right of return has expired. We enter into distribution service agreements with major wholesalers, which provide a financial disincentive for the wholesalers to purchase product quantities in excess of current customer demand. Where possible, we adjust shipping patterns for our products to maintain wholesalers’ inventory levels consistent with underlying patient demand. We offer cash discounts to customers to encourage prompt payment. Cash discounts are estimated and accrued at the time of invoicing and are deducted from revenue. Following a decrease in the price of a product, we generally grant customers a “shelf stock adjustment” for their existing inventory for the relevant product. Provi- sions for shelf stock adjustments, which are primarily relevant within the Sandoz Division, are determined at the time of the price decline or at the point of sale, if the impact of a price decline on the products sold can be reasonably estimated based on the customer’s inventory levels of the relevant product. Other sales discounts, such as consumer coupons and co-pay discount cards, are offered in some markets. The estimated amounts of these discounts are recorded at the time of sale or when the coupons are issued, and are estimated utilizing historical experience and the spe- cific terms for each program. If a discount for a proba- ble future transaction is offered as part of a sales trans- action, then an appropriate portion of revenue is deferred to cover this estimated obligation. We adjust provisions for revenue deductions period- ically to reflect actual experience. To evaluate the ade- quacy of provision balances, we use internal and exter- nal estimates of the inventory in transit, the level of inventory in the distribution and retail channels, actual claims data received, and the time lag for processing rebate claims. External data sources include reports from wholesalers and third-party market data purchased by Novartis. For the table showing the worldwide extent of our revenue deductions provisions and related payment experiences for the Group see “Item 18. Financial State- ments – Note 21 Provisions and other current liabilities”. 101 Item 5. Operating and Financial Review and Prospects Gross-to-net sales reconciliation The table below shows the gross to net sales reconciliation for our Innovative Medicines Division: Income statement charge Charged through revenue deduction Charged directly without being recorded in revenue provisions deduction provisions Total USD millions USD millions In % of gross sales 2018 Innovative Medicines gross sales subject to deductions US-specific healthcare plans and program rebates Non-US-specific healthcare plans and program rebates Non-healthcare plans and program-related rebates, returns and other deductions Total Innovative Medicines gross-to-net sales adjustments Innovative Medicines net sales 2018 20171 Innovative Medicines gross sales subject to deductions US-specific healthcare plans and program rebates Non-US-specific healthcare plans and program rebates Non-healthcare plans and program-related rebates, returns and other deductions Total Innovative Medicines gross-to-net sales adjustments Innovative Medicines net sales 2017 20161 Innovative Medicines gross sales subject to deductions US-specific healthcare plans and program rebates Non-US-specific healthcare plans and program rebates Non-healthcare plans and program-related rebates, returns and other deductions Total Innovative Medicines gross-to-net sales adjustments Innovative Medicines net sales 2016 1 Restated to reflect the product transfers between divisions, that was effective as of January 1, 2018 USD millions – 3 921 – 2 108 – 3 157 – 9 186 – 3 303 – 1 712 – 2 652 – 7 667 – 3 051 – 1 341 – 2 696 – 7 088 47 785 100.0 – 3 921 – 1 032 – 3 140 – 2 675 – 5 832 – 3 707 – 12 893 34 892 – 8.2 – 6.6 – 12.2 – 27.0 73.0 43 127 100.0 – 3 303 – 940 – 2 652 – 2 242 – 4 894 – 3 182 – 10 849 32 278 – 7.7 – 6.1 – 11.4 – 25.2 74.8 41 798 100.0 – 3 051 – 873 – 2 214 – 2 006 – 4 702 – 2 879 – 9 967 31 831 – 7.3 – 5.3 – 11.2 – 23.8 76.2 Surgical equipment revenue Surgical equipment may be sold together with other products and services under a single contract. Revenues are recognized upon satisfaction of each of the perfor- mance obligations in the contract and the consideration is allocated based on the standalone selling price of each performance obligation. For surgical equipment, in addition to cash and install- ment sales, revenue is recognized under finance and operating lease arrangements. Arrangements in which Novartis transfers substantially all the risks and rewards incidental to ownership to the customer are treated as finance lease arrangements. Revenue from finance lease arrangements is recognized at amounts equal to the fair values of the equipment, which approximate the present values of the minimum lease payments under the arrange- ments. As interest rates embedded in lease arrange- ments are approximately market rates, revenue under finance lease arrangements is comparable to revenue for outright sales. Finance income for arrangements in excess of twelve months is deferred and subsequently recognized based on a pattern that approximates the use of the effective interest method. It is recorded in “Other income.” Operating lease revenue for equipment rentals is recognized on a straight line basis over the lease term. Impairment of goodwill, intangible assets and property, plant and equipment We review long-lived intangible assets and property, plant and equipment for impairment whenever events or changes in circumstance indicate that the asset’s bal- ance sheet carrying amount may not be recoverable. Goodwill, the Alcon brand name and other currently not amortized intangible assets are reviewed for impairment at least annually. An asset is generally considered impaired when its balance sheet carrying amount exceeds its estimated recoverable amount, which is defined as the higher of its fair value less costs of disposal and its value in use. Usu- ally, Novartis adopts the fair value less costs of disposal method for its impairment evaluation. In most cases, no directly observable market inputs are available to mea- sure the fair value less costs of disposal. Therefore, an estimate of fair value less costs of disposal is derived indirectly and is based on net present value techniques utilizing post-tax cash flows and discount rates. In the 102 Item 5. Operating and Financial Review and Prospects limited cases where the value in use method is applied, net present value techniques are utilized using pre-tax cash flows and discount rates. Fair value reflects estimates of assumptions that mar- ket participants would be expected to use when pricing the asset and, for this purpose, management considers the range of economic conditions that are expected to exist over the remaining useful life of the asset. The esti- mates used in calculating net present values are highly sensitive and depend on assumptions specific to the nature of the Group’s activities with regard to: • The amount and timing of projected cash flows • The behavior of competitors (launch of competing products, marketing initiatives, etc.) • The probability of obtaining regulatory approvals • Future tax rates • The appropriate royalty rate for the Alcon brand name • The appropriate terminal growth rate • The appropriate discount rate Due to the above factors and those further described in “Item 18. Financial Statements—Note 1. Significant accounting policies – Impairment of goodwill and intan- gible assets”, actual cash flows and values could vary significantly from forecasted future cash flows and related values derived using discounting techniques. The recoverable amount of the grouping of cash-gen- erating units to which goodwill and indefinite life intan- gible assets are allocated is based on fair value less costs of disposal. The valuations are derived from applying dis- counted future cash flows based on key assumptions, including the terminal growth rate and discount rate. For additional information, see “Item 18. Financial Statements – Note 1. Significant accounting policies – Impairment of goodwill and intangible assets and Note 10. Goodwill and intangible assets.” In 2018, intangible asset impairment charges of USD 1.2 billion were recognized, of which USD 592 million was recorded in the Innovative Medicines Division, USD 249 million was recorded in the Sandoz Division, and USD 391 million was recorded in the Alcon Division. In 2017, intangible asset impairment charges of USD 709 million were recognized, of which USD 591 million was recorded in the Innovative Medicines Division, USD 61 million was recorded in the Sandoz Division, and USD 57 million was recorded in the Alcon Division. In 2016, intangible asset impairment charges of USD 591 million were recognized, of which USD 522 million was recorded in the Innovative Medicines Division, USD 65 million was recorded in the Sandoz Division, and USD 4 million was recorded in the Alcon Division. In 2018, 2017 and in 2016, there were no reversals of prior-year impairment charges. Goodwill and other intangible assets represent a sig- nificant part of our consolidated balance sheet, primar- ily due to acquisitions. Although no significant additional impairments are currently anticipated, impairment eval- uation could lead to material impairment charges in the future. For more information, see “Item 18. Financial Statements—Note 10. Goodwill and intangible assets.” Additionally, net impairment charges for property, plant and equipment during 2018 amounted to USD 304 million (2017: USD 157 million; 2016: USD 102 million). Impairment of associated companies accounted for at equity Novartis considers investments in associated compa- nies for impairment evaluation whenever objective evi- dence indicates the net investment may be impaired, including when a quoted share price indicates a fair value less than the per share balance sheet carrying value for the investment. If the recoverable amount of the investment is esti- mated to be lower than the balance sheet carrying amount, an impairment charge is recognized for the dif- ference in the consolidated income statement under “Income from associated companies.” Trade receivables Trade receivables are initially recognized at their invoiced amounts, including any related sales taxes less adjust- ments for estimated revenue deductions such as rebates, chargebacks and cash discounts. From January 1, 2018, with the adoption of IFRS 9 Financial Instruments, provisions for expected credit losses are established using an expected credit loss model (ECL). The provisions are based on a forward-look- ing ECL, which includes possible default events on the trade receivables over the entire holding period of the trade receivable. These provisions represent the differ- ence between the trade receivable’s carrying amount in the consolidated balance sheet and the estimated col- lectible amount. Charges for doubtful trade receivables are recorded as marketing and selling costs recognized in the consolidated income statement within “Selling, General & Administration” expenses. Trade receivable balances include sales to drug wholesalers, retailers, private health systems, govern- ment agencies, managed care providers, pharmacy ben- efit managers and government-supported healthcare systems. Novartis continues to monitor sovereign debt issues and economic conditions in Greece, Italy, Portu- gal, Spain, Brazil, Russia, Saudi Arabia, Turkey, Argen- tina, and other countries, and evaluates trade receivables in these countries for potential collection risks. Substan- tially all of the trade receivables overdue from Greece, Portugal, Spain, Brazil, Argentina and Saudi Arabia are due directly from local governments or from govern- ment-funded entities. Deteriorating credit and economic conditions as well as other factors in these countries have resulted in – and may continue to result in – an increase in the average length of time that it takes to col- lect these trade receivables, and may require the Group to re-evaluate the estimated collectable amount of these trade receivables in future periods. Contingent consideration In a business combination or divestment of a business, it is necessary to recognize contingent future payments to previous owners representing contractually defined potential amounts as a liability or asset. Usually for Novartis, these are linked to milestone or royalty pay- 103 Item 5. Operating and Financial Review and Prospects ments related to certain assets and are recognized as a financial liability or financial asset at their fair value, which is then remeasured at each subsequent reporting date. These estimations typically depend on factors such as technical milestones or market performance, and are adjusted for the probability of their likelihood of payment and, if material, are appropriately discounted to reflect the impact of time. Changes in the fair value of contingent consideration liabilities in subsequent periods are recognized in the consolidated income statement in “Cost of goods sold” for currently marketed products and in “Research and development” for In-Process Research and Develop- ment (IPR&D). Changes in contingent consideration assets are recognized in “Other income” or “Other expense,” depending on its nature. The effect of unwinding the discount over time is rec- ognized for contingent liabilities in “Interest expense” and for contingent assets are recorded as interest income recognized in the consolidated income state- ment within “other financial income and expense”. Retirement and other post- employment benefit plans We sponsor pension and other post-employment bene- fit plans in various forms that cover a significant portion of our current and former associates. For post-employ- ment plans with defined benefit obligations, we are required to make significant assumptions and estimates about future events in calculating the expense and the present value of the liability related to these plans. These include assumptions about the interest rates we apply to estimate future defined benefit obligations and net periodic pension expense, as well as rates of future pen- sion increases. In addition, our actuarial consultants pro- vide our management with historical statistical informa- tion, such as withdrawal and mortality rates in connection with these estimates. Assumptions and estimates used by the Group may differ materially from the actual results we experience due to changing market and economic conditions, higher or lower withdrawal rates, and longer or shorter life spans of participants, among other factors. For example, in 2018, a decrease in the interest rate we apply in deter- mining the present value of the defined benefit obliga- tions of one-quarter of 1% would have increased our year-end defined benefit pension obligation for plans in Switzerland, the United States, the United Kingdom, Ger- many and Japan, which represent 94% of the Group total defined benefit pension obligation, by approximately USD 0.8 billion. Similarly, if the 2018 interest rate had been one-quarter of 1 percentage point lower than actu- ally assumed, the net periodic pension cost for pension plans in these countries, which represent about 86% of the Group’s total net periodic pension cost for pension plans, would have increased by approximately USD 26 million. Depending on events, such differences could have a material effect on our total equity. For more infor- mation on obligations under retirement and other post-employment benefit plans and underlying actuarial assumptions, see “Item 18. Financial Statements—Note 24. Post-employment benefits for associates.” Provisions and contingencies A number of Group companies are involved in various government investigations and legal proceedings (intel- lectual property, sales and marketing practices, product liability, commercial, employment and wrongful dis- charge, environmental claims, etc.) arising out of the nor- mal conduct of their businesses. For more information, see “Item 18. Financial Statements—Note 19. Provisions and other non-current liabilities” and “Item 18. Financial Statements—Note 27. Commitments and contingencies.” We record provisions for legal proceedings when it is probable that a liability has been incurred and the amount can be reliably estimated. These provisions are adjusted periodically as assessments change or addi- tional information becomes available. For significant product liability cases, the provision is actuarially deter- mined based on factors such as past experience, amount and number of claims reported, and estimates of claims incurred but not yet reported. Provisions are recorded for environmental remedia- tion costs when expenditure on remedial work is proba- ble and the cost can be reliably estimated. Remediation costs are provided for under “Non-current liabilities” in the Group’s consolidated balance sheet. Provisions relating to estimated future expenditure for liabilities do not usually reflect any insurance or other claims or recoveries, since these are only recognized as assets when the amount is reasonably estimable and collection is virtually certain. Research and development Internal research and development costs are fully charged to the consolidated income statement in the period in which they are incurred. We consider that reg- ulatory and other uncertainties inherent in the develop- ment of new products preclude the capitalization of inter- nal development expenses as an intangible asset usually until marketing approval from the regulatory authority is obtained in a relevant major market, such as for the United States, the European Union, Switzerland or Japan. Healthcare contributions In many countries, our subsidiaries are required to make contributions to the countries’ healthcare costs as part of programs other than the ones mentioned above under deductions from revenues. The amounts to be paid depend on various criteria such as the subsidiary’s mar- ket share or sales volume compared to certain targets. Considerable judgment is required in estimating these contributions, as not all data is available when the esti- mates need to be made. The largest of these healthcare contributions relates to the US Healthcare Reform fee, which was introduced in 2011. This fee is an annual levy to be paid by US phar- maceutical companies, including various Novartis sub- sidiaries, based on each company’s prior-year qualifying sales as a percentage of the prior year’s govern- ment-funded program sales. This pharmaceutical fee levy is recognized in “Other expense.” 104 Item 5. Operating and Financial Review and Prospects Taxes We prepare and file our tax returns based on an inter- pretation of tax laws and regulations, and we record esti- mates based on these judgments and interpretations. Our tax returns are subject to examination by the com- petent taxing authorities, which may result in an assess- ment being made, requiring payments of additional tax, interest or penalties. Since Novartis uses its intellectual property globally to deliver goods and services, the transfer prices within the Group as well as arrangements between subsidiaries to finance research and develop- ment and other activities may be challenged by the national tax authorities in any of the jurisdictions in which Novartis operates. Therefore, inherent uncertainties exist in our estimates of our tax positions, but we believe that our estimated amounts for current and deferred tax assets or liabilities, including any amounts related to any uncertain tax positions, are appropriate based on cur- rently known facts and circumstances. Internal control over financial reporting The Group’s management has assessed the effective- ness of internal control over financial reporting. The Group’s independent statutory auditor also issued an opinion on the effectiveness of internal control over financial reporting. Both the Group’s management and its external auditors concluded that the Group main- tained, in all material respects, effective internal control over financial reporting as of December 31, 2018. Factors affecting results of operations Transformational changes fueling demand Accelerating biomedical innovation We are seeing an explosion of innovation in medical sci- ence. Better understanding of the molecular mecha- nisms of disease, coupled with new types of therapies, promises to yield powerful new medicines for patients. The trend toward patient-specific precision treatments will likely accelerate. Further advances in molecular biology, which has been a mainstay of research for decades, is expected to continue to yield results. In addition, new molecular tech- niques, such as gene editing, personalized cell therapies and harnessing the cell’s own waste disposal system, could open new treatment opportunities – including ones that go beyond what has been possible using today’s drugs. The advent of digital technologies as therapeutic aids is also starting to alter the conventional notion of medi- cal treatment. For instance, mobile applications that aim to treat substance abuse and help diabetics manage their disease have received clearance from the FDA. Combining traditional medicines with digital technology that helps patients follow healthy behaviors holds great promise for improving the quality of care as well as treat- ment outcomes for patients. Transforming how doctors diagnose and treat diseases Although the digital revolution has been relatively slow to arrive in healthcare, it is gaining momentum and will likely bring radical change in the coming years. A growing proliferation of sensor technology is help- ing researchers and doctors gather increasing amounts of information about patients’ health and how they respond to treatment. Care providers are starting to mine healthcare data using a combination of statistical meth- ods and artificial intelligence to flag emerging medical problems and help physicians diagnose and treat patients. Patients, armed with greater access to their own medical data, will likely play a more active role in prevent- ing diseases and managing their own care when they become ill. The role of physicians and other care provid- ers will likely also evolve as they help educate patients on treatment options and steer patients toward the most effective choices. Transforming drug research and development Digital technology may also increasingly improve the effi- ciency and effectiveness of researching and developing potential new therapies. The marriage of data and arti- ficial intelligence could enable complex biological simu- lations that complement human scientific ingenuity. Such tools are already being considered by the FDA as replace- ments for preclinical animal studies to assess toxicity in potential new medicines. In 2017, for example, the FDA announced a collaboration with Emulate, Inc. to evaluate the company’s “organs-on-chips” technology – part of a system that recreates the physiology of human tissues and organs, and is designed to predict human responses to diseases with greater precision than animal-based testing. As digital tools become more widespread, they may be able to shorten research times and improve the likelihood that experimental drugs will prove safe and effective. This surge in medical innovation will likely occur in an increasingly diverse and fragmented research environ- ment, with new advances coming from a variety of sources – sometimes unexpected ones. Molecular biol- ogy may intersect with other disciplines, from engineer- ing to computer science, to advance the practice of med- icine. And we expect there will be greater diversity in funding for research. Already we see governments, com- panies and venture capitalists increasingly supporting academic researchers’ efforts to advance promising experimental therapies. All of these factors are contributing to greater com- petition at the forefront of innovation in medical science. One upshot is that medicines will likely be held to a higher standard of efficacy in the future. 105 Item 5. Operating and Financial Review and Prospects Aging populations While accelerating medical innovation could help tame some of the devastating diseases that still plague human- ity, other trends in society pose significant challenges. Rapidly aging populations continue to put pressure on health systems around the world. People are living longer and the worldwide elderly population continues to grow at a rapid pace. The num- ber of people in the world aged 60 or over will reach nearly 2.1 billion by 2050, according to projections by the United Nations, up from less than 1 billion today. Aging populations, in addition to rapid urbanization and chang- ing lifestyles in the developing world, are contributing to increased prevalence of chronic ailments such as heart disease and cancer. At the same time, many countries are working to expand access to healthcare. For example, China has expanded reimbursement of some medicines. These factors are driving higher healthcare spend- ing, which is expected to grow at an annual rate of 4.3% between 2015 and 2020, reaching a total of USD 8.7 tril- lion worldwide, projects the Economist Intelligence Unit. By 2020, about half of that spending is expected to go toward treating the three leading causes of death world- wide: cardiovascular disease, cancer and respiratory dis- ease. To keep costs in check, governments and health insurers are already employing a variety of tactics, includ- ing increasing the use of generics and biosimilars, impos- ing price cuts, and limiting access to some innovative therapies. The pharmaceutical industry is also playing a role, exploring new pricing models and delivering innovative new treatments that maximize benefits for patients. Better health outcomes for patients In pursuit of greater efficiency and effectiveness, some healthcare systems are also expediting the transition from a system based on fees for services toward one based on reimbursement for specific health outcomes in patients. As the transition accelerates, we expect health systems will increasingly find ways to discourage the use of medical treatments that bring little or no value for patients or healthcare systems. In parallel, they will likely place greater value on treatments that delay the progression of disease or that help avoid events requir- ing expensive acute care, such as heart attacks. With people living longer and retirement ages rising, we also anticipate countries and health systems will put greater emphasis on keeping people fit and productive later in life. And we think there will be growing emphasis on maintaining quality of life as people age, with less focus on extending life by a few more months. We think the trends driving changes in healthcare will bring new opportunities for Novartis, as well as new chal- lenges. And we believe the changes now underway in our industry raise the importance of delivering true inno- vation that produces better health outcomes for patients and health systems, with greater efficiency. Increasingly challenging business environment Loss of exclusivity for patented products Pharmaceutical companies routinely face generic com- petition when their products lose patent or other intel- lectual property protection, and Novartis is no exception. Major products of our Innovative Medicines Division, as well as certain products of our Alcon and Sandoz Divi- sions, are protected by patent or other intellectual prop- erty rights, allowing us to exclusively market those prod- ucts. The loss of exclusivity has had, and will continue to have, an adverse effect on our results. In 2018, the total impact of generic competition on our net sales amounted to approximately USD 1 billion. Some of our best selling products face or are expected to face considerable competition due to the expiration of patent or other intellectual property pro- tection. For example, our former top selling products Gleevec/Glivec, Diovan and Exforge all face continued and increasing generic competition in major markets. which will continue. Patent protection for our Sandostatin products has expired and there is a risk that generic competition for Sandostatin LAR may arise in the future. Looking forward, intellectual property protecting a num- ber of our major products will expire at various times in the coming years, raising the likelihood of further generic competition. Among our products expected to begin los- ing intellectual property protection in key countries during the coming years are Gilenya, our everolimus products (Afinitor/Votubia and Certican/Zortress), Exjade/Jadenu and Lucentis. To counter the impact of patent expirations, we con- tinuously invest in R&D to rejuvenate our portfolio. For example, in 2018, we invested 17% of total net sales in R&D. One measure of the output of our efforts is the per- formance of our growth drivers, including Cosentyx, Entresto, Kymriah and Kisqali, and the Sandoz biosimi- lars. Novartis also has a number of late stage product candidates in its pipeline with the potential to come to market in the next few years. Novartis plans to launch three potentially significant products in 2019, AVXS-101, BAF312 and RTH258 (brolucizumab). Commercial success of key products Our ability to maintain and grow our business and to replace revenue and income lost to generic and other competitors depends in part on our commercial success, particularly with respect to our key growth driver prod- ucts, which we consider to be an indicator of our ability to renew our portfolio. The commercial success of these products could be impacted at any time by a number of factors, including new competitors, changes in doctors’ prescribing habits, pricing pressure, manufacturing issues, and loss of intellectual property protection. In addition, our revenue could be significantly impacted by the timing and rate of commercial acceptance of new products. All of our businesses face intense competition from new products and scientific advances from competitors. Physicians, patients and payers may choose competitor products instead of ours if they perceive them to be bet- ter in terms of efficacy, safety, cost or convenience. 106 Item 5. Operating and Financial Review and Prospects For example, our US Sandoz business has suffered significant declines in sales and profits in recent years due, at least in part, to increased competition for its prod- ucts. There can be no certainty that Sandoz US sales will recover in the coming years. In any event, such com- petition and the costs of our efforts to improve the busi- ness’s performance, as well as other factors, can be expected to affect the business, financial condition or results of operations of this organization, at least in the near term. In addition, despite the devotion of significant resources to our efforts to improve the performance of Sandoz US, and our agreement to sell the Sandoz US dermatology business and generic US oral solids port- folio to Aurobindo Pharma USA Inc., our efforts may ulti- mately prove insufficient. Should our efforts fail to accom- plish their goals, or fail to do so in a timely manner, it could have a material adverse impact on our business, financial condition or results of operations beyond the near term, as well. Ability to deliver new products Our ability to grow depends not only on the commercial success of our marketed products, but also on the suc- cess of our R&D activities in identifying and developing new treatments that address unmet medical needs, are accepted by patients and physicians, and are reimbursed by payers. Developing new healthcare products and bringing them to market is a costly, lengthy and uncertain pro- cess. R&D for a new product in our Innovative Medicines Division can take 15 years or more, from discovery to commercial launch. With time limits on intellectual prop- erty protections, the longer it takes to develop a prod- uct, the less time we may have to recoup our costs. During each stage of development, there is a significant risk that we will encounter obstacles. They may cause a delay or add substantial expense, limit the potential for commercial success, or force us to abandon a product in which we have invested substantial amounts of time and money. In addition, as healthcare costs continue to rise, gov- ernments and payers around the world are increasingly focused on health outcomes, rewarding new products that represent truly breakthrough innovation versus those that offer an incremental benefit over other prod- ucts in the same therapeutic class. This has led to requests for more clinical trial data than has been required in the past, the inclusion of significantly higher numbers of patients in clinical trials, and more detailed analyses of the trials. As a result, despite significant efforts by health authorities such as the FDA to acceler- ate the development of new drugs, the already lengthy and expensive process of obtaining regulatory approv- als and reimbursement for pharmaceutical products has become even more challenging. Our Sandoz Division faces similar challenges, partic- ularly in the development of biosimilars. While Sandoz was a pioneer in introducing biosimilars to the European market in 2006, and was the first company to win approval for a biosimilar under the new regulatory path- way in the United States in 2015, many countries still lack fully developed regulatory frameworks for the develop- ment, approval and marketing of biosimilars. Further delays in establishing regulatory frameworks, or any other difficulties that may arise in the development or marketing of biosimilars, could put at risk the significant investments that Sandoz has made, and will continue to make, in this area. Our Alcon Division faces medical device develop- ment and approval processes that are often similarly dif- ficult. As part of its growth plan, Alcon has taken steps to accelerate innovation. It has started to see the results of its efforts, with the approval and launch of intraocular lens innovations in recent years, including Clareon and PanOptix IOLs, AutonoMe and Ultrasert IOL delivery sys- tems, and, ReSTOR Toric IOL with ACTIVEFOCUS opti- cal design, as well as a multifocal version of Dailies Total1. But there is no certainty that Alcon will continue to be successful in these efforts, and if it is not, there could be a material adverse effect on the success of the Alcon Division, and on the Group as a whole. In spite of our significant investments, there can be no guarantee that our R&D activities will produce com- mercially viable new products that will enable us to grow our business and replace revenue and income lost to competition. Pricing and reimbursement Around the world, governments and payers continue to struggle with rising healthcare costs as aging popula- tions contribute to increased prevalence of chronic dis- eases. There have also been examples of significant con- troversies about prices for pharmaceuticals that some politicians and members of the public have considered excessive. These factors have intensified the pressures we face regarding the prices we charge for our drugs, and our ability to establish satisfactory rates of reim- bursement for our products by governments, insurers and other payers. We expect scrutiny to continue in 2019, and the fol- lowing years, as governments and insurers around the world strive to reduce healthcare costs through steps such as restricting access to higher priced new medicines, increasing coinsurance or copays owed by patients for medicines, increasing the use of generics, and imposing price cuts. In this environment, we believe it is more important than ever to demonstrate the value that true innovation brings to the healthcare system. To manage these pressures, we are investing in real world data and analytics to provide additional evidence of the health benefits of our products, exploring new technologies and patient management services, and partnering with payers to develop and scale outcomes based commercial models. For example, we are working with customers on flexible pricing approaches where we are fully compensated only if a drug succeeds in meet- ing certain performance targets. Business practices In recent years, there has been a trend of increasing gov- ernment investigations and litigation against companies operating in our industry, including in the United States and other countries. We are obligated to comply with the laws of all countries in which we operate, as well as any new requirements that may be imposed upon us. In addi- tion, governments and regulatory authorities worldwide 107 Item 5. Operating and Financial Review and Prospects are also increasingly challenging practices previously considered to be legal and compliant. But beyond legal requirements, we strive to meet evolving public expec- tations for ethical behavior. We have a significant global compliance program in place, and we devote substantial time and resources to efforts to ensure that our business is conducted in a legal and publicly acceptable manner. Despite these efforts, any failure to comply with the law could lead to substantial liabilities that may not be cov- ered by insurance and could affect our business and rep- utation. Responding to these challenges and new regulations is costly. Investigations and litigation may affect our rep- utation, create a risk of potential exclusion from govern- ment reimbursement programs in the United States and other countries, and potentially lead to large damage payments and agreements intended to regulate com- pany behavior. This is why we continued to strengthen the Integrity & Compliance function in 2018. The func- tion is headed by our Chief Ethics, Risk and Compliance Officer, who reports directly to the CEO of Novartis. Investors and Novartis are increasingly focused on Environmental, Social and Governance (ESG) issues. Novartis has made strides to transform culture and return more to society in 2018, which are two of the key prior- ities of our new CEO. We continue our journey to rebuild trust with society and for all our new medicines, we will systematically integrate access strategies in how we research, develop and deliver globally and we are devel- oping innovative treatments for under-treated diseases, including SEG101 in sickle cell disease. Supply continuity The production of pharmaceutical products and medi- cal devices can be highly complex, and any manufactur- ing issue compromising supply or quality could have seri- ous consequences for the health of patients. For this reason, there are strict regulatory requirements sur- rounding our manufacturing processes, which, in addi- tion to our own quality standards, introduce a greater chance for disruptions and liabilities. Any significant fail- ure by us or our third party suppliers to comply with these requirements or the health authorities’ expectations may cause us to shut down the production facilities or pro- duction lines. Alternately, we may be forced to shut them down by a government health authority. Beyond regulatory requirements, many of our prod- ucts involve technically sophisticated manufacturing pro- cesses or require specialized raw materials. For exam- ple, we manufacture and sell a number of sterile products, biologic products and products involving advanced ther- apy platforms, such as CAR-T therapies, gene therapy and radioligand therapy, all of which are particularly com- plex and involve highly specialized manufacturing tech- nologies. As a result, even slight deviations at any point in their production process may lead to production fail- ures or recalls. Given the complexity of our manufacturing pro- cesses, we have worked for several years to adopt a sin- gle high quality standard across the company. We believe these efforts are having an impact. The results of inspec- tions by regulatory agencies in 2018 were consistent with the year before. Out of a total of 192 inspections, all but two (99%) were without major findings. IT security, data integrity and data privacy We are heavily dependent on critical, complex and inter- dependent information technology systems, including Internet based systems, to support our business pro- cesses. The size, age and complexity of our information tech- nology systems make them potentially vulnerable to external and internal security threats, outages, mis- placed or lost data, programming or human errors, or other similar events. Although we have devoted and con- tinue to devote significant resources and management attention to cybersecurity, information management and business continuity efforts, like many companies, we have experienced certain of these events and expect to continue to experience them in the future, as the exter- nal and internal information security threat continues to grow. We believe that the information security incidents we have experienced to date have yet to result in signif- icant disruptions to our operations, and have not had a significant adverse effect on our results of operations, or on third parties. However, we may not be able to pre- vent future outages, security incidents or other breaches in our systems from having a material adverse effect on our business, financial condition, results of operation or reputation. In addition, our routine business operations increas- ingly involve our gathering personal information (includ- ing sensitive personal information) about patients, ven- dors, customers, employees, collaborators and others, through the use of information technologies such as the Internet, social media, mobile technologies, and technol- ogy based medical devices. Breaches of our systems or those of our third party contractors, or other failures to protect such information, could expose such people’s personal data to unauthorized persons. Any event involv- ing the substantial loss of personal data could give rise to significant potential liability, reputational harm, dam- aged relationships with business partners and potentially substantial monetary penalties under laws enacted or being enacted around the world. Such events could also lead to restrictions on our ability to transfer personal data across country borders. Transformational technologies and business models Rapid progress in digital technologies and in the devel- opment of new business models is substantially trans- forming numerous industries around the world, while sometimes quickly rendering established businesses uncompetitive or obsolete. To take advantage of these opportunities, Novartis has embarked upon a digital transformation strategy, with the goal of making Novartis an industry leader in leveraging advanced analytics and other new technologies. This includes the 2018 launch of reSET the first digital therapeutic for substance abuse disorder. At the same time, there is a risk that other com- panies with specialized expertise or business models may enter the healthcare field, potentially disrupting our relationships with patients, healthcare professionals, customers, distributors and suppliers, with unknown potential consequences for us. If we should fail to succeed in our efforts at a digital transformation of our company, then there is a risk that we may fail to create the innovative new products, tools or techniques that such technologies may make possi- 108 Item 5. Operating and Financial Review and Prospects ble, or may fail to create them as quickly and efficiently as such technologies may enable. We may also lose opportunities to engage with our stakeholders and to profit from improved business processes, and may lose the resources devoted to these efforts to transform our business. At the same time, should third parties success- fully enter the healthcare field with disruptive new tech- nologies or business models, then we potentially may see our business supplanted in whole or in part by these new entrants. Intangible assets and goodwill We carry a significant amount of goodwill and other intangible assets on our consolidated balance sheet, pri- marily due to acquisitions, including the acquisition of Alcon and the oncology assets acquired from GSK. As a result, we may incur significant impairment charges if the fair value of intangible assets and groupings of cash generating units containing goodwill are less than their carrying value on the Group’s consolidated balance sheet at any point in time. We regularly review our long lived intangible and tan- gible assets for impairment. In 2018, for example, we recorded intangible asset impairment charges of USD 1.2 billion, including USD 0.4 billion write-down of Votrient, USD 0.3 billion for the net charges from the voluntary withdrawal of CyPass and USD 0.2 billion related to the write-down of the goodwill and the currently marketed products related to the sale of the Sandoz US portfolio to Aurobindo Pharma USA Inc. Impairment testing may lead to additional impairment charges in the future. Any significant impairment charges could have a material adverse effect on our results of operations and financial condition. Tax Our multinational operations are taxed under the laws of the countries and other jurisdictions in which we oper- ate. However, the integrated nature of our worldwide operations can produce conflicting claims from revenue authorities in different countries as to the profits to be taxed in the individual countries, including potential dis- putes relating to the prices our subsidiaries charge one another for intercompany transactions, known as trans- fer pricing. The majority of the jurisdictions in which we operate have double tax treaties with other foreign juris- dictions, which provide a framework for mitigating the impact of double taxation on our revenues and capital gains. However, mechanisms developed to resolve such conflicting claims are largely untried, and can be expected to be very lengthy. In recent years, tax authorities around the world, including in the EU, Switzerland and the US, have increased their scrutiny of company tax filings, and have become more rigid in exercising any discretion they may have, and numerous changes in tax laws and rules have been enacted or proposed. The current tax regime of Switzerland is under international pressure and efforts are underway in Switzerland to transform its corporate tax laws and regulations. The outcome of these efforts remains subject to change and could end up in a mate- rially different form from what is currently proposed, or could be administered or implemented in a manner dif- ferent from our expectations. As a result, such tax reform efforts, including with respect to tax base or rate, transfer pricing, intercom- pany dividends, cross border transactions, controlled corporations, and limitations on tax relief allowed on the interest on intercompany debt, will require us to contin- ually assess our organizational structure against tax pol- icy trends, and could lead to an increased risk of inter- national tax disputes and an increase in our effective tax rate, and could adversely affect our financial results. Approach to risk management See “Item 6. Directors, Senior Management and Employ- ees—Item 6.C Board Practices—Our Board of Direc- tors—Information and control systems of the Board vis- à-vis management—Risk management” and “Item 18. Financial Statements—Note 28. Financial instruments— additional disclosures.” Non-IFRS measures as defined by Novartis Novartis uses certain non-IFRS metrics when measur- ing performance, especially when measuring cur- rent-year results against prior periods, including core results, constant currencies, free cash flow and net debt. Despite the use of these measures by management in setting goals and measuring the Group’s performance, these are non-IFRS measures that have no standardized meaning prescribed by IFRS. As a result, such measures have limits in their usefulness to investors. Because of their non-standardized definitions, the non-IFRS measures (unlike IFRS measures) may not be comparable to the calculation of similar measures of other companies. These non-IFRS measures are pre- sented solely to permit investors to more fully understand how the Group’s management assesses underlying per- formance. These non-IFRS measures are not, and should not be viewed as, a substitute for IFRS measures. As an internal measure of Group performance, these non-IFRS measures have limitations, and the Group’s performance management process is not solely restricted to these metrics. Core results The Group’s core results – including core operating income, core net income and core earnings per share – exclude fully the amortization and impairment charges of intangible assets, except software, net gains and losses on fund investments and equity securities valued at fair value through profit and loss, and certain acquisi- tion-related items. The following items that exceed a threshold of USD 25 million are also excluded: integra- tion- and divestment-related income and expenses; 109 Item 5. Operating and Financial Review and Prospects divestment gains and losses; restructuring charges/ releases and related items; legal-related items; impair- ments of property, plant and equipment, and financial assets; as well as income and expense items that man- agement deems exceptional and that are or are expected to accumulate within the year to be over a USD 25 mil- lion threshold. Novartis believes that investor understanding of the Group’s performance is enhanced by disclosing core measures of performance because, since they exclude items that can vary significantly from year to year, the core measures enable better comparison of business performance across years. For this same reason, Novartis uses these core measures in addition to IFRS and other measures as important factors in assessing the Group’s performance. The following are examples of how these core mea- sures are utilized: • In addition to monthly reports containing financial infor- mation prepared under IFRS, senior management receives a monthly analysis incorporating these core measures. • Annual budgets are prepared for both IFRS and core measures. A limitation of the core measures is that they provide a view of the Group’s operations without including all events during a period, such as the effects of an acqui- sition, divestments, or amortization/impairments of pur- chased intangible assets and restructurings. Constant currencies Changes in the relative values of non-US currencies to the US dollar can affect the Group’s financial results and financial position. To provide additional information that may be useful to investors, including changes in sales volume, we present information about our net sales and various values relating to operating and net income that are adjusted for such foreign currency effects. Constant currency calculations have the goal of elim- inating two exchange rate effects so that an estimate can be made of underlying changes in the consolidated income statement excluding the impact of fluctuations in exchange rates: • The impact of translating the income statements of consolidated entities from their non-US dollar func- tional currencies to US dollars • The impact of exchange rate movements on the major transactions of consolidated entities performed in cur- rencies other than their functional currency We calculate constant currency measures by translating the current year’s foreign currency values for sales and other income statement items into US dollars, using the average exchange rates from the prior year and compar- ing them to the prior-year values in US dollars. We use these constant currency measures in evalu- ating the Group’s performance, since they may assist us in evaluating our ongoing performance from year to year. However, in performing our evaluation, we also consider equivalent measures of performance that are not affected by changes in the relative value of currencies. Free cash flow Free cash flow is presented as additional information because management believes it is a useful supplemen- tal indicator of the Group’s ability to operate without reli- ance on additional borrowing or use of existing cash. Free cash flow is a measure of the net cash generated that is available for debt repayment and investment in strategic opportunities, and for returning to sharehold- ers. Free cash flow is a non-IFRS measure, which means it should not be interpreted as a measure determined under IFRS. Free cash flow is not intended to be a sub- stitute measure for net cash flows from operating activ- ities as determined under IFRS. Novartis defines free cash flow as net cash flows from operating activities and cash flows associated with the purchase or sale of property, plant and equipment, as well as intangible, other non-current and financial assets, excluding marketable securities. Cash flows in connec- tion with the acquisition or divestment of subsidiaries, associated companies and non-controlling interests in subsidiaries are not taken into account to determine free cash flow. Net debt Net debt is presented as additional information because management believes it is a useful supplemental indica- tor of the Group’s ability to pay dividends, to meet finan- cial commitments, and to invest in new strategic oppor- tunities, including strengthening its balance sheet. Net debt is a non-IFRS measure, which means it should not be interpreted as a measure determined under IFRS. Novartis defines net debt as current and non-current financial debt less cash and cash equivalents, current investments and derivative financial instruments. Novartis Cash Value Added Novartis Cash Value Added (NCVA) is a metric that is based on what the Company assesses to be its cash flow return less a capital charge on gross operating assets. NCVA is used as the primary internal financial measure for determining payouts under the Long-Term Performance Plan introduced in 2014. More information on NCVA is presented as part of the Compensation Report; see “Item 6. Directors, Senior Management and Employees—Item 6.B Compensation.” 110 Item 5. Operating and Financial Review and Prospects Additional information EBITDA Novartis defines earnings before interest, tax, depreci- ation and amortization (EBITDA) as operating income, excluding depreciation of property, plant and equipment (including any related impairment charges) and amorti- zation of intangible assets (including any related impair- ment charges). (USD millions) 2018 2017 Operating income 8 169 8 629 2016 8 268 Enterprise value Enterprise value represents the total amount that share- holders and debt holders have invested in Novartis, less the Group’s liquidity. (USD millions unless indicated otherwise) Dec 31, 2018 Dec 31, 2017 Dec 31, 2016 Market capitalization 196 950 195 541 172 048 Non-controlling interests 78 59 59 Financial debts and derivatives 32 148 28 532 23 802 Liquidity – 15 964 – 9 485 – 7 777 Enterprise value 213 212 214 647 188 132 Depreciation of property, plant and equipment Amortization of intangible assets Impairments of property, plant and equipment, and intangible assets 1 717 1 520 1 489 Enterprise value/EBITDA 14 15 13 3 639 3 690 3 861 1 536 866 693 EBITDA 15 061 14 705 14 311 111 Item 5. Operating and Financial Review and Prospects 2018 and 2017 reconciliation from IFRS results to core results Innovative Medicines Sandoz Alcon Corporate Group (USD millions unless indicated otherwise) 2018 2017 restated 1 2018 2017 2018 2017 restated 1 2018 2017 2018 2017 IFRS operating income 7 871 7 595 1 332 1 368 – 194 – 3 – 840 – 331 8 169 8 629 Amortization of intangible assets 2 158 2 119 363 454 1 007 1 025 3 528 3 598 592 591 249 61 391 57 1 232 709 Impairments Intangible assets Property, plant and equipment related to the Group-wide rationalization of manufacturing sites Other property, plant and equipment Financial assets 2 170 65 7 77 63 60 13 Total impairment charges 827 675 312 134 391 Acquisition or divestment of businesses and related items - Income - Expense Total acquisition or divestment of businesses and related items, net Other items Divestment gains 126 – 2 32 126 30 – 482 – 368 – 78 Financial assets – fair value adjustments 2 – 107 – 18 Restructuring and related items 233 65 67 90 226 197 197 1 530 1 092 29 86 – 21 – 115 – 21 – 117 29 130 155 162 8 15 134 45 – 56 113 – 616 – 368 – 12 - Income - Expense Legal-related items - Income - Expense Additional income Additional expense Total other items Total adjustments – 25 665 – 53 268 – 12 179 – 7 134 – 4 45 – 4 34 – 2 133 – 1 – 43 29 1 022 – 1 36 – 21 – 63 35 90 28 61 – 64 154 – 65 465 – 21 96 – 73 – 534 – 171 – 3 – 66 – 51 – 19 – 372 – 329 – 960 156 273 169 – 400 50 – 5 124 90 75 20 60 54 46 350 339 223 – 298 462 – 514 3 280 2 424 670 712 1 473 1 171 231 – 86 5 654 4 221 Core operating income 11 151 10 019 2 002 2 080 1 279 1 168 – 609 – 417 13 823 12 850 as % of net sales 32.0% 31.0% 20.3% 20.7% 17.9% 17.3% 26.6% 26.2% Income from associated companies 1 – 1 5 23 6 432 1 086 6 438 1 108 Core adjustments to income from associated companies, net of tax Interest expense Other financial income and expense Taxes, adjusted for above items (core taxes) Core net income Core net income attributable to shareholders of Novartis AG Core basic EPS (USD) 3 1 – 5 325 226 – 5 325 227 – 957 – 777 185 39 – 2 226 – 2 056 11 938 11 391 11 935 11 391 5.15 4.86 1 Restated to reflect the product transfers between Innovative Medicines and Alcon that was effective as of January 1, 2018 2 For financial instruments accounted for as fair value through profit and loss, as of January 1, 2018, unrealized gains/losses on financial assets are shown under “Financial assets – fair value adjustments”, due to the change in IFRS 9 (see Note 1). 3 Earnings per share (EPS) is calculated on the amount of net income attributable to shareholders of Novartis AG. 112 Impairments Intangible assets Property, plant and equipment related to the Group-wide rationalization of manufacturing sites Other property, plant and equipment Financial assets Acquisition or divestment of businesses and related items - Income - Expense Total acquisition or divestment of businesses and related items, net Other items Divestment gains Restructuring and related items - Income - Expense Legal-related items - Income - Expense Additional income Additional expense Total other items Total adjustments Item 5. Operating and Financial Review and Prospects 2017 and 2016 reconciliation from IFRS results to core results Innovative Medicines Sandoz Alcon Corporate Group (USD millions unless indicated otherwise) 2017 restated 1 2016 restated 1 2017 2016 2017 restated 1 2016 restated 1 2017 2016 2017 2016 IFRS operating income 7 595 7 255 1 368 1 445 – 3 39 – 331 – 471 8 629 8 268 Amortization of intangible assets 2 119 2 316 454 460 1 025 1 025 3 598 3 801 591 522 61 65 57 4 709 591 Total impairment charges 675 617 134 66 7 77 1 76 18 60 13 – 7 8 67 90 29 86 197 197 99 226 99 1 092 4 – 6 84 117 786 – 2 32 – 68 41 30 – 27 – 115 – 229 – 117 – 297 130 223 162 264 15 – 6 45 – 33 – 368 – 608 – 6 – 48 – 368 – 662 – 53 268 – 41 413 – 7 134 – 23 123 – 4 34 – 4 38 – 1 29 – 5 65 – 65 465 – 21 35 – 534 273 – 99 205 – 61 84 61 – 21 96 – 3 – 51 – 13 – 372 – 22 – 960 – 400 – 107 2 424 2 799 124 712 6 100 20 60 61 82 46 100 339 – 298 90 – 514 626 1 171 1 111 – 86 183 4 221 4 719 – 73 639 – 99 205 – 96 251 165 Core operating income 10 019 10 054 2 080 2 071 1 168 1 150 – 417 – 288 12 850 12 987 as % of net sales 31.0% 31.6% 20.7% 20.4% 17.3% 17.6% 26.2% 26.8% Income from associated companies Core adjustments to income from associated companies, net of tax Interest expense – 1 1 Other financial income and expense 2 Taxes, adjusted for above items (core taxes) Core net income Core net income attributable to shareholders of Novartis AG Core basic EPS (USD) 3 23 6 1 086 697 1 108 703 226 431 227 431 – 777 – 707 39 – 99 – 2 056 – 2 001 11 391 11 314 11 391 11 307 4.86 4.75 1 Restated to reflect the product transfers between Innovative Medicines and Alcon that was effective as of January 1, 2018 2 Adjusted for charges of USD 0.3 billion in 2016 related mainly to devaluation losses in Venezuela 3 Earnings per share (EPS) is calculated on the amount of net income attributable to shareholders of Novartis AG. 113 Item 5. Operating and Financial Review and Prospects 2018, 2017 and 2016 reconciliation from IFRS results to core results – Group 2018 (USD millions unless indicated otherwise) Gross profit Operating income Income before taxes Taxes 5 Net income Basic EPS (USD) 6 Amortization of intangible assets 1 IFRS results Acquisition or divestment of businesses and Impairments 2 related items 3 Other items 4 Core results 34 759 8 169 13 835 – 1 221 12 614 5.44 3 338 3 528 3 972 877 1 530 5 134 1 530 – 5 656 439 462 483 39 418 13 823 14 164 – 2 226 11 938 5.15 The following are adjustments to arrive at core gross profit Cost of goods sold – 18 407 3 338 877 5 439 – 13 748 The following are adjustments to arrive at core operating income Selling, general and administration Research and development Other income Other expense – 16 471 – 9 074 1 690 – 2 735 190 2 167 28 23 12 13 – 16 429 – 8 681 – 21 – 1 073 596 484 99 1 071 – 1 081 The following are adjustments to arrive at core income before taxes Income from associated companies 6 438 444 – 5 790 21 1 113 1 Amortization of intangible assets: cost of goods sold includes amortization of acquired rights to in-market products, and other production-related intangible assets; research and development includes the amortization of acquired rights, including technology platforms; income from associated companies includes USD 444 million for the Novartis share of the estimated Roche core items 2 Impairments: cost of goods sold, selling, general and administration and research and development include impairment charges related to intangible assets; research and development also includes impairment reversals of property, plant and equipment; other expense includes impairment charges related to property, plant and equipment; cost of goods sold and other expense include impairment charges related to a disposal group held for sale for goodwill and currently marketed products 3 Acquisition or divestment of businesses and related items, including restructuring and integration charges: cost of goods sold, selling, general and administration, research and development and other expense include charges related to acquisitions; other income and other expense include transitional service fee income and expenses, and other items related to the portfolio transformation; income from associated companies includes the pre-tax gain of USD 5.8 billion on the sale of the 36.5% investment in GSK Consumer Healthcare Holdings Ltd. 4 Other items: cost of goods sold, selling, general and administration and research and development include charges and reversal of charges related to a product’s voluntary market withdrawal; cost of goods sold, other income and other expense include net restructuring and other charges related to the Group-wide rationalization of manufacturing sites; cost of goods sold, selling, general and administration, research and development, other income and other expense include other restructuring income and charges and related items; cost of goods sold and other expense include charges related to changes in a contractual agreement; cost of goods sold also includes inventory write-off and other product recall-related costs; selling, general and administration includes a reversal of a provision; research and development includes fair value adjustments of contingent consideration liabilities, a charge for onerous contracts, and amortization of option rights; other income and other expense include fair value adjustments and divestment gains and losses on financial assets; other income also includes product divestment gains, divestment gains on property, plant and equipment, releases of accruals and a legal settlement gain; other expense includes legal-related items and restructuring charges; income from associated companies includes an adjustment of USD 21 million for the Novartis share of the estimated GSK Consumer Healthcare Holdings Ltd. core items 5 Taxes on the adjustments between IFRS and core results take into account, for each individual item included in the adjustment, the tax rate that will finally be applicable to the item based on the jurisdiction where the adjustment will finally have a tax impact. Generally, this results in amortization and impairment of intangible assets and acquisition-related restructuring and integration items having a full tax impact. There is usually a tax impact on other items, although this is not always the case for items arising from legal settlements in certain jurisdictions. Adjustments related to income from associated companies are recorded net of any related tax effect. Due to these factors and the differing effective tax rates in the various jurisdictions, the tax on the total adjustments of USD 329 million to arrive at the core results before tax amounts to USD -1.0 billion. Excluding the gain on the sale of the 36.5% investment in GSK Cosumer Healthcare Holdings Ltd., the tax on the total adjustments of USD 6.1 billion to arrive at the core results before tax amounts to USD 1.1 billion. The average tax rate on the adjustments excluding this transaction is 17.4% 6 Earnings per share (EPS) is calculated on the amount of net income attributable to shareholders of Novartis AG. 114 Item 5. Operating and Financial Review and Prospects 2017 (USD millions unless indicated otherwise) Gross profit Operating income Income before taxes Taxes 5 Net income Basic EPS (USD) 6 Amortization of intangible assets 1 IFRS results Acquisition or divestment of businesses and Impairments 2 related items 3 Other items 4 Core results 32 960 8 629 8 999 – 1 296 7 703 3.28 3 401 3 598 3 974 92 1 092 1 093 125 36 578 – 514 12 850 – 664 13 447 45 45 – 2 056 11 391 4.86 The following are adjustments to arrive at core gross profit Cost of goods sold – 17 175 3 401 92 125 – 13 557 The following are adjustments to arrive at core operating income Selling, general and administration Research and development Other income Other expense – 14 997 – 8 972 1 969 – 2 331 197 680 – 9 329 – 3 – 15 000 – 218 – 8 313 – 117 – 1 065 778 162 647 – 1 193 The following are adjustments to arrive at core income before taxes Income from associated companies 1 108 376 1 – 150 1 335 1 Amortization of intangible assets: cost of goods sold includes recurring amortization of acquired rights to in-market products and other production-related intangible assets; research and development includes the recurring amortization of acquired rights for technology platforms; income from associated companies includes USD 376 million for the Novartis share of the estimated Roche core items 2 Impairments: cost of goods sold and research and development include impairment charges related to intangible assets; research and development and other expense include impairment charges related to financial assets; research and development, other income and other expense include reversals and charges related to the impairment of property, plant and equipment 3 Acquisition or divestment of businesses and related items, including restructuring and integration charges: other income and other expense include transitional service fee income and expenses, and other items related to the portfolio transformation 4 Other items: cost of goods sold, other income and other expense include net restructuring and other charges related to the Group-wide rationalization of manufacturing sites; cost of goods sold, research and development, selling, general and administration, other income and other expense include other restructuring income and charges and related items; selling, general and administration includes an income from the release of a provision; research and development includes fair value adjustments to contingent consideration liabilities; other income and other expense include legal-related items; other income also includes a gain from a Swiss pension plan amendment, product and financial asset divestment gains, a partial reversal of a prior period charge, income from a settlement of a contract dispute and a fair value adjustment to contingent consideration sales milestone receivables; other expense also includes a provision for contract termination costs, a charge for onerous contracts, and an amendment to the Swiss pension plan; income from associated companies includes an adjustment of USD 150 million for the Novartis share of the estimated GSK Consumer Healthcare Holdings Ltd. core items 5 Taxes on the adjustments between IFRS and core results take into account, for each individual item included in the adjustment, the tax rate that will finally be applicable to the item based on the jurisdiction where the adjustment will finally have a tax impact. Generally, this results in amortization and impairment of intangible assets and acquisition-related restructuring and integration items having a full tax impact. There is usually a tax impact on other items, although this is not always the case for items arising from legal settlements in certain jurisdictions. Adjustments related to income from associated companies are recorded net of any related tax effect. Due to these factors and the differing effective tax rates in the various jurisdictions, the tax on the total adjustments of USD 4.4 billion to arrive at the core results before tax amounts to USD 760 million. The average tax rate on the adjustments is 17.1%. 6 Earnings per share (EPS) is calculated on the amount of net income attributable to shareholders of Novartis AG. 115 Item 5. Operating and Financial Review and Prospects 2016 (USD millions unless indicated otherwise) Gross profit Operating income Income before taxes Taxes 5 Net income Basic EPS (USD) 6 The following are adjustments to arrive at core gross profit Other revenues Cost of goods sold Amortization of intangible assets 1 IFRS results Acquisition or divestment of businesses and Impairments 2 related items 3 Other items 4 Core results 3 758 3 801 4 097 96 786 786 31 916 8 268 7 817 – 1 119 6 698 2.82 918 – 17 520 3 758 96 36 35 806 – 33 – 33 165 648 12 987 13 315 – 2 001 11 314 4.75 – 50 868 86 – 13 580 The following are adjustments to arrive at core operating income Selling, general and administration Research and development Other income Other expense – 14 192 – 9 039 1 927 – 2 344 43 495 – 10 205 81 99 – 14 111 – 8 402 – 297 – 867 753 264 816 – 1 059 The following are adjustments to arrive at core income before taxes Income from associated companies Other financial income and expense 703 – 447 296 135 348 1 134 – 99 1 Amortization of intangible assets: cost of goods sold includes recurring amortization of acquired rights to in-market products and other production-related intangible assets; research and development includes the recurring amortization of acquired rights for technology platforms; income from associated companies includes USD 296 million for the Novartis share of the estimated Roche core items 2 Impairments: cost of goods sold and research and development include impairment charges related to intangible assets; other income includes impairment reversals of property, plant and equipment; other expense includes impairment charges related to property, plant and equipment, and financial assets 3 Acquisition or divestment of businesses and related items, including restructuring and integration charges: other income and other expense include transitional service fee income and expenses, and other items related to the portfolio transformation; other income also includes a gain from the revaluation of a previously held financial investment in a newly acquired company 4 Other items: other revenues include an early release of deferred income associated with a collaboration agreement; cost of goods sold, other income and other expense include net restructuring and other charges related to the Group-wide rationalization of manufacturing sites; research and development, selling, general and administration, other income and other expense include other restructuring income and charges; cost of goods sold and research and development include adjustments of contingent considerations; selling, general and administration, other income and other expense include items related to setup costs for Novartis Business Services; other income and other expense also include legal settlements and changes in provisions; other income also includes gains from product divestments, other income related to the portfolio transformation, and a gain related to the sale of real estate; other expense also includes a charge as a result of a pension plan amendment, a charge for an indirect tax settlement, and other costs; income from associated companies includes USD 135 million for the Novartis share of the estimated GSK Consumer Healthcare Holdings Ltd. core items; other financial income and expense relates mainly to devaluation losses in Venezuela 5 Taxes on the adjustments between IFRS and core results take into account, for each individual item included in the adjustment, the tax rate that will finally be applicable to the item based on the jurisdiction where the adjustment will finally have a tax impact. Generally, this results in amortization and impairment of intangible assets and acquisition-related restructuring and integration items having a full tax impact. There is usually a tax impact on other items, although this is not always the case for items arising from legal settlements in certain jurisdictions. Adjustments related to income from associated companies are recorded net of any related tax effect. Due to these factors and the differing effective tax rates in the various jurisdictions, the tax on the total adjustments for continuing operations of USD 5.5 billion to arrive at the core results before tax amounts to USD 882 million. The average tax rate on the adjustments is 16.0%. 6 Earnings per share (EPS) is calculated on the amount of net income attributable to shareholders of Novartis AG. 116 Item 5. Operating and Financial Review and Prospects 2018, 2017 and 2016 reconciliation from IFRS results to core results – Innovative Medicines 2018 (USD millions) Gross profit Operating income Amortization of intangible assets 1 IFRS results Acquisition or divestment of businesses and Impairments 2 related items 3 Other items 4 Core results 26 951 7 871 1 979 2 158 423 827 5 126 329 169 29 687 11 151 The following are adjustments to arrive at core gross profit Cost of goods sold – 9 870 1 979 423 5 329 – 7 134 The following are adjustments to arrive at core operating income Selling, general and administration – 10 907 Research and development – 7 675 179 167 28 23 Other income Other expense 977 – 1 475 237 70 – 11 – 10 890 – 34 – 7 340 – 671 556 306 – 612 1 Amortization of intangible assets: cost of goods sold includes amortization of acquired rights to in-market products and other production-related intangible assets; research and development includes the amortization of acquired rights, including technology platforms 2 Impairments: cost of goods sold and research and development include impairment charges related to intangible assets; research and development also includes impairment reversals of property, plant and equipment; other expense includes impairment charges related to property, plant and equipment 3 Acquisition or divestment of businesses and related items, including restructuring and integration charges: cost of goods sold, selling, general and administration, research and development and other expense include charges related to acquisitions; other expense also includes items related to the portfolio transformation 4 Other items: cost of goods sold and other expense include restructuring and other charges related to the Group-wide rationalization of manufacturing sites and charges related to changes in a contractual agreement; cost of goods sold, research and development, other income and other expense include other restructuring income and charges and related items; cost of goods sold and research and development also include fair value adjustments of contingent consideration liabilities; cost of goods sold also includes an inventory write-off; selling, general and administration includes a reversal of a provision; research and development includes a charge for onerous contracts; other income and other expense include fair value adjustments on financial assets and legal-related items; other income also includes product divestment gains and releases of accruals 2017 (USD millions) Gross profit Operating income IFRS Amortization of intangible assets 2 restated results 1 25 194 7 595 1 932 2 119 Acquisition or divestment of businesses and related items 4 Impairments 3 31 675 Other items 5 Core restated results 1 56 27 213 30 – 400 10 019 The following are adjustments to arrive at core gross profit Cost of goods sold – 8 650 1 932 31 56 – 6 631 The following are adjustments to arrive at core operating income Selling, general and administration Research and development Other income Other expense – 9 887 – 7 615 1 027 – 1 124 187 594 – 9 59 – 2 32 – 3 – 9 890 – 200 – 7 034 – 665 412 351 – 621 1 Restated to reflect the product transfers between Innovative Medicines and Alcon that was effective as of January 1, 2018 2 Amortization of intangible assets: cost of goods sold includes recurring amortization of acquired rights to in-market products and other production-related intangible assets; research and development includes the recurring amortization of acquired rights for technology platforms 3 Impairments: cost of goods sold and research and development include impairment charges related to intangible assets; research and development, other income and other expense include reversals and charges related to the impairment of property, plant and equipment 4 Acquisition or divestment of businesses and related items, including restructuring and integration charges: other income includes transitional service fee income; other expense includes items related to the portfolio transformation and costs related to an acquisition 5 Other items: cost of goods sold, other income and other expense include net restructuring and other charges related to the Group-wide rationalization of manufacturing sites; costs of goods sold, research and development, selling, general and administration, other income and other expense include other restructuring income and charges and related items; selling, general and administration includes an income from the release of a provision; research and development includes fair value adjustments to contingent consideration liabilities; other income and other expense include legal-related items; other income also includes a gain from a Swiss pension plan amendment, income from a settlement of a contract dispute, as well as product and financial asset divestment gains; other expense also includes a provision for contract termination costs, an amendment to the Swiss pension plan, a charge for onerous contracts, and other charges 117 Item 5. Operating and Financial Review and Prospects 2016 (USD millions) Gross profit Operating income IFRS Amortization of intangible assets 2 restated results 1 24 294 7 255 2 285 2 316 Acquisition or divestment of businesses and Impairments 3 related items 4 Other items 5 Core restated results 1 41 617 – 10 26 610 – 27 – 107 10 054 The following are adjustments to arrive at core gross profit Other revenues Cost of goods sold 815 – 8 976 2 285 41 – 50 765 40 – 6 610 The following are adjustments to arrive at core operating income Selling, general and administration Research and development Other income Other expense – 9 225 – 7 696 1 091 – 1 209 31 481 95 – 68 41 7 84 – 759 571 – 9 218 – 7 100 264 – 502 1 Restated to reflect the product transfers between Innovative Medicines and Alcon that was effective as of January 1, 2018 2 Amortization of intangible assets: cost of goods sold includes recurring amortization of acquired rights to in-market products and other production-related intangible assets; research and development includes the recurring amortization of acquired rights for technology platforms 3 Impairments: cost of goods sold and research and development include impairment charges related to intangible assets; other expense includes impairment charges related to property, plant and equipment, and financial assets 4 Acquisition or divestment of businesses and related items, including restructuring and integration charges: other income and other expense include transitional service fee income and expenses, and other items related to the portfolio transformation; other income also includes a gain from the revaluation of a previously held financial investment in a newly acquired company 5 Other items: other revenues include an early release of deferred income associated with a collaboration agreement; cost of goods sold, other income and other expense include net restructuring and other charges related to the Group-wide rationalization of manufacturing sites; research and development, selling, general and adminstration, other income and other expense include other restructuring income and charges; research and development also includes an expense due to an adjustment of a contingent consideration; other income and other expense also include legal settlements and changes in provisions; other income also includes gains from product divestments; other expense also includes a charge as a result of a pension plan amendment 2018, 2017 and 2016 reconciliation from IFRS to core results – Sandoz 2018 (USD millions) Gross profit Operating income Amortization of intangible assets 1 IFRS results Acquisition or divestment of businesses and Impairments 2 related items Other items 3 Core results 4 568 1 332 363 363 65 312 133 – 5 5 129 2 002 The following are adjustments to arrive at core gross profit Cost of goods sold – 5 530 363 65 133 – 4 969 The following are adjustments to arrive at core operating income Selling, general and administration Other income Other expense – 2 305 505 – 622 247 10 – 2 295 – 295 147 210 – 228 1 Amortization of intangible assets: cost of goods sold includes amortization of acquired rights to in-market products and other production-related intangible assets 2 Impairments: cost of goods sold includes impairment charges related to intangible assets and impairment charges for currently marketed products related to a disposal group held for sale; other expense includes impairment charges related to property, plant and equipment, and goodwill impairment charges related to a disposal group held for sale 3 Other items: cost of goods sold, other income and other expense include net restructuring and other charges related to the Group-wide rationalization of manufacturing sites; cost of goods sold also includes inventory write-off and other product recall-related costs; cost of goods sold, selling, general and administration, other income and other expense include other restructuring income and charges and related items; other income also includes product divestment gains, a legal settlement gain and fair value adjustments of contingent consideration liabilities; other expense includes legal-related items and restructuring charges 118 Item 5. Operating and Financial Review and Prospects 2017 (USD millions) Gross profit Operating income Amortization of intangible assets 1 IFRS results Acquisition or divestment of businesses and related items Impairments 2 4 415 1 368 454 454 61 134 Other items 3 69 124 Core results 4 999 2 080 The following are adjustments to arrive at core gross profit Cost of goods sold – 5 800 454 61 69 – 5 216 The following are adjustments to arrive at core operating income Other income Other expense 204 – 351 73 – 10 65 194 – 213 1 Amortization of intangible assets: cost of goods sold includes recurring amortization of acquired rights to in-market products and other production-related intangible assets 2 Impairments: cost of goods sold includes impairment charges related to intangible assets; other expense includes impairment charges related to property, plant and equipment 3 Other items: cost of goods sold, other income and other expense include net restructuring and other charges related to the Group-wide rationalization of manufacturing sites, and other restructuring income and charges and related items; other income also includes a gain from a Swiss pension plan amendment 2016 USD millions) Gross profit Operating income Amortization of intangible assets 1 IFRS results 4 314 1 445 460 460 Acquisition or divestment of businesses and related items Impairments 2 55 66 Other items 3 60 100 Core results 4 889 2 071 The following are adjustments to arrive at core gross profit Cost of goods sold – 5 971 460 55 60 – 5 396 The following are adjustments to arrive at core operating income Research and development Other income Other expense – 814 185 – 259 10 – 10 11 – 29 69 – 804 146 – 179 1 Amortization of intangible assets: cost of goods sold includes recurring amortization of acquired rights to in-market products and other production-related intangible assets 2 Impairments: cost of goods sold and research and development include impairment charges related to intangible assets; other income includes impairment reversals of property, plant and equipment; other expense includes impairment charges related to property, plant and equipment 3 Other items: cost of goods sold, other income and other expense include net restructuring and other charges related to the Group-wide rationalization of manufacturing sites, and other restructuring income and charges; other income also includes gains from product divestments; other expense also includes other costs 2018, 2017 and 2016 reconciliation of IFRS results to core results – Alcon 2018 (USD millions) Gross profit Operating income Amortization of intangible assets 1 IFRS results Acquisition or divestment of businesses and related items Impairments 2 3 170 – 194 996 1 007 389 391 Other items 3 Core results – 23 75 4 532 1 279 The following are adjustments to arrive at core gross profit Cost of goods sold – 3 983 996 389 – 23 – 2 621 The following are adjustments to arrive at core operating income Selling, general and administration Research and development Other income Other expense 2 11 – 2 754 – 585 58 – 83 13 47 – 23 61 – 2 739 – 527 35 – 22 1 Amortization of intangible assets: cost of goods sold includes amortization of acquired rights to in-market products and other production-related intangible assets; research and development includes the amortization of acquired rights for technology platforms 2 Impairments: cost of goods sold and selling, general and administration includes impairment charges related to intangible assets 3 Other items: cost of goods sold, selling, general and administration and research and development include charges and reversal of charges related to a product’s voluntary market withdrawal; cost of goods sold, selling, general and administration, research and development, other income and other expense also include other restructuring income and charges and related items; research and development also includes amortization of option rights and a fair value adjustment of a contingent consideration liability; other income includes fair value adjustments on a financial asset; other expense includes legal-related items 119 Item 5. Operating and Financial Review and Prospects 2017 (USD millions) Gross profit Operating loss/income IFRS Amortization of intangible assets 2 restated results 1 3 189 – 3 1 015 1 025 Acquisition or divestment of businesses and related items Impairments 3 86 Other items 4 60 The following are adjustments to arrive at core gross profit Cost of goods sold – 3 588 1 015 Core restated results 1 4 204 1 168 – 2 573 The following are adjustments to arrive at core operating income Research and development Other income Other expense 10 86 – 583 47 – 124 – 18 – 17 95 – 505 30 – 29 1 Restated to reflect the product transfers between Innovative Medicines and Alcon that was effective as of January 1, 2018 2 Amortization of intangible assets: cost of goods sold includes recurring amortization of acquired rights to in-market products and other production-related intangible assets; research and development includes the recurring amortization of acquired rights for technology platforms 3 Impairments: research and development includes impairment charges related to intangible and financial assets 4 Other items: research and development includes fair value adjustments to contingent consideration liabilities; other income and other expense include restructuring income and charges and related items; other income also includes a gain from a Swiss pension plan amendment and the partial reversal of a prior period charge; other expense also includes legal-related items 2016 (USD millions) Gross profit Operating income IFRS Amortization of intangible assets 2 restated results 1 3 100 39 1 013 1 025 Acquisition or divestment of businesses and related items Impairments 3 4 Other items 4 – 14 82 Core restated results 1 4 099 1 150 The following are adjustments to arrive at core gross profit Cost of goods sold – 3 447 1 013 – 14 – 2 448 The following are adjustments to arrive at core operating income Research and development Other income Other expense 12 4 – 529 48 – 100 15 – 4 85 – 498 44 – 15 1 Restated to reflect the product transfers between Innovative Medicines and Alcon that was effective as of January 1, 2018 2 Amortization of intangible assets: cost of goods sold includes recurring amortization of acquired rights to in-market products and other production-related intangible assets; research and development includes the recurring amortization of acquired rights for technology platforms 3 Impairments: research and development includes impairment charges related to intangible assets 4 Other items: cost of goods sold includes income due to an adjustment of a contingent consideration; research and development, other income and other expense include restructuring income and charges; research and development also includes an expense due to an adjustment of a contingent consideration; other expense also includes a charge for an indirect tax settlement 2018, 2017 and 2016 reconciliation from IFRS results to core results – Corporate Amortization of intangible assets IFRS results Acquisition or divestment of businesses and related items 1 Impairments 2018 (USD millions) Gross profit Operating loss The following are adjustments to arrive at core operating loss Other income Other expense 70 – 840 150 – 555 Other items 2 Core results 70 8 223 – 609 – 21 29 – 84 307 45 – 219 1 Acquisition or divestment of businesses and related items, including restructuring and integration charges: other income and other expense include transitional service fee income and expenses, and other items related to the portfolio transformation 2 Other items: other income and other expense include fair value adjustments and divestment gains and losses on financial assets, as well as restructuring income and charges and related items; other income also includes divestment gains on property, plant and equipment 120 Item 5. Operating and Financial Review and Prospects 2017 (USD millions) Gross profit Operating loss The following are adjustments to arrive at core operating loss Other income Other expense Amortization of intangible assets IFRS results Acquisition or divestment of businesses and related items 2 Impairments 1 Other items 3 162 – 331 691 – 732 197 15 – 298 – 115 – 373 197 130 75 Core results 162 – 417 203 – 330 1 Impairments: other expense includes impairment charges related to financial assets 2 Acquisition or divestment of businesses and related items, including restructuring and integration charges: other income and other expense include transitional service fee income and expenses, and other items related to the portfolio transformation 3 Other items: other income includes a fair value adjustment to contingent consideration sales milestone receivables, a Swiss pension plan amendment and other items; other income and other expense include restructuring income and charges and related items; other expense also includes an amendment to the Swiss pension plan 2016 (USD millions) Gross profit Operating loss The following are adjustments to arrive at core operating loss Selling, general and administration Other income Other expense Amortization of intangible assets IFRS results Acquisition or divestment of businesses and related items 2 Impairments 1 Other items 3 Core results 208 – 471 – 506 603 – 776 99 – 6 90 – 229 223 99 74 – 75 91 208 – 288 – 432 299 – 363 1 Impairments: other expense includes impairment charges related to financial assets 2 Acquisition or divestment of businesses and related items, including restructuring and integration charges: other income and other expense include transitional service fee income and expenses, and other items related to the portfolio transformation 3 Other items: selling, general and administration, other income and other expense include items related to setup costs for Novartis Business Services; other income also includes income related to the portfolio transformation and a gain related to the sale of real estate; other expense also includes other restructuring charges and other costs 121 Item 5. Operating and Financial Review and Prospects 5.B Liquidity and capital resources The following tables summarize the Group’s cash flow and net debt. (USD millions) Net cash flows from operating activities Net cash flows used in investing activities Net cash flows used in investing activities from discontinued operations Net cash flows used in financing activities Effect of exchange rate changes on cash and cash equivalents Net change in cash and cash equivalents Change in marketable securities, commodities, time deposits and derivative financial instruments 2018 2017 2016 14 272 12 621 11 475 – 5 591 – 2 979 – 2 693 – 140 – 748 – 4 244 – 7 733 – 5 314 – 26 4 411 2 068 84 1 853 – 145 – 387 2 333 – 3 Change in current and non-current financial debts and derivative financial instruments – 3 616 – 4 730 – 1 871 Change in net debt Net debt at January 1 Net debt at December 31 Cash flow 2 863 – 3 022 459 – 19 047 – 16 025 – 16 484 – 16 184 – 19 047 – 16 025 Financial year 2018 Net cash flows from operating activities amounted to USD 14.3 billion, compared to USD 12.6 billion in 2017. The increase was mainly driven by higher net income adjusted for non-cash items and other adjustments, including divestment gains, as well as favorable hedging results and working capital, which includes the receipt of a GSK sales milestone from the divested Vaccines business. Net cash flows used in investing activities amounted to USD 5.6 billion, compared to USD 3.1 billion in 2017. The current year includes cash inflows of USD 13.0 bil- lion from the divestment of our 36.5% stake in the GSK consumer healthcare joint venture and of USD 1.1 billion for the proceeds from sales of property, plant and equip- ment, intangible and financial assets. This was offset by cash outflows for the acquisitions of businesses of USD 13.9 billion, mainly Advanced Accelerator Applications S.A. of USD 3.5 billion, net (USD 3.9 billion, net of cash acquired USD 0.4 billion), AveXis, Inc. of USD 8.3 billion, net (USD 8.7 billion, net of cash acquired USD 0.4 billion) and Endocyte, Inc. of USD 1.8 billion, net (USD 2.1 billion, net of cash acquired USD 0.3 billion), as well as for the purchase of property, plant and equipment of USD 1.8 billion and for the purchase of intangible assets of USD 1.6 billion. Net purchases of marketable securities and commodities amounted to USD 2.0 billion. Net cash flows used in financing activities amounted to USD 4.2 billion, compared to USD 7.7 billion in 2017. The current year mainly includes the cash outflows for the dividend payment of USD 7.0 billion and for net trea- sury share transactions of USD 1.3 billion, partly offset by a net increase in current and non-current financial debt of USD 4.2 billion. This increase was mainly from the issuance of euro bonds totaling USD 2.8 billion (notional amount EUR 2.25 billion) and the net increase in current financial debts of USD 1.7 billion, partly offset by repayments of non-current financial debts of USD 0.4 billion. Financial year 2017 Net cash flows from operating activities amounted to USD 12.6 billion, compared to USD 11.5 billion in 2016. The increase of USD 1.1 billion was mainly driven by favor- able working capital changes, lower legal settlement payments out of provisions, and lower taxes paid, partly offset by the decrease in net income adjusted for non- cash items and other adjustments. Net cash flows used in investing activities from con- tinuing operations amounted to USD 3.0 billion in 2017. This amount included cash outflows for the purchase of property, plant and equipment of USD 1.7 billion, intan- gible assets of USD 1.1 billion, and financial assets and other non-current assets of USD 0.5 billion; and for acquisitions and divestments of businesses, net (includ- ing the Ziarco Group Limited and Encore Vision, Inc. acquisitions) of USD 0.8 billion. This was partly offset by cash inflows from the sale of property, plant and equip- ment; intangible assets; and financial assets of USD 1.1 billion. Net cash flows used in investing activities from dis- continued operations, which consists of payments out of provisions related to the portfolio transformation transactions, amounted to USD 0.1 billion, compared to USD 0.7 billion in 2016, which also included capital gains taxes. The net cash flows used in financing activities amounted to USD 7.7 billion, compared to USD 5.3 billion in 2016. The 2017 amount included mainly cash outflows for the dividend payment of USD 6.5 billion and for net treasury share transactions of USD 5.2 billion. The net cash inflows from current and non-current financial debts of USD 4.0 billion were mainly from the issuance of bonds denominated in US dollar and euro for a notional amount of USD 3.0 billion and EUR 1.85 billion (USD 2.0 billion), respectively, partially offset by the repayment of current and non-current financial debt of USD 0.9 billion. 122 Item 5. Operating and Financial Review and Prospects Financial year 2016 Net cash flows from operating activities from continuing operations amounted to USD 11.5 billion, compared to USD 12.1 billion in 2015. The decrease of USD 0.6 billion was driven by lower operating income adjusted for non- cash items and other adjustments, lower hedging results and higher payments out of provisions, partially offset by dividends received from GSK Consumer Healthcare Holdings Ltd., lower cash outflows for taxes paid, and net current assets and other operating cash flow items. Net cash flows used in investing activities from con- tinuing operations amounted to USD 2.7 billion in 2016. This amount includes cash outflows of USD 1.9 billion for the purchase of property, plant and equipment; USD 1.4 billion for intangible, financial and other non-current assets; and USD 0.8 billion for acquisitions and divest- ments of businesses, net (including the Transcend Med- ical, Inc. and Reprixys Pharmaceuticals Corporation acquisitions). This was offset by cash inflows of USD 1.3 billion of proceeds from the sale of non-current assets, and USD 0.1 billion net proceeds from the sales of mar- ketable securities and commodities. In 2015, cash flows used in investing activities from continuing operations amounted to USD 19.7 billion, primarily due to the acqui- sition of the GSK oncology assets for USD 16.0 billion. Group net debt Net cash flows used in investing activities from dis- continued operations amounted to USD 0.7 billion in 2016 due to portfolio transformation transactions payments, including capital gains taxes. In 2015, the cash flows from investing activities from discontinued operations of USD 8.9 billion were mainly driven by net proceeds from the portfolio transformation divestments. The net cash flows used in financing activities amounted to USD 5.3 billion, compared to USD 9.2 bil- lion in 2015. The 2016 amount includes cash outflows of USD 6.5 billion for the dividend payment and USD 0.9 billion for treasury share transactions, net. The net inflow of USD 2.1 billion from current and non-current financial debts was due to the increase in short-term borrowings of USD 1.8 billion and the issuance of two euro-denom- inated bonds for total proceeds of USD 1.9 billion, par- tially offset by the repayment at maturity of a euro-de- nominated bond of USD 1.7 billion. The 2015 amount included mainly a cash outflow of USD 6.6 billion for the dividend payment, and USD 4.5 billion for treasury share transactions, net, partially off- set by a net inflow from financial debts of USD 2.0 bil- lion. Net debt constitutes a non-IFRS financial measure, which means that it should not be interpreted as a mea- sure determined under International Financial Reporting Standards (IFRS). Net debt/liquidity is presented as addi- tional information, as it is a useful indicator of the Group’s ability to meet financial commitments and to invest in new strategic opportunities, including strengthening its balance sheet. Group net debt consists of: (USD millions) Non-current financial debts Current financial debts and derivative financial instruments Total financial debt Less liquidity Cash and cash equivalents Marketable securities, commodities, time deposits and derivative financial instruments Total liquidity Net debt at December 31 2018 2017 Change – 22 470 – 23 224 754 – 9 678 – 5 308 – 4 370 – 32 148 – 28 532 – 3 616 13 271 8 860 4 411 2 693 625 15 964 9 485 – 16 184 – 19 047 2 068 6 479 2 863 Financial year 2018 Group net debt at December 31, 2018, decreased to USD 16.2 billion, compared to USD 19.0 billion at December 31, 2017. Total financial debt increased by USD 3.6 billion to USD 32.1 billion at December 31, 2018, from USD 28.5 billion at December 31, 2017. Non-current financial debt decreased by USD 0.8 billion to USD 22.5 billion at December 31, 2018, from USD 23.2 billion at December 2017, mainly driven by foreign exchange translation adjustments, as the issuance of euro bonds totaling USD 2.8 billion (notional amount EUR 2.25 billion) was offset by the reclassification of a US dollar bond of USD 3.0 billion, which becomes due in 2019, to current financial debt. Current financial debts and derivative financial instru- ments increased by USD 4.4 billion to USD 9.7 billion at December 31, 2018, from USD 5.3 billion at December 31, 2017, mainly due to higher net short-term borrowings and the reclassification of a US dollar bond of USD 3.0 123 Item 5. Operating and Financial Review and Prospects billion from non-current liabilities, which becomes due in 2019. Novartis has two US commercial paper programs under which it can issue up to USD 9.0 billion in the aggregate of unsecured commercial paper notes. Novartis also has a Japanese commercial paper program under which it can issue up to JPY 150 billion (approxi- mately USD 1.4 billion) of unsecured commercial paper notes. Commercial paper notes totaling USD 4.0 billion under these three programs were outstanding as per December 31, 2018 (2017: USD 2.3 billion). Novartis fur- ther has a committed credit facility of USD 6.0 billion, entered into on September 23, 2015. This credit facility is provided by a syndicate of banks and is intended to be used as a backstop for the United States commercial paper programs. It matures in September 2020 and was undrawn as per December 31, 2018 and December 31, 2017. As of year-end 2018, Moody’s Investor Service rated the Company A1 for long-term maturities and P-1 for short-term maturities and S&P Global Ratings AA- for long-term maturities and A-1+ for short-term maturities. Financial year 2017 Group net debt at December 31, 2017, increased to USD 19.0 billion compared to USD 16.0 billion at the end of 2016, mainly due to increased borrowings. Total financial debt increased by USD 4.7 billion to USD 28.5 billion at December 31, 2017, from USD 23.8 billion at December 31, 2016. Non-current financial debt increased by USD 5.3 billion to USD 23.2 billion at Decem- ber 31, 2017, from USD 17.9 billion at December 2016, The maturity schedule of our net debt is as follows: mainly due to the issuance of bonds in the first quarter that are denominated in US dollar and euro for a notional amount of USD 3.0 billion and EUR 1.85 billion (USD 2.0 billion), respectively. Current financial debt decreased by USD 0.6 billion to USD 5.3 billion at December 31, 2017, from USD 5.9 billion at December 31, 2016, mainly due to a reduction in short term borrowings. Overall current financial debt consists of the current portion of non-current financial debt of USD 0.4 billion and other short term borrowings of USD 4.9 billion, including derivatives and commercial paper. Novartis has two US commercial paper programs under which it can issue up to USD 9.0 billion in the aggregate of unsecured commercial paper notes. Novartis also has a Japanese commercial paper program under which it can issue up to JPY 150 billion (approxi- mately USD 1.3 billion) of unsecured commercial paper notes. Commercial paper notes totaling USD 2.3 billion under these three programs were outstanding as per December 31, 2017. Novartis further has a committed credit facility of USD 6.0 billion, entered into on Septem- ber 23, 2015. This credit facility is provided by a syndi- cate of banks and is intended to be used as a backstop for the US commercial paper programs. It matures in September 2020 and was undrawn as per December 31, 2017. As of year-end 2017, Moody’s Investor Service rated the Company Aa3 for long-term maturities and P-1 for short-term maturities and S&P Global Ratings AA- for long-term maturities and A-1+ for short-term maturities. 2018 (USD millions) Current assets Marketable securities, time deposits and short-term investments with original maturity more than 90 days Commodities Derivative financial instruments and accrued interest Cash and cash equivalents Total current financial assets Non-current liabilities Financial debt Financial debt – undiscounted Total non-current financial debt Current liabilities Financial debt Financial debt – undiscounted Derivative financial instruments Total current financial debt Due later than Due later than Due later than one year Due within but less than but less than but less than five years one month three months three months one month one year 39 56 2 091 198 40 3 571 3 650 75 9 700 9 831 27 Due after five years Total 63 104 2 447 104 142 13 271 2 118 198 167 15 964 – 8 980 – 13 490 – 22 470 – 9 025 – 13 623 – 22 648 – 8 980 – 13 490 – 22 470 – 5 217 – 4 084 – 5 217 – 4 084 – 16 – 34 – 319 – 319 – 8 – 5 233 – 4 118 – 327 – 9 620 – 9 620 – 58 – 9 678 Net debt – 1 583 5 713 1 791 – 8 782 – 13 323 – 16 184 124 Item 5. Operating and Financial Review and Prospects 2017 Due later than Due later than Due later than one year Due within but less than but less than but less than five years one month three months three months one month one year (USD millions) Current assets Marketable securities and time deposits 71 72 105 181 Commodities Derivative financial instruments and accrued interest Cash and cash equivalents Total current financial assets Non-current liabilities Financial debt Financial debt – undiscounted Total non-current financial debt Current liabilities Financial debt Financial debt – undiscounted Derivative financial instruments Total current financial debt Due after five years 58 106 Total 487 106 32 8 860 9 485 7 4 260 4 338 19 4 600 4 691 6 111 181 164 – 9 849 – 13 375 – 23 224 – 9 893 – 13 519 – 23 412 – 9 849 – 13 375 – 23 224 – 4 576 – 4 576 – 31 – 4 607 – 169 – 169 – 48 – 217 – 456 – 456 – 28 – 484 – 5 201 – 5 201 – 107 – 5 308 Net debt – 269 4 474 – 373 – 9 668 – 13 211 – 19 047 125 Item 5. Operating and Financial Review and Prospects The following table provides a breakdown of liquidity and financial debt by currency as of December 31: Liquidity and financial debt by currency USD EUR CHF JPY Other Liquidity in % 2018 1 Liquidity in % 2017 1 Liquidity in % 2016 1 Financial debt in % 2018 2 Financial debt in % 2017 2 Financial debt in % 2016 2 83 6 7 4 100 77 8 5 1 9 100 77 9 5 9 100 60 25 10 3 2 63 20 11 4 2 66 13 13 5 3 100 100 100 1 Liquidity includes cash and cash equivalents, marketable securities, commodities and time deposits. 2 Financial debt includes non-current and current financial debt. Effects of currency fluctuations We transact our business in many currencies other than the US dollar, our reporting currency. The following provides an overview of net sales and operating expenses for our operations based on IFRS values for 2018, 2017 and 2016, for currencies most important to the Group: Currency US dollar (USD) Euro (EUR) Swiss franc (CHF) Japanese yen (JPY) Chinese yuan (CNY) British pound (GBP) Canadian dollar (CAD) Brazilian real (BRL) Australian dollar (AUD) Russian ruble (RUB) Other currencies 2018 2017 2016 Net sales % Operating expenses % Net sales % Operating expenses % Net sales % Operating expenses % 37 27 2 6 5 2 3 2 2 2 12 37 24 17 3 3 2 2 1 1 1 9 37 26 2 6 4 2 3 2 2 2 14 42 22 15 4 3 2 1 1 1 1 8 38 26 2 7 4 3 3 2 2 1 12 43 23 15 5 3 2 1 1 1 1 5 Operating expenses in the above table include cost of goods sold, selling, general and administration, research and development, other income and other expense. We prepare our consolidated financial statements in US dollars. As a result, fluctuations in the exchange rates between the US dollar and other currencies can have a significant effect on both the Group’s results of opera- tions as well as the reported value of our assets, liabili- ties and cash flows. This in turn may significantly affect reported earnings (both positively and negatively) and the comparability of period-to-period results of opera- tions. For purposes of our consolidated balance sheets, we translate assets and liabilities denominated in other cur- rencies into US dollars at the prevailing market exchange rates as of the relevant balance sheet date. For purposes of the Group’s consolidated income and cash flow state- ments, revenue, expense and cash flow items in local currencies are translated into US dollars at average exchange rates prevailing during the relevant period. As a result, even if the amounts or values of these items remain unchanged in the respective local currency, changes in exchange rates have an impact on the amounts or values of these items in our consolidated financial statements. Because our expenditures in Swiss francs are sig- nificantly higher than our revenues in Swiss francs, vol- atility in the value of the Swiss franc can have a signifi- cant impact on the reported value of our earnings, assets and liabilities, and the timing and extent of such volatility can be difficult to predict. In addition, there is a risk that certain countries could take steps that could significantly impact the value of their currencies. 126 Item 5. Operating and Financial Review and Prospects There is also a risk that certain countries could devalue their currency. If this occurs, it could impact the effective prices we would be able to charge for our prod- ucts and also have an adverse impact on both our con- solidated income statement and balance sheet. The Group is exposed to a potential adverse devalu- ation risk on its intercompany funding and total invest- ment in certain subsidiaries operating in countries with exchange controls. The most significant country in this respect was Venezuela, where the Group incurred sig- nificant foreign exchange losses in 2015 and 2016. Since November 2016, the Group has applied the floating rate of DICOM (Sistema de Divisa Complemen- taria) to translate the financial statements of its Venezu- elan subsidiaries. In 2016, this resulted in a USD 0.3 bil- lion revaluation loss on the outstanding intercompany balances, which was recorded in the income statement of the year 2016. In August 2018, Venezuela introduced a new currency Bolivar Soberano (VES), replacing the former currency Bolivar Fuerte (VEF) at a rate of 1 VES for 100 000 VEF. The net outstanding intercompany pay- able balance of Venezuela subsidiaries was not signifi- cant at December 31, 2018, and at December 31, 2017, due to reserves against the intercompany balances. Subsidiaries whose functional currencies have expe- rienced a cumulative inflation rate of more than 100% over the past three years apply the rules of IAS 29 “Finan- cial Reporting in Hyperinflationary Economies.” Gains and losses incurred upon adjusting the carrying amounts of non-monetary assets and liabilities for inflation are recognized in the income statement. The hyperinflation- ary economies in which Novartis operates are Venezu- ela and Argentina. Venezuela was hyperinflationary for all years presented and Argentina became hyperinfla- tionary effective July 1, 2018, requiring retroactive imple- mentation of hyperinflation accounting as of January 1, 2018. The impacts from applying IAS 29 are not signifi- cant. The Group manages its global currency exposure by engaging in hedging transactions where management deems appropriate, after taking into account the natural hedging afforded by our global business activity. For 2018, we entered into various contracts that change in value with movements in foreign exchange rates to pre- serve the value of assets, commitments and expected transactions. We use forward contracts and foreign cur- rency options to hedge. For more information on how these transactions affect our consolidated financial statements and on how foreign exchange rate exposure is managed, see “Item 18. Financial Statements—Note 1. Significant accounting policies,” “Item 18. Financial State- ments—Note 5. Interest expense and other financial income and expense,” “Item 18. Financial Statements— Note 14. Trade receivables,” and “Item 18. Financial State- ments—Note 27. Commitments and contingencies” and “Item 18. Financial Statements—Note 28. Financial instru- ments – additional disclosures.” The following table sets forth the foreign exchange rates of the US dollar against key currencies used for foreign currency translation when preparing the Group’s consolidated financial statements: USD per unit Australian dollar (AUD) Brazilian real (BRL) Canadian dollar (CAD) Swiss franc (CHF) Chinese yuan (CNY) Euro (EUR) British pound (GBP) Japanese yen (JPY (100)) Russian ruble (RUB (100)) USD per unit Australian dollar (AUD) Brazilian real (BRL) Canadian dollar (CAD) Swiss franc (CHF) Chinese yuan (CNY) Euro (EUR) British pound (GBP) Japanese yen (JPY (100)) Russian ruble (RUB (100)) Average for year Year-end 2018 0.748 0.275 0.772 1.023 0.151 1.181 1.336 0.906 1.600 2017 Change in % 0.766 0.313 0.771 1.016 0.148 1.129 1.288 0.892 1.715 – 2 – 12 0 1 2 5 4 2 – 7 2018 0.707 0.258 0.735 1.014 0.145 1.144 1.274 0.907 1.437 2017 Change in % 0.779 0.302 0.797 1.024 0.154 1.195 1.347 0.888 1.734 – 9 – 15 – 8 – 1 – 6 – 4 – 5 2 – 17 Average for year Year-end 2016 Change in % 0.744 0.288 0.755 1.015 0.151 1.107 1.355 0.922 1.498 3 9 2 0 – 2 2 – 5 – 3 14 2017 0.779 0.302 0.797 1.024 0.154 1.195 1.347 0.888 1.734 2016 Change in % 0.722 0.307 0.741 0.978 0.144 1.051 1.227 0.854 1.648 8 – 2 8 5 7 14 10 4 5 2017 0.766 0.313 0.771 1.016 0.148 1.129 1.288 0.892 1.715 127 Item 5. Operating and Financial Review and Prospects The following table provides a summary of the currency impact on key Group figures due to their conversion into USD, the Group’s reporting currency, of the financial data from entities reporting in non US dollars. Constant cur- rency (cc) calculations apply the exchange rates of the prior year to the current year financial data for entities reporting in non US dollars. Currency impact on key figures Net sales Operating income Net income Core operating income Core net income Change in constant currencies % 2018 5 – 5 64 8 5 USD % 2018 6 – 5 64 8 5 Percentage Change in point currency Change in constant impact currencies % 2017 2018 Percentage Change in point currency impact 2017 USD % 2017 1 0 0 0 0 2 7 12 0 2 1 4 15 – 1 1 – 1 – 3 3 – 1 – 1 For additional information on the effects of currency fluctuations, see “Item 18. Financial Statements—Note 28. Financial instruments – additional disclosures.” Free cash flow Novartis defines free cash flow as net cash flows from operating activities and cash flows associated with the purchase or sale of property, plant and equipment, as well as intangible, other non-current assets and financial assets, excluding marketable securities. Cash flows in connection with the acquisition or divestment of subsid- iaries, associated companies and non-controlling inter- ests in subsidiaries are not taken into account to deter- mine free cash flow. For further information about the free cash flow measure, which is a non-IFRS measure, see “Item 5. Operating and Financial Review and Pros- pects—Item 5.A Operating results—Non-IFRS measures as defined by Novartis—Free cash flow” above. The fol- lowing is a summary of the free cash flow: (USD millions) Operating income Adjustments for non-cash items Depreciation, amortization and impairments Change in provisions and other non-current liabilities Other Operating income adjusted for non-cash items Dividends received from associated companies and others Interest and other financial receipts Interest and other financial payments Taxes paid Payments out of provisions and other net cash movements in non-current liabilities Change in inventory and trade receivables less trade payables Change in other net current assets and other operating cash flow items Net cash flows from operating activities Purchase of property, plant and equipment Proceeds from sales of property, plant and equipment Purchase of intangible assets Proceeds from sales of intangible assets Purchase of financial assets Proceeds from sales of financial assets Purchase of other non-current assets Proceeds from sales of other non-current assets Free cash flow 128 2018 2017 8 169 8 629 6 881 6 332 876 160 – 141 – 360 2016 8 268 6 175 956 – 264 15 785 14 761 15 135 719 461 987 97 899 43 – 858 – 980 – 878 – 1 670 – 1 611 – 2 111 – 664 – 793 1 292 – 877 – 1 536 – 393 – 1 051 637 974 14 272 12 621 11 475 – 1 773 – 1 696 – 1 862 102 92 161 – 1 582 – 1 050 – 1 017 823 640 – 262 – 468 167 – 39 9 330 – 42 1 847 – 247 247 – 149 11 717 10 428 9 455 Item 5. Operating and Financial Review and Prospects Financial year 2018 Free cash flow amounted to USD 11.7 billion (+12% USD) compared to USD 10.4 billion in 2017 as higher cash flows from operating activities, which includes the receipt of a GSK sales milestone from the divested Vaccines busi- ness, were partly offset by higher net investments in intangible assets. Financial year 2017 Free cash flow amounted to USD 10.4 billion (+10% USD), compared to USD 9.5 billion in 2016. The increase was mainly driven by favorable working capital changes, lower legal settlement payments out of provisions, and lower taxes paid, partly offset by the decrease in oper- ating income adjusted for non-cash items and higher net investments. Financial year 2016 In 2016, free cash flow from continuing operations amounted to USD 9.5 billion (+2% USD), compared to USD 9.3 billion in 2015. The increase of USD 0.2 billion was mainly driven by lower net investments in property, plant and equipment. Free cash flow for the total Group amounted to USD 9.5 billion in 2016, compared to USD 9.0 billion in 2015. The prior year included a negative free cash flow of approximately USD 0.3 billion from discontinued opera- tions. Condensed consolidated balance sheets (USD millions) Assets Property, plant and equipment Goodwill Intangible assets other than goodwill Financial and other non-current assets Total non-current assets Inventories Trade receivables Other current assets Cash, marketable securities, commodities, time deposits and derivative financial instruments Total current assets without disposal group Assets of disposal group held for sale Total current assets Total assets Equity and liabilities Total equity Financial debts Other non-current liabilities Total non-current liabilities Trade payables Financial debts and derivatives Other current liabilities Total current liabilities without disposal group Liabilities of disposal group held for sale Total current liabilities Total liabilities Total equity and liabilities Dec 31, 2018 Dec 31, 2017 Change 15 696 16 464 35 294 31 750 38 719 29 997 – 768 3 544 8 722 20 291 26 660 – 6 369 110 000 104 871 5 129 6 956 8 727 3 109 6 867 8 600 3 256 15 964 9 485 34 756 28 208 807 89 127 – 147 6 479 6 548 807 35 563 28 208 7 355 145 563 133 079 12 484 78 692 74 227 22 470 23 224 14 794 12 225 37 264 35 449 5 556 9 678 5 169 5 308 14 322 12 926 29 556 23 403 51 29 607 23 403 66 871 58 852 4 465 – 754 2 569 1 815 387 4 370 1 396 6 153 51 6 204 8 019 145 563 133 079 12 484 Total non-current assets of USD 110.0 billion at Decem- ber 31, 2018, increased by USD 5.1 billion compared to December 31, 2017. Property, plant and equipment decreased by USD 0.8 billion to USD 15.7 billion, mainly due to unfavorable cur- rency translation adjustments and depreciation and impairments, which more than offset net additions. Goodwill increased by USD 3.5 billion to USD 35.3 billion, and intangible assets other than goodwill increased by USD 8.7 billion to USD 38.7 billion. These increases were mainly due to the acquisitions of Advanced Accelerator Applications S.A., AveXis, Inc. and Endocyte, Inc. Financial and other non-current assets decreased by USD 6.4 billion to USD 20.3 billion, mainly due to the divestment of the 36.5% stake in the GSK consumer healthcare joint venture to GSK in 2018, partially offset by an increase in deferred tax assets from acquisitions. Total current assets of USD 35.6 billion at December 31, 2018 increased by USD 7.4 billion, compared to December 31, 2017, mainly due to an increase in cash and cash equivalents of USD 4.4 billion and marketable 129 Item 5. Operating and Financial Review and Prospects securities, commodities, time deposits and derivative financial instruments of USD 2.1 billion. Trade receivables increased slightly by USD 0.1 billion to USD 8.7 billion whereas inventories and income tax receivables remained flat compared to the previous year end. This was offset by a decrease in other current assets of USD 0.1 billion. Assets of disposal group held for sale of USD 0.8 bil- lion include net assets related to the pending divestment of the Sandoz US dermatology business and generic US oral solids portfolio to Aurobindo Pharma USA Inc., as announced on September 6, 2018 (see “item 18. Finan- cial Statements – Note 2 Significant pending transac- tions). We consider that our provisions for doubtful trade receivables are adequate. We continue to monitor the level of trade receivables, particularly in Greece, Italy, Portugal, Spain, Brazil, Russia, Saudi Arabia, Turkey and Argentina, which has been included in 2018. Should there be a substantial deterioration in our economic exposure with respect to those countries, we may change the terms of trade on which we operate. The gross trade receivables from these countries at December 31, 2018 amount to USD 1.7 billion (2017: USD 1.7 billion), of which USD 97 million is past due for more than one year (2017: USD 124 million), and for which pro- visions of USD 44 million have been recorded (2017: USD 95 million). At December 31, 2018, amounts past due for more than one year are not significant in any of these countries on a standalone basis. The majority of the out- standing trade receivables from Greece, Portugal, Saudi Arabia and Spain are due directly from local governments or government-funded entities. The following table provides an overview of the aging analysis of total trade receivables and the total amount of the provision for doubtful trade receivables as of December 31, 2018 and 2017: (USD millions) Not overdue Past due for not more than one month Past due for more than one month but less than three months Past due for more than three months but less than six months Past due for more than six months but less than one year Past due for more than one year 2018 7 916 296 2017 7 758 279 194 136 98 213 230 137 137 249 Provisions for doubtful trade receivables Total trade receivables, net – 126 8 727 – 190 8 600 There is also a risk that certain countries could devalue their currency. Currency exposures are described in more detail in “—Effects of currency fluctuations” above. Total non-current liabilities of USD 37.3 billion at December 31, 2018, increased by USD 1.8 billion com- pared to December 31, 2017. Long-term financial debts decreased by USD 0.8 bil- lion to USD 22.5 billion, mainly driven by foreign exchange translation adjustments, as the issuance of a euro bond of USD 2.8 billion (notional amount EUR 2.25 billion) was offset by the reclassification from non-current to current financial debts of a US dollar bond of USD 3.0 billion. Other non-current liabilities increased by USD 2.6 billion to USD 14.8 billion. This includes deferred tax lia- bilities, which increased by USD 2.3 billion to USD 7.5 billion, mainly due to the acquisitions of Advanced Accel- erator Applications S.A., AveXis, Inc. and Endocyte, Inc., and provisions and other non-current liabilities, which increased by USD 0.3 billion to USD 7.3 billion, mainly due to an increase of the pension liabilities of USD 0.4 billion, mainly resulting from actuarial losses. Novartis believes that its total provisions are ade- quate based upon currently available information. How- ever, given the inherent difficulties in estimating liabilities in this area, Novartis may incur additional costs beyond the amounts provided. Management believes that such additional amounts, if any, would not be material to the Group’s financial condition but could be material to the results of operations or cash flows in a given period. Total current liabilities of USD 29.6 billion at Decem- ber 31, 2018 increased by USD 6.2 billion compared to December 31, 2017. Trade payables of USD 5.6 billion increased slightly by USD 0.4 billion. Current financial debts and derivatives of USD 9.7 billion increased by USD 4.4 billion, due to higher net short-term borrowings and the reclassification of the US dollar bond of USD 3.0 bil- lion from non-current to current financial debts. Other current liabilities of USD 14.3 billion include current income tax liabilities of USD 2.0 billion, which increased by USD 0.3 billion compared to December 31, 2017, and provisions and other current liabilities of USD 12.3 billion, which increased by USD 1.1 billion compared to Decem- ber 31, 2017, mainly on account of accruals for revenue deductions and restructuring provisions. In our key countries, Switzerland and the United States, assessments have been agreed by the tax author- ities up to 2014 in Switzerland and up to 2012 in the United States, with the exception of one open United States position related to the 2007 tax filing. In addition, a subsidiary in France, acquired with the AAA acquisi- tion, has an open position related to the tax years 2014 and 2015. The Group’s equity of USD 78.7 billion at December 31, 2018, increased by USD 4.5 billion compared to USD 74.2 billion at December 31, 2017. The increase was mainly due to net income of USD 12.6 billion, partially off- set by the dividend payment of USD 7.0 billion. The increase in equity from the exercise of options and employee transactions, equity-based compensation and sale of treasury shares of USD 1.5 billion was more than offset by the net purchase of treasury shares of USD 2.0 billion. Treasury share repurchase obligation under a share buyback trading plan decreased equity by USD 0.3 billion. The net debt decreased to USD 16.2 billion at Decem- ber 31, 2018, compared to USD 19.0 billion at December 31, 2017 . The Group’s liquidity amounted to USD 16.0 billion at December 31, 2018, compared to USD 9.5 billion at December 31, 2017, and total non-current and current financial debt, including derivatives, amounted to USD 32.1 billion at December 31, 2018, compared to USD 28.5 billion at December 31, 2017. The debt/equity ratio increased to 0.41:1 at December 31, 2018, compared to 0.38:1 at December 31, 2017. 130 Item 5. Operating and Financial Review and Prospects Summary of equity movements attributable to Novartis AG shareholders Number of outstanding shares (in millions) Issued share capital and reserves attributable to Novartis AG shareholders 2018 2017 Change Change USD millions USD millions USD millions 2017 2018 Balance at beginning of year Impact of change in accounting policy 1 Restated equity at January 1, 2018 Shares acquired to be canceled Other share purchases Exercise of options and employee transactions Other share sales Equity-based compensation Increase of treasury share repurchase obligation under a share buyback trading plan Transaction costs 2 Dividends Net income of the year attributable to shareholders of Novartis AG Impact of change in ownership of consolidated entities Other comprehensive income attributable to shareholders of Novartis AG Other movements 3 Balance at end of year 2 317.5 2 374.1 – 56.6 74 168 74 832 – 664 – 23.3 – 66.2 42.9 – 1 859 – 5 270 60 74 228 74 832 – 1.2 7.8 3.0 7.4 – 3.8 4.6 2.6 3.2 3.0 8.8 – 1.4 – 114 – 304 255 612 434 263 756 – 284 – 79 – 6 966 – 6 495 60 – 604 3 411 190 179 263 144 – 284 – 79 – 471 12 611 7 703 4 908 – 13 – 13 – 401 2 835 – 3 236 38 38 2 311.2 2 317.5 – 6.3 78 614 74 168 4 446 1 The impact of change in accounting policy includes USD 60 million relating to IFRS 15 implementation and USD 177 million relating to IFRS 9 implementation. (See “Item 18. Financial Statements—Note 1. Significant accounting policies; and Note 29. Impacts of adoption of new IFRS standards.”) 2 Transaction costs directly attributable to the potential distribution (spin-off) of Alcon to Novartis shareholders. (See “Item 18. Financial Statements—Note 1. Significant accounting policies”) 3 Impact of hyperinflationary economies. (See “Item 18. Financial Statements—Note 1. Significant accounting policies”) In 2018, Novartis repurchased a total of 23.3 million shares for USD 1.9 billion on the SIX Swiss Exchange second trading line under the CHF 10 billion share buy- back authority approved at the 2016 Annual General Meeting. This included 9.3 million shares (USD 0.8 bil- lion) under the new up-to USD 5 billion share buyback announced in June 2018 and 14.0 million shares (USD 1.1 billion) to offset the dilutive impact from equity-based participation plans of associates (2017: 66.2 million shares for USD 5.3 billion, including 56.4 million shares bought for USD 4.5 billion under the up to USD 5.0 bil- lion share buyback announced in January 2017, and 9.8 million shares bought for USD 0.8 billion to offset the dilutive impact from equity-based participation plans). In addition, 1.2 million shares for USD 0.1 billion were acquired from employees, which were previously granted to them under the respective programs (2017: 3.8 million for USD 0.3 billion). In 2018, 15.2 million treasury shares for USD 1.2 billion were delivered as a result of options being exercised and physical share deliveries related to equity-based participation plans (2017: 13.4 million shares for USD 0.9 billion). Other share sales for USD 0.3 billion resulted in an increase of 3.0 million shares outstanding (2017: nil). With these transactions, the total number of shares outstanding decreased by 6.3 million shares in 2018 (2017: decrease of 56.6 million shares). These treasury share transactions resulted in an equity decrease of USD 0.5 billion and a net cash outflow of USD 1.3 billion. Treasury shares At December 31, 2018, our holding of treasury shares amounted to 239.5 million shares, or approximately 10% of the total number of issued shares. Approximately 122 million treasury shares were held in entities that limit their availability for use. At December 31, 2017, our holding of treasury shares amounted to 299.4 million shares, or approximately 10% of the total number of issued shares. Approximately 131 million treasury shares were held in entities that limit their availability for use. At December 31, 2016, our holding of treasury shares amounted to 253.1 million shares, or approximately 10% of the total number of issued shares. Approximately 135 million treasury shares were held in entities that limit their availability for use. Bonds In February 2018, three euro bonds totaling EUR 2.25 billion were issued: a 5.5 year bond of EUR 750 million with a coupon of 0.5%, a 12.5 year bond of EUR 750 mil- lion with a coupon of 1.375% and a 20.5 year bond of EUR 750 million with a coupon of 1.7%. In February 2017, three US dollar bonds totaling USD 3.0 billion were issued; a 3 year bond of USD 1.0 billion with a coupon of 1.80%, a 5 year bond of USD 1.0 billion with a coupon of 2.40% and a 10 year bond of USD 1.0 billion with a coupon of 3.10%. In March 2017, two EUR bonds totaling EUR 1.85 bil- lion were issued; a 4 year bond of EUR 1.25 billion with a coupon of 0% and a 10 year bond of EUR 0.6 billion with a coupon of 1.125%. 131 Item 5. Operating and Financial Review and Prospects In September 2016, two EUR bonds totaling EUR 1.75 billion were issued; a 7 year bond of EUR 1.25 billion with a coupon of 0.125% and a 12 year bond of EUR 0.5 bil- lion with a coupon of 0.625%. In June 2016, a EUR bond of EUR 1.5 billion with a coupon of 4.25% was repaid at maturity. Liquidity/short-term funding We continuously track our liquidity position and asset/ liability profile. This involves modeling cash flow maturity profiles based on both historical experiences and con- tractual expectations to project our liquidity require- ments. We seek to preserve prudent liquidity and fund- ing capabilities. We are not aware of any significant demands to change the level of liquidity needed to support our nor- mal business activities. We make use of various borrow- ing facilities provided by several financial institutions. We also successfully issued various bonds in previous years (including 2016, 2017 and 2018), and raised funds through our commercial paper programs. In addition, reverse repurchasing agreements are contracted, and Novartis has entered into credit support agreements with various banks for derivative transactions. The maturity schedule of our net debt can be found in “Item 18. Financial Statements—Note 28. Financial instruments – additional disclosures.” 5.C Research and development, patents and licenses Our R&D spending totaled USD 9.1 billion, USD 9.0 bil- lion and USD 9.0 billion (USD 8.7 billion, USD 8.1 billion and USD 8.5 billion, excluding impairments and amorti- zation charges) for the years 2018, 2017 and 2016, respectively. Each of our divisions has its own R&D and patent pol- icies. Our divisions have numerous products in various stages of development. For further information on these policies and these products in development, see “Item 4. Information on the Company—Item 4.B Business over- view.” As described in the risk factors section and else- where in this Annual Report, our drug development efforts are subject to the risks and uncertainties inher- ent in any new drug development program. Due to the risks and uncertainties involved in progressing through preclinical development and clinical trials, and the time and cost involved in obtaining regulatory approvals, among other factors, we cannot reasonably estimate the timing, completion dates and costs, or range of costs, of our drug development program, or of the development of any particular development compound (see “Item 3. Key Information—Item 3.D Risk factors”). In addition, for a description of the research and development process for the development of new drugs and our other prod- ucts, and the regulatory process for their approval, see “Item 4. Information on the Company—Item 4.B Business overview.” 5.D Trend information Please see “—Item 5.A Operating results—Factors affect- ing results of operations” and “Item 4. Information on the Company—Item 4.B Business overview” for trend infor- mation. 5.E Off-balance sheet arrangements We have no unconsolidated special purpose financing or partnership entities or other off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources, that is material to investors. See also “Item 18. Financial Statements—Note 27. Commitments and contingencies,” and matters described in “— Item 5.F Tabular disclosure of contractual obligations.” 132 Item 5. Operating and Financial Review and Prospects 5.F Tabular disclosure of contractual obligations The following table summarizes the Group’s contractual obligations and other commercial commitments, as well as the effect these obligations and commitments are expected to have on the Group’s liquidity and cash flow in future periods: (USD millions) Payments due by period Total Less than 1 year 2–3 years 4–5 years After 5 years Non-current financial debt, including current portion 25 660 3 190 4 117 4 863 13 490 Interest on non-current financial debt, including current portion Operating leases Unfunded pensions and other post-employment benefit plans Research and development potential milestone commitments Property, plant and equipment purchase commitments 5 994 3 612 2 094 4 417 289 572 372 122 228 280 892 500 254 775 377 266 1 632 1 663 9 3 755 2 363 1 452 894 Total contractual cash obligations 42 066 4 764 7 404 7 944 21 954 The Group intends to fund the research and develop- ment; property, plant and equipment; and intangible asset purchase commitments with internally generated resources. For other contingencies, see “Item 4. Information on the Company—Item 4.D Property, plants and equip- ment—Environmental matters,” “Item 8. Financial Infor- mation—Item 8.A Consolidated statements and other financial information,” “Item 18. Financial Statements— Note 19. Provisions and other non-current liabilities,” and “Item 18. Financial Statements—Note 27. Commitments and contingencies.” 133 Item 6. Directors, Senior Management and Employees Item 6. Directors, Senior Management and Employees 6.A Directors and senior management The information set forth under “Item 6.C Board prac- tices—Corporate governance—Our Board of Directors— Board of Directors” and “Item 6.C Board practices—Cor- porate governance—Our management—Executive Committee” is incorporated by reference. 134 Item 6. Directors, Senior Management and Employees 6.B Compensation Dear shareholder, As Chairman of the Compensation Committee of the Board of Directors, I am pleased to share with you the 2018 Compensation Report of Novartis AG. It follows a similar structure to the report presented in January 2018, which was supported by over 90% of shareholders. During 2018, we continued to engage with sharehold- ers and proxy advisors to gather feedback on the pro- posed evolution of the compensation system for the Executive Committee, and we would like to thank you for the constructive dialogue. It has helped shape the changes, enhancements and simplifications we are mak- ing (effective January 1, 2019) to further align our com- pensation systems and disclosures with our strategy and best practice. The Executive Committee underwent a number of key changes during the course of 2018, with the most significant being the appointment of our new Chief Exec- utive Officer, Vasant Narasimhan, in February 2018. Dr. Narasimhan was appointed by the Board of Directors not only for his innovative mindset and leadership experi- ence but also for his integrity, values and behaviors, which are the foundation blocks of our culture. Dr. Nara- simhan and the other Executive Committee members are driving our strategy to build a leading, focused innovative medicines company powered by advanced therapy platforms and data science with five strategic priorities: innovation, operational excellence, data and digital, people and culture, and building trust with soci- ety. 2018 Company performance Novartis delivered strong performance in 2018, with net sales up 5% in constant currencies (cc), core operating income up 8%, and free cash flow up 12%. All these were ahead of targets set by the Board of Directors at the start of the year. Operating income declined 5%, mainly due to the impact of M&A transactions made to transform Novartis into a leading, focused medicines company, and of restructuring to drive major productivity programs. Net income increased 64%, primarily due to the one-off gain from the sale of the OTC joint venture. Strong perfor- mance was driven by the growth drivers, mainly in the Innovative Medicines Division, including contributions from the AAA acquisition. Cosentyx sales reached USD 2.8 billion (+36% cc), Entresto sales more than doubled to reach USD 1 billion, and Promacta/Revolade, Tafinlar + Mekinst, Jakavi and Kisqali sales all delivered strong double-digit growth. Results in the Sandoz Division were negatively impacted by continued industrywide pricing pressures in the US retail generics market. Sandoz Bio- pharmaceuticals sales grew to USD 1.4 billion (+24% cc), mainly driven by the launch of Erelzi (etanercept) and Rixathon (rituximab) in Europe, and Zarxio (filgrastim) in the US. The Alcon turnaround continued. In addition to delivering 2018 performance through strong sales growth and commercial execution, Novartis continued to focus on managing its costs, including actions to streamline the Novartis Business Services and Novartis Technical Operations organizations. Further highlights of strong performance against the five strategic priorities included above-target perfor- mance on the delivery of the innovation pipeline; optimi- zation of the business unit portfolio through major spin- off, divestment and acquisition activity; good commercial execution; starting a culture transformation; taking steps to simplify processes globally; and finally, prioritizing cor- porate responsibility projects, including the renewed commitment to malaria and leprosy. In 2018, shareholders benefited from a one-year total shareholder return (TSR) of 4.5%, and between 2016 and 2018, they benefited from a three-year TSR of 8.5%. 2018 realized compensation In light of our CEO’s achievements, including the Com- pany’s strong performance and his focus on the five stra- tegic priorities noted above, the Board of Directors deter- mined that he will be awarded a 2018 Annual Incentive of CHF 3 189 606, which is 145% of target, within the payout range 0% to 200%. The Long-Term Performance Plan (LTPP) 2016-2018 performance cycle award vested at a value of CHF 1 796 381, which is 136% of target, within the pay- out range of 0% to 200%. This was based on cumulative three-year Novartis Cash Value Added performance above target (driven by strong sales execution and solid cost controls) and long-term innovation achievements also above target. Further information on this perfor- mance is provided on page 148. The Long-Term Relative Performance Plan (LTRPP) 2016-2018 award was based on three-year relative TSR compared to the global healthcare peer group (see page 149). Novartis ranked No. 11 out of 13 companies, result- ing in the award lapsing in full. These incentive performance outcomes, combined with base salary, pension, other benefits, share price movement and dividend equivalents, resulted in 2018 total realized compensation for the CEO of CHF 6 680 288. The 2018 total realized compensation for the Exec- utive Committee members (comprising the CEO, the 12 active Executive Committee members, and the four pre- vious Executive Committee members who stepped down during the financial year) was CHF 66.3 million. When compared to the total realized compensation for 2017 (CHF 47.5 million), the difference is primarily due to changes in the composition of the Executive Committee. There has been both an increase in the number of Exec- utive Committee members and an overlap of departing and appointed members, including the CEO in 2018. Details on realized compensation for the Executive Com- mittee members can be found on page 151. 135 Item 6. Directors, Senior Management and Employees In 2018, there was no legal or factual basis on which to exercise malus or clawback for current or former Executive Committee members. However, the Compen- sation Committee and the Board of Directors decided to apply its discretion, as foreseen in the plan rules, to reduce the 2018 Annual Incentive to below-target levels for certain executives in relation to their responsibilities. Executive Committee compensation system for 2019 Every year, the Compensation Committee conducts a review of the Executive Committee compensation sys- tem. The 2018 review focused on the structure and per- formance measures of the Long-Term Incentive plans, taking into account a desire for simplification and the principle of compensating executives more directly on performance linked to our strategic priorities of accel- erating top- and bottom-line growth. This led to the decision to combine the existing Long- Term Performance Plan and Long-Term Relative Perfor- mance Plan into a single Long-Term Incentive plan and to replace Novartis Cash Value Added with net sales growth and core operating income growth for the 2019- 2021 performance cycle onward. The objective is to align the Long-Term Incentive with the evolving Group strate- gic imperatives of accelerating growth and margin expansion to drive long-term value. The Compensation Committee decided to retain the long-term innovation and relative total shareholder return performance mea- sures, and an equal weighting will apply to each of the four performance measures. he joined Novartis, subject to the achievement of targets linked to the turnaround of Alcon during the 2016-2018 performance cycle. In 2016, performance was tracking below target. However, in 2017 and 2018, Alcon began to close the gap versus the targets. Given that some of the performance measures are assessed relative to peers, the achievements and final payout of this three- year Long-Term Incentive award will be disclosed in the 2019 Compensation Report, once the final performance is known. 2019 Annual General Meeting In line with our Articles of Incorporation, at the 2019 Annual General Meeting (AGM), shareholders will be asked to approve the maximum aggregate amount of compensation for members of the Board of Directors from the 2019 AGM to the 2020 AGM, and the maximum aggregate amount of compensation for members of the Executive Committee for financial year 2020. For the Board of Directors, the amount remains broadly unchanged compared to the prior year. For the Execu- tive Committee, the requested maximum aggregate amount of compensation remains unchanged compared to the prior year. Shareholders will also be asked to endorse this Compensation Report in an advisory vote. On behalf of Novartis and the Compensation Com- mittee, I would like to thank you for your continued sup- port and feedback, which we consider extremely valu- able in driving improvements in our compensation systems and practices. I invite you to send your comments to me at the follow- Further details on the 2019 compensation system can ing email address: investor.relations@novartis.com. be found on pages 162 and 163. Alcon In 2018, the Board of Directors communicated its inten- tion to spin off Alcon in the first half of 2019. To avoid any conflict of interest following news of the intention to spin off Alcon, the former CEO, Alcon, F. Michael Ball, stepped down from the CEO, Alcon position and from the Novartis Executive Committee on July 1, 2018, commencing his 12-month contractual notice period that will end on the Alcon spin-off date (or June 30, 2019, if later). He is still entitled to the one-off award of 50 000 performance share units that were awarded in February 2016 when Respectfully, Enrico Vanni, Ph.D. Chairman of the Compensation Committee 136 Item 6. Directors, Senior Management and Employees Compensation at a glance 2018 Executive Committee compensation system Fixed pay and benefits Performance-related variable pay Annual base salary Pension and other benefits Annual Incentive Long-term share awards Purpose Reflects responsibil- ities, experience and skill sets Provides retirement and risk insurances (tailored to local market practices/regulations) Form of payment Cash Country/ individual-specific Performance measures – – Rewards for perfor- mance against short- term financial and stra- tegic objectives, and Values and Behaviors 50% cash 50% equity3 deferred for three years Balanced scorecard comprising: • Financial measures (60%) • Strategic objectives4 (40%) LTPP1 LTRPP2 Rewards long-term shareholder value creation and innovation in line with our strategy Equity, vesting following a three- year performance period • Novartis Cash Value Added (75%) • Innovation mile- stones (25%) • Relative TSR versus global sector peers (100%)5 1 LTPP = Long-Term Performance Plan 2 LTRPP = Long-Term Relative Performance Plan 3 Executive Committee members may elect to receive more of their Annual Incentive in equity instead of cash. 4 Strategic objectives are aligned with the five strategic pillars: innovation, operational excellence, data and digital, people and culture, and building trust with society. 5 For the 2018-2020 performance cycle, the peer group comprises 15 global healthcare companies, as listed on page 140. Target incentive opportunity levels for the CEO are 150% and 325% of base salary for the Annual Incentive and Long-Term Incentives (LTPP and LTRPP), respectively. Based on Novartis compensation guidelines, the other mem- bers of the Executive Committee have Annual Incentive and Long-Term Incentive target opportunity levels that range from 80% to 120%, and 160% to 270% of base salary, respectively. The payout range remains at 0% to 200% of target opportunity based on achievement against performance. Compensation governance at a glance A summary of the compensation decision authorization levels within the parameters set by the AGM is shown below, along with an overview of the risk management principles. DECISION ON Compensation of Chairman and other Board members Compensation of CEO Compensation of other Executive Committee members DECISION-MAKING AUTHORITY Board of Directors Board of Directors Compensation Committee EXECUTIVE COMMITTEE COMPENSATION RISK MANAGEMENT PRINCIPLES • Rigorous performance management • Performance-based Long-Term process Incentives, with three-year cycles • Balanced mix of short-term and • All variable compensation is capped at • Good and bad leaver provisions apply to the variable compensation of leavers • No severance payments or change-of- long-term variable compensation elements • Performance evaluation under the Annual Incentive includes an individual balanced scorecard 200% of target control clauses • Contractual notice period of 12 months • Post-contractual non-compete period limited to a maximum of 12 months from the end of employment (annual base salary and prior-year Annual Incentive only) as per contract, if applicable • Clawback and malus principles apply to all elements of variable compensation • Share ownership requirements; no hedging or pledging of Novartis share ownership position 137 Item 6. Directors, Senior Management and Employees 2018 CEO pay for performance – outcomes Measure Target Achievement versus target 2018 ANNUAL INCENTIVE (SEE PAGES 145-146 FOR FURTHER DETAILS) Financial measures – 60% of total Annual Incentive, comprising: Group net sales (cc) (30%) Group operating income (cc) (30%) Group free cash flow as a % of sales (cc) (20%) Share of peers for Novartis Group (USD) (20%) USD 50 447 million USD 8 504 million 20% 9.3% Overall assessment of Group financial targets in constant currencies Strategic objectives – 40% of total Annual Incentive, comprising: Innovation (20%) Operational excellence (20%) Data and digital (20%) People and culture (including Values and Behaviors) (20%) Building trust with society (including access to healthcare and reputation) (20%) Overall assessment of strategic objectives Above Met* Significantly above Met Above Significantly above Above Met Above Met Above Overall assessment of CEO balanced scorecard Above Target TOTAL Annual Incentive: 145% of target (payout range 0% – 200%) * The Board concluded that the achievement for Group operating income versus target was “met” following adjustments mainly for M&A transactions made to transform Novartis into a leading, focused medicines company, and for higher restructuring costs to drive major productivity programs, which were not known at the time of target setting. 2016-2018 LONG-TERM INCENTIVES (SEE PAGES 147-149 FOR FURTHER DETAILS) Long-Term Performance Plan (LTPP) Novartis Cash Value Added (cc) (75%) Key innovation milestones (25%) TOTAL LTPP: Long-Term Relative Performance Plan (LTRPP) Relative TSR against a global healthcare peer group (USD) TOTAL LTRPP: USD 5.1 billion Above Above 136% of target (payout range 0% – 200%) Below threshold 0% of target (payout range 0% – 200%) 2018 total realized compensation for the CEO The 2018 total realized compensation for the CEO was CHF 6 680 288. It includes payouts of the Annual Incen- tive, LTPP and LTRPP based on actual performance assessed for cycles concluding in 2018. Fixed pay and benefits Variable pay − performance-related CHF Annual base salary1 Pension and other benefits 2018 Annual Incentive1 LTPP 2016-20182 LTRPP 2016-20182 Total realized compensation Vasant Narasimhan (CEO from February 1, 2018) 1 491 667 202 634 3 189 606 1 796 381 0 6 680 288 1 Base salary and Annual Incentive reflect the compensation relating to Vasant Narasimhan’s roles in 2018 as Head of Global Drug Development (January 1, 2018 – January 31, 2018) and CEO (from February 1, 2018). 2 The shown amounts represent the underlying share value of the total number of shares vested (including dividend equivalents) to the CEO for the LTPP and LTRPP performance cycle 2016 -2018, which were granted before Vasant Narasimhan was appointed CEO. 138 Item 6. Directors, Senior Management and Employees 2018 Board compensation system A cost-neutral rebalancing of the Board of Directors fee structure was approved at the 2018 AGM, better recog- nizing the increased responsibilities and time commitment of the Board committees. All fees to Board members are delivered at least 50% in equity and the remainder in cash. CHF 000s Chairman of the Board Board membership Vice Chairman Chair of the Audit and Compliance Committee Chair of the Compensation Committee Chair of the following committees: • Governance, Nomination and Corporate Responsibilities Committee • Research & Development Committee • Risk Committee Membership of the Audit and Compliance Committee Membership of the following committees: • Compensation Committee • Governance, Nomination and Corporate Responsibilities Committee • Research & Development Committee • Risk Committee 2018 Board compensation AGM 2018-2019 annual fee 3 800 280 50 130 90 70 70 40 Total actual compensation earned by Board members in the 2018 financial year is shown in the table below. CHF 000s Chairman of the Board Other 12 members of the Board Total 2018 total compensation 1 3 804 4 431 8 235 1 Includes an amount of CHF 19 958 for mandatory employer contributions for all Board members paid by Novartis to governmental social security systems. This amount is out of total employer contributions of CHF 383 864, and provides a right to the maximum future insured government pension benefit for the Board member. 139 Item 6. Directors, Senior Management and Employees Executive Committee compensation philosophy and principles Novartis compensation philosophy Our compensation philosophy aims to ensure that Exec- utive Committee members are rewarded according to their success in implementing the Company strategy, and their contribution to Company performance and long- term value creation. Pay for performance Shareholder alignment • Variable compensation is tied directly to the achievement of strategic Company targets • Our incentives are significantly weighted toward long-term equity-based plans • Measures under the Long-Term Incentive plans are calibrated to promote the creation of shareholder value • Executive Committee members are expected to build and maintain substantial shareholdings Balanced rewards • Balanced set of measures to create sustainable value • Mix of targets based on financial metrics, strategic objectives, and performance versus our competitors Business ethics • The Novartis Values and Behaviors are an integral part of our compensation system performance within the pharmaceutical and biotechnol- ogy industries. As such, external peer compensation data is one of a number of key reference points consid- ered by the Board of Directors and the Compensation Committee when making decisions on executive pay, helping to ensure that the compensation system and compensation levels at Novartis remain competitive. Novartis makes the commitment to shareholders to con- firm benchmarking practices, including the peer group, each year. The Compensation Committee believes in a rigorous approach to peer group construction and maintenance. The Compensation Committee also believes that using a consistent set of peers that are similar in size and scope enables shareholders to evaluate the compensation year on year and make pay-for-performance comparisons. As such, following a review of the benchmarking peer group, the Compensation Committee decided to maintain the same primary peer group of 15 global healthcare com- panies, as presented below. GLOBAL HEALTHCARE PEER GROUP AbbVie Biogen Amgen AstraZeneca Bristol-Myers Squibb Celgene • They underpin the assessment of overall performance for the Annual Incentive Eli Lilly & Co. Gilead Sciences GlaxoSmithKline Johnson & Johnson Merck & Co. Novo Nordisk Competitive compensation • Total compensation must be sufficient to attract and retain key global talent Pfizer Roche Sanofi • Overarching emphasis on pay for performance Alignment with Company strategy The Novartis strategy is to reimagine medicine to improve and extend people’s lives. We use innovative science and technology to address some of society’s most challeng- ing healthcare issues. We discover and develop break- through treatments and find new ways to deliver them to as many people as possible. We reward those who invest their money, time and ideas in our Company. We have five strategic priorities: innovation, operational excel- lence, data and digital, people and culture, and building trust with society. To align the compensation system with this strategy and to ensure that Novartis is a high-performing organi- zation, the Company operates both a short-term Annual Incentive and two Long-Term Incentive plans with a bal- anced set of measures and targets. The Board of Directors determines specific, measur- able and time-bound performance measures for the Annual Incentive and the two Long-Term Incentive plans. Approach to market benchmarking There remains significant competition for top executive talent with deep expertise, competencies and proven The companies in this peer group reflect our industry and are similar to Novartis in terms of both size and scope of operations. Target compensation is generally posi- tioned around the market median benchmark for compa- rable roles within this group. Although Novartis is headquartered in Switzerland, more than a third of sales come from the US market, and the US remains a significant talent pool for the recruit- ment of executives by the Company. All current Execu- tive Committee members have either worked in or have extensive experience with the US market. It is therefore critical that Novartis is able to attract and retain key tal- ent globally, especially from the US. For consideration of European and local practices, the Compensation Committee also references a cross-in- dustry peer group of Europe-headquartered multina- tional companies, selected on the basis of comparability in size, scale, global scope of operations, and economic influence to Novartis. Five of these companies focus exclusively on healthcare: AstraZeneca, GlaxoSmith- Kline, Novo Nordisk, Roche and Sanofi. Ten companies are selected from the STOXX® All Europe 100 Index rep- resenting multiple sectors: Anheuser-Busch InBev, Bayer, BMW, Daimler, Danone, Heineken, L’Oréal, Merck KgaA, Nestlé and Unilever. 140 Item 6. Directors, Senior Management and Employees Executive Committee appointments compensation policy ELEMENT OF COMPENSATION POLICY Level The overall package should be market-competitive to facilitate the recruitment of global executive talent with deep expertise and competencies. The Compensation Committee will always intend to pay no more than it believes is necessary to attract the required individual. Annual base salary The Compensation Committee may appoint individuals who are new to a role on an annual base salary that is below the market level, with a view to increasing this toward a market level over a period of three to four years as an individual develops in the role. This prudent approach ensures pay levels are merit-based, with increases dependent on strong performance and proven ability in the role over a sustained period. Incentives The ongoing compensation package will normally include the key compensation elements and incentive opportunities in line with those offered to current Executive Committee members. In exceptional circumstances, higher Long-Term Incentive opportunities than those offered to current Executive Committee members may be provided, at the Compensation Committee’s discretion. Performance measures may include business-specific measures tailored to the specific role. Pension and other benefits Newly appointed Executive Committee members are eligible for a local market pension and other benefits in line with the wider senior employee group. Buyouts The Compensation Committee seeks to balance the need to offer competitive compensation opportunities to acquire the talent required by the business with the principle of maintaining a strong focus on pay for performance. As such, when an individual forfeits variable compensation as a result of an appointment at Novartis, the Compensation Committee may offer replacement awards in such form as the Compensation Committee considers appropriate, taking into account relevant factors. Relevant factors include the replacement vehicle (i.e., cash, restricted share units, restricted shares or performance share units), whether the award is contingent on meeting performance conditions or not, the expected value of the forfeited award, the timing of forfeiture (i.e., Novartis mirrors the blocking or vesting period of the forfeited award) and the leaver conditions, in case the recruited individual leaves Novartis prior to the end of the blocking or vesting period. The Compensation Committee will seek to pay no more than is required to match the commercial value or fair value of payments and awards forfeited by the individual. International mobility If individuals are required to relocate or be assigned away from their home location to take up their position, relocation support may be provided in line with our global mobility policies (i.e., relocation support, tax equalization). 141 Item 6. Directors, Senior Management and Employees Treatment of variable compensation for Executive Committee leavers ELEMENT OF COMPENSATION POLICY Annual Incentive – cash element Retirement, termination by the Company (for reasons other than performance or conduct), change of control, disability, death Pro-rata Annual Incentive is paid to reflect the portion of the year the individual was employed. Any other reason No Annual Incentive. Annual Incentive – mandatory deferral into restricted shares/ RSUs If a participant leaves employment due to voluntary resignation or misconduct, unvested restricted shares and restricted share units (RSUs) are forfeited. All awards are subject to non-compete terms until the end of the three-year blocking date, starting from the date of grant. Annual Incentive – voluntary restricted shares/RSUs/ADRs (US associates only) Awards are not subject to forfeiture during the deferral period. Long-Term Incentives (LTPP/LTRPP) Voluntary resignation or termination by the Company for misconduct All of the award will be forfeited. Termination by the Company for reasons other than performance or conduct, and change in control due to divestment Awards vest on the regular vesting date, subject to performance, on a pro-rata basis for time spent with the Company during the performance cycle. There is no accelerated vesting. Retirement For grants made until the end of 2018, awards will vest on the normal vesting date, subject to performance, without the application of time pro-rating. For grants made to members of the Executive Committee from 2019 onward, awards will vest on the normal vesting date, subject to performance, with the application of time pro-rating. Death or long-term disability Accelerated vesting at target will be applied. Non-compete agreement All awards are subject to non-compete terms against the healthcare peer group until the vesting date. Malus and clawback Any incentive compensation paid to Executive Commit- tee members is subject to malus and clawback rules. This means that the Board for the CEO, and the Com- pensation Committee for the other Executive Commit- tee members, may decide – subject to applicable law – to retain any unpaid or unvested incentive compensation (malus), or to recover incentive compensation that has been paid or has vested in the past (clawback). This applies in cases where the payout conflicts with internal management standards, including Company and accounting policies, or violates laws. This principle applies to both the short-term Annual Incentive and Long-Term Incentive plans. 142 Item 6. Directors, Senior Management and Employees Executive Committee performance management process To foster a high-performance culture, the Company applies a uniform performance management process worldwide, based on quantitative and qualitative criteria, including our Values and Behaviors. All Novartis associ- ates, including the CEO and other Executive Committee members, are subject to a formal three-step process: objective setting, performance evaluation and compen- sation determination. This process is explained below. Performance targets are generally set before the start of the relevant performance cycle. There is a rigor- ous framework in place for establishing targets to ensure they are suitably robust and challenging, and align with the strategic priorities of the Group. The key factors taken into account when setting targets include: • Novartis strategic priorities • Internal and external market expectations • Regulatory factors (e.g., new launches, patent expiries) • Investment in capital expenditure • Values and Behaviors The targets are challenged at multiple stages before they are ultimately approved by the Board of Directors. In line with good governance practices, the Compensation Committee works to set targets that are ambitious and challenging but that do not encourage undue risk-taking. Following the end of the performance cycle, the Board of Directors and the Compensation Committee consider performance against the targets originally set. The CEO and Executive Committee members are not present while the Board of Directors and Compensation Committee discuss their individual performance evaluations. Prior to determining the final outcome, related factors such as performance relative to peers, wider market conditions, general industry trends and good practice are used to inform the overall performance assessment. Objective setting Performance evaluation Compensation determination • The CEO discusses his targets with the Chairman of the Board; they are then reviewed and approved by the Board of Directors, based on input from the Compensation Committee. • For other Executive Committee members, targets for their division or unit are initially discussed with the CEO and subsequently approved by the Board and Compensation Committee. • The CEO’s performance against • A recommendation for the CEO’s the individual balanced scorecard is assessed by the Board. • For Executive Committee members, the CEO discusses with the Chairman each member’s performance (assessed against his or her individual balanced scorecard) before making recommendations to the Board. • Periodic assessments, including at the mid-year stage, ensure progress is suitably tracked. variable pay is made by the Compensation Committee to the Board for final determination. • For the Long-Term Incentive financial measure payout schedules, a formulaic approach applies and the Compensation Committee can also exercise judgment to ensure there is appropriate alignment between payout levels and overall performance achieved. The same principle of discretion applies to the relative TSR and innovation performance measures. • The CEO’s recommendations for other Executive Committee members are considered and approved by the Compensation Committee, after which the Board is notified of the outcomes. 143 Item 6. Directors, Senior Management and Employees 2018 Executive Committee compensation Performance outcomes Annual base salary Overview • The annual base salary is reviewed each year, taking into account the individual’s role, performance and experience; business performance and the external environment; increases across the Group; and market movements. 2018 annual base salaries The 2018 annual base salaries were as follows: • CEO (effective February 1, 2018): CHF 1 550 000 (CEO base salary may increase as he develops in the role) • OTHER EXECUTIVE COMMITTEE MEMBERS (effective March 1, 2018): Increases for two individuals based on their promotions were made as of March 1, 2018, as disclosed in the 2017 Compensation Report. For the other Executive Committee members, no merit increases were awarded during the year, except for promotions in roles, and appointments to the Executive Committee during the course of 2018. Pension and other benefits Overview • Pension and other benefits do not constitute a significant proportion of total compensation and are provided to Executive Committee members on the same terms as all other associates, based on country practices and regulations. • The Company operates both defined benefit and defined contribution pension plans (see also Note 24 to the Group’s consolidated financial statements). • Novartis may provide other benefits according to local market practice. These include Company car provision, tax and financial planning, and insurance benefits. • Executive Committee members who are required to relocate internationally may also receive additional benefits (including tax equalization), in line with the Company’s global mobility policies. 144 Item 6. Directors, Senior Management and Employees 2018 Annual Incentive PLAN OVERVIEW Target Annual Incentive Annual base salary x Target incentive (% of base salary) = Target Annual Incentive On-target opportunities • CEO: 150% of annual base salary • Other Executive Committee members: 80% to 120% of annual base salary Performance measures • A simplified Annual Incentive balanced scorecard was introduced in 2018, containing: • Financial performance measures related to Group, division or business unit, where relevant (60% weighting) • Five key strategic objectives in the areas of innovation, operational excellence, data and digital, people and culture, and building trust with society (40% weighting) • The 2018 balanced scorecard targets and achievements of the CEO are detailed on the next page. • The 2018 balanced scorecard for other Executive Committee members includes Group financial targets as well as financial or other quantitative targets that relate to their division or business unit, if applicable. • Values and Behaviors are a key component of the Annual Incentive and are embedded in our culture. As such, members of the Executive Committee are expected to demonstrate these to the highest standards. Target setting • Financial targets are set at the beginning of each financial year and align with the strategic plan proposed by management to the Board for approval. • The strategic objectives are aligned with the most important priorities in any performance year. Payout ranges • The simplified payout schedule for the Annual Incentive incorporates performance against financial and strategic objectives. The payout range is 0% to 200% of on-target opportunity based on performance, as shown below: PERFORMANCE Outstanding Exceeds expectations Meets expectations Partially meets expectations Below expectations PAYOUT (% of on-target) 170% – 200% 130% – 160% 80% – 120% 40% – 70% 0% – 30% Payout formula Payout vehicle Annual base salary x Target incentive (% of base salary) x Payout factor (% of target: 0%–200%) = Realized Annual Incentive • At the end of the performance period, 50% is paid in cash, and the remaining 50% is delivered in Novartis restricted shares or RSUs, deferred for three years (see table on page 142 for details on leaver treatment). • Executives may choose to receive all or part of the cash portion of their Annual Incentive in Novartis shares or American Depositary Receipts (ADRs; US only) that will not be subject to forfeiture conditions. In the US, awards may also be delivered in cash under the US-deferred compensation plan. • Clawback and malus provisions apply to all Annual Incentive awards. Dividend rights, voting rights and settlement • Novartis restricted shares carry voting rights and dividends during the vesting period. RSUs are of equivalent value but do not carry voting rights and dividends during the vesting period. • Following the vesting period, settlement of RSUs is made in unrestricted Novartis shares or ADRs. 145 Item 6. Directors, Senior Management and Employees 2018 CEO BALANCED SCORECARD This section presents the balanced scorecard for the CEO. Balanced scorecard performance is measured in constant curren- cies to reflect operational performance that can be influenced. The Board uses a stringent process to set ambitious financial targets to incentivize superior performance. CEO achievements – 2018 Financial measures – 60% of total Annual Incentive, comprising: Group net sales (cc) (30%) Group operating income (cc) (30%) Group free cash flow as a % of sales (cc) (20%) Share of peers for Novartis Group (USD) (20%) Overall assessment of Group financial targets in constant currencies Target Achievement versus target 50 447 million | 8 504 million | 20% 9.3% | | Above Met* Significantly above Met Above * The Board concluded that the achievement for Group operating income versus target was “met” following adjustments mainly for M&A transactions made to transform Novartis into a leading, focused medicines company, and for higher restructuring costs to drive major productivity programs, which were not known at the time of target setting. Strategic objectives – 40% of total Annual Incentive, comprising: Innovation (20%) Novartis was ranked No. 1 by EvaluatePharma on value creation from pipeline products, with more than 200 pro- jects in clinical development, as of December 31, 2018. With the acquisitions of AveXis, AAA and Endocyte, Novartis is building leading advanced therapy platforms in gene therapy, radioligand therapy and cell therapy. Novartis had four US FDA breakthrough therapy designations (e.g., AVXS-101), 20 major approvals (e.g., Aimovig in the US and EU), and 20 major submissions (e.g., BYL719, alpelisib). 70% of Phase II and III trials in Global Drug Development are on track for recruitment targets. The majority of projects in the Novartis Institutes for BioMedical Research are either first-in-class targets or modalities. Operational excellence (20%) Novartis set out on its strategy to focus as a leading innovative medicines company. We announced the planned Alcon spin-off, divested the Sandoz US dermatology business and generic oral solids portfolio to Aurobindo, and divested the OTC joint venture stake to GSK. The manufacturing and Novartis Business Services transformations are in early stages and need to be carefully executed. Global Drug Development efficiency has improved, strengt- hened by the launch of a series of process automations. Launch capability has been built to further strengthen com- mercial execution, contributing to four new drugs reaching blockbuster status. 98.5% of inspections at manufac- turing sites resulted in at least acceptable outcomes. Additional financial targets, including core operating income, net income, core EPS and reported EPS, were all ahead of target. Data and digital (20%) Priority digital initiatives were defined for all business units to improve the way we innovate (e.g., partnerships with Science 37 and Pear Therapeutics), operate and commercialize new therapies, including data acquisition, data governance and infrastructure. Twelve major projects to embed digital technologies and advanced data into all areas of the business were initiated, and strong progress was made. The digital organization was established, and includes 1 500 associates from teams across the organization. Capability building is ongoing to upskill the organi- zation in data and digital at global scale. People and culture (20%) Novartis began a cultural transformation toward a curious, inspired and “unbossed” organization. Around 14 000 associates completed a survey (Organizational Culture Inventory®) to establish a baseline for measuring pro- gress toward the desired culture. Around 27 000 associates took part in a crowdsourcing event seeking ways to implement culture change. Significant progress was made toward simplifying the organization and reducing bureaucracy with the simplification of the process for reviewing employee performance and the introduction of a companywide (rather than divisional) business performance factor contributing to bonus payouts for the associ- ates below Executive Committee level (excluding the field force). Good progress was made on diversity, with two female Executive Committee members and two senior female leaders reporting to the CEO. Novartis ranked No. 2 in the Thomson Reuters Diversity & Inclusion Index and pledged its commitment to gender-equal pay and LGBTI rights at the United Nations. Building trust with society (including access to healthcare and reputation) (20%) Projects in corporate responsibility were prioritized with a renewed commitment to malaria and leprosy. Almost 2.3 million Novartis Access treatments were delivered to patients at USD 1 per treatment, per month, and Healthy Family reached 7.8 million people with health education initiatives. Our ranking in the Access to Medicine Index rose to No. 2, and our ranking in the Dow Jones Sustainability Index remained at No. 4. The role of Chief Ethics, Risk and Compliance Officer was added to the Executive Committee, and a principles-based approach to compliance through the Professional Practices Policy (P3) was established. Novartis approved new environmental sustainabi- lity targets, including the goal to achieve carbon neutrality by 2025. Important reputational matters occurred over the year, and the CEO is working to address them. | Significantly above | | | | Above Met Above Met Overall assessment of strategic objectives Overall assessment of CEO balanced scorecard Above Above Target ANNUAL INCENTIVE PAYOUT Payout Overall, the Board approved an Annual Incentive payout for the CEO amounting to CHF 3 189 606, which is 145% of target, within the range of 0–200%. 146 Item 6. Directors, Senior Management and Employees Long-Term Incentive plans, 2016-2018 cycle • The Long-Term Performance Plan (LTPP) is the first of two Long-Term Incentive plans, which rewards creation of long-term value and innovation. • The Long-Term Relative Performance Plan (LTRPP) is the second of two Long-Term Incentive plans, which rewards competitive shareholder return relative to the global healthcare peer group. The structure of the two plans is summarized below. OVERVIEW OF LONG-TERM INCENTIVE PLANS Grant formula At the start of the performance cycle, performance share units (PSUs) are granted under each of the Long- Term Incentive plans, as follows: Step 1 Annual base salary Step 2 Grant value x / Target incentive % Share price = = Grant value Target number of PSUs On-target opportunity and payout range LTPP: • CEO: 200% of annual base salary • Other Executive Committee members: between 130% and 190% of annual base salary Payout range Award vehicle LTRPP: • CEO: 125% of annual base salary • Other Executive Committee members: between 30% and 80% of annual base salary • From 0% to 200% of the on-target amount based on performance PSUs granted at the beginning of the cycle vest at the end of the three-year performance cycle and are converted into Novartis shares. PSUs carry dividend equivalents that are paid in shares at the end of the cycle to the extent that performance conditions have been met. Payout formula: Target number of PSUs x Performance factor + Dividend equivalents = Realized PSUs Policy information on page 142 provides details on the treatment of Long-Term Incentive awards for leavers. 147 Item 6. Directors, Senior Management and Employees LTPP performance outcomes NOVARTIS CASH VALUE ADDED (NCVA) (75% OF LTPP) Description NCVA incentivizes sales growth and margin improvement as well as asset efficiency. It is calculated as follows: Operating income + Amortization, impairments, and adjusting for gains/losses from non-operating assets – Taxes – Capital charge (based on WACC1) on gross operational assets = NCVA2 1 WACC = weighted average cost of capital 2 NCVA = (cash flow return on investment % – WACC) x gross operational assets in constant currencies The NCVA performance factor is based on a 1:3 payout curve, whereby a 1% deviation in realization versus target leads to a 3% change in payout (for example, a realization of 105% leads to a payout factor of 115%). Accordingly, if performance over the three-year vesting period falls below 67% of target, no payout is made for this portion of the LTPP. Conversely, if performance over the three-year vesting period is above 133% of target, payout for this portion of the LTPP is capped at 200% of target. Group performance outcome for the 2016-2018 cycle During the 2016-2018 cycle, Novartis delivered an NCVA of USD 5.8 billion, 15% ahead of a target of USD 5.1 billion in constant currencies. When setting the target for the 2016-2018 cycle, the Compensation Committee took into account an impact of USD 3 billion for the loss of patent of Glivec/Gleevec compared to the previous cycle and other generic erosion. The 2016-2018 NCVA performance was mainly driven by the following: • Strong sales execution over the three-year cycle, including Cosentyx (+ USD 2.6 billion1), Entresto (+ USD 1.0 billion1), Promacta/Revolade (+ USD 0.8 billion1,2) and Tafinlar + Mekinist (+ USD 0.7 billion1,2), and the return of Alcon to growth. • Solid cost controls resulting in improved gross margin, including benefits from the implementation of the manufacturing transformation program, and increased R&D productivity. Over the three-year cycle, these cost actions supported launches via increased sales and marketing investments while broadly maintaining core operating income margin in constant currencies. Following the application of the agreed payout curve, the 115% achievement versus target generates a performance factor of 144% of target for this part of the LTPP. For Long-Term Incentive cycles starting from 2019, Novartis has decided to replace NCVA as the financial metric with a combination of a three-year net sales CAGR3 and a three-year core operating income CAGR.3 1 Represents the USD growth in annual sales (2018 vs. 2015) 2 Acquisition of GSK oncology products closed in March 2015. 2015 Novartis results include 10 months of sales. 3 Compound annual growth rate Innovation is a key value driver for shareholders and is critical to our future. At the beginning of the cycle, the Research & Development Committee determines the most important target milestones, considering the following: • The expected future potential revenue • The potential qualitative impact of research and development on science and medicine • The potential impact of research and development on the treatment or care of patients Innovation is specific to the respective head of the division or unit, and is a weighted average of the divisions or units for the CEO and Group function heads. At the end of the cycle, the Compensation Committee determines the payout factor based on the performance assessment made by the Research & Development Committee. In the healthcare industry, achievement of 60% to 80% of pipeline targets set at the beginning of a three-year cycle is considered good performance. The payout range 0% to 150% of target is based on the achievement of the target milestones, and payout above 150% of target is only delivered for truly exceptional performance. During the 2016-2018 performance cycle, Novartis delivered solid performance versus target on innovation, which accelerated over the three-year performance period. Novartis was ranked No. 1 in 2018 by EvaluatePharma on value creation from pipeline products. The Innovative Medicines Division achieved the US and EU submissions of Aimovig, the US and EU approvals of Kisqali (breast cancer), and the US and EU pediatric submissions of Kymriah (hematology and solid tumors). The US and EU filings of RTH258 (nAMD) are on track. Sandoz achievements included EU and US approvals of Hyrimoz, and EU approval of Zessly. Alcon achieved the EU launch of a next-generation IOL (Clareon monofocal) and the US filing of Daily Disposable Mass Market SiHy Sphere. NIBR initiated 10 new projects in Respiratory and discovered 27 new targets in Oncology. The US and EU submission of RLX030 (acute heart failure) was missed, as the pivotal Phase III study failed to confirm efficacy in the acute heart failure indication. Sandoz did not achieve the approval of several biosimilars in the US, including rituximab. Alcon voluntarily withdrew the recently approved CyPass from the market. Achievements during the cycle will contribute to the future success of Novartis and will bring innovative treatments to patients. Following input from the Research & Development Committee, the Board approved an innovation performance factor for the CEO and Group function heads of 110% of target. INNOVATION (25% OF LTPP) Description Group performance outcome for the 2016-2018 cycle LTPP PAYOUT Payout Overall, the Board approved an LTPP payout for the CEO amounting to CHF 1 796 381, which is of 136% of target, within the range of 0–200%. This amount includes CHF 153 716 of dividend equivalents accrued, and CHF 172 016 in share price evolution over the performance cycle. It is based on grants made in January 2016, prior to Vasant Narasimhan being appointed CEO. 148 Item 6. Directors, Senior Management and Employees LTRPP performance outcomes RELATIVE TOTAL SHAREHOLDER RETURN (TSR) (100% OF LTRPP) Description Performance is based on our TSR relative to a global healthcare peer group. Outperformance of this peer group is a key indicator that Novartis is delivering long-term value to its shareholders. The peer group and payout matrix for the 2016-2018 performance cycle are as follows: 2016-2018 peer group (12 companies, excluding Novartis) Novartis position in the peer group Payout range (% of target) Abbot AbbVie Amgen Position 1 – 3 AstraZeneca Bristol-Myers Squibb Eli Lilly & Co. Position 4 – 6 GlaxoSmithKline Johnson & Johnson Merck & Co. Position 7 – 10 Pfizer Roche Sanofi Position 11 – 13 160% – 200% 100% – 140% 20% – 80% 0% The payout matrix includes a significant reduction (including scope to reduce to nil) when Novartis does not outperform the majority of the companies in the group. At the end of the performance cycle, all companies are ranked in order of highest to lowest TSR in USD. The Compensation Committee uses its discretion to determine the payout factor within the ranges shown above, and takes into consideration factors such as absolute TSR, overall economic conditions, currency fluctuations and other unforeseeable economic situations. For the LTRPP 2017-2019 performance cycle onward, the revised peer group of 15 global healthcare companies applies, as listed on page 140. There will be no vesting for below-median performance for the LTRPP 2018-2020 performance cycle onward. Group performance outcome for the 2016-2018 cycle Novartis TSR over the three-year period (2016-2018) was 8.5%. When compared to the global healthcare peer group, Novartis TSR ranked 11 out of 13 companies. LTRPP PAYOUT FOR THE 2016-2018 CYCLE Payout Based on the ranking, the Board approved an LTRPP payout of 0% of target for the CEO. 149 Item 6. Directors, Senior Management and Employees Executive Committee membership changes in 2018 2018 Executive Committee member external appointments and buyout awards The table below provides an overview of the Executive Committee external hires made during 2018. When an indi- vidual forfeits variable compensation as a result of an appointment at Novartis, the Compensation Committee may offer replacement awards, for example performance share units (PSUs), restricted share units (RSUs) or cash, on a like-for-like basis to mirror the forfeited compensation, based on evidence. Further details on our policy approach can be found on page 141. During 2018, out of the four external newly appointed Executive Committee members, three were granted buy- out awards in place of forfeited compensation, as described in the table below. Buyout awards are of equivalent economic value and are subject to the same vesting or performance period, payable no earlier than the compen- sation forfeited upon joining Novartis. Further details on the vesting of the awards below will be provided in rele- vant future compensation reports. Name Date of appointment Cash payments (CHF) Equity awards (CHF) Total value at grant (CHF) Elizabeth Barrett, 1 CEO Oncology John Tsai, Head of Global Drug Development and Chief Medical Officer Klaus Moosmayer, Chief Ethics, Risk and Compliance Officer February 1, 2018 837 258 May 1, 2018 2 089 657 21 267 PSUs, vesting over the period 2019-2024 6 095 PSUs and 21 286 RSUs, vesting over the period 2018-2022 December 1, 2018 No cash buyout 8 857 PSUs, vesting over the period 2020-2022 1 The equity awards presented in the table for Elizabeth Barrett were forfeited in full on December 31, 2018. 2 613 478 4 181 566 808 821 2018 Executive Committee member departures In determining the compensation arrangements for departing Executive Committee members, the Compensation Committee ensures that contractual entitlements are respected and that all payments are in line with our plan rules and the Swiss Ordinance against Excessive Compensation in Listed Companies. All Executive Committee members have a 12-month notice period during which they are entitled to their con- tractual base salary, Annual Incentive, pension and other benefits. During the notice period, no new grants of LTPP/ LTRPP awards are made. The plan rules require that any equity vesting will occur on the normal vesting date (i.e., there is no accelerated vesting), and malus and clawback as well as non-compete restrictions will continue to apply. No severance or non-compete payments are made to departing Executive Committee members. Further details on the policy treat- ment of variable compensation for departing Executive Committee members can be found on page 142. Retired CEO Joseph Jimenez stepped down from his role on January 31, 2018, and his notice period ended on August 31, 2018. No Long-Term Incentive grants were awarded in January 2018 for the 2018-2020 performance cycle. In 2018, for the three Executive Committee members who retired (the CEO, Group General Counsel and CEO of Alcon), full vesting of equity applies as per previous plan rules, as communicated in the 2017 Compensation Report. Going forward, retiring Executive Committee members will receive pro-rata vesting of equity. The Board of Directors agreed to a six-month reduction of the notice period, without compensation, of the Pres- ident of Novartis Operations and Country President of Switzerland, to allow him to take on a new position with a company that does not compete with Novartis from October 1, 2018. Pro-rata vesting of equity will apply. The CEO, Novartis Oncology decided to step down and leave Novartis, as of December 31, 2018. The Board of Directors agreed to waive her 12-month notice period in full. Her final annual base salary payment was made in December 2018. Strictly in line with the Novartis incentive plan rules, her Annual Incentive for the 2018 performance cycle, her Long-Term Incentives granted for the 2018-2020 performance cycle, and her unvested equity buyouts of 21 267 PSUs that were made at the point of her recruitment to replace lost equity at her former employer were forfeited in full. 150 Item 6. Directors, Senior Management and Employees Realized compensation To aid shareholders’ understanding of the link between pay and performance, the Compensation Committee dis- closes the realized compensation for the CEO individually, and for the other members of the Executive Committee on an aggregated basis. Disclosing realized compensation means that the Annual Incentive and the Long-Term Incentives are disclosed at the end of their respective performance cycles, reflecting actual payouts based on per- formance. The total actual payout may vary year on year depending on multiple factors, including the composition of the Executive Committee and the tenure of its members (as new members may not have vested Long-Term Incentives), compensation increases, payout of variable compensation based on actual performance, share price fluctuations of Long-Term Incentives, and dividend equivalents. 2018 realized compensation for the CEO and other Executive Committee members The table below reports fixed and other compensation for the year, including the Annual Incentive for the 2018 per- formance year, the realized Long-Term Incentives for the 2016-2018 performance cycle, and any buyouts vesting in 2018. The portion of the Annual Incentive paid in shares for the year 2018 is disclosed using the underlying value of Novartis shares at the date of grant, while the realized values of any other equity awards (including dividend equivalents) are calculated using the share price on the date of vesting. 2018 annual base salary 2018 pension benefits1 2018 Annual Incentive Long-Term Incentives LTPP 2016-2018 cycle LTRPP 2016-2018 cycle Currency Cash (amount) Amount Cash Equity2 Equity (value at vesting date)3 Equity (value at vesting date) Other 2018 compensation Total realized compensation (incl. share Amount2,4 price movement)5 Executive Committee members active on December 31, 2018 Vasant Narasimhan (CEO from February 1, 2018) CHF 1 491 667 168 233 1 594 801 1 594 805 1 796 381 0 34 401 6 680 288 Aggregate realized compensation of the other 16 Executive Committee members, including the four members who stepped down during financial year 2018 6, 7 Total CHF 9 297 021 CHF 10 788 688 1 874 671 1 2 042 904 5 727 765 7 322 566 5 532 316 24 079 974 7 127 121 25 876 355 0 13 131 653 59 643 400 0 13 166 054 66 323 688 See the next page for 2017 comparative figures. 1 Includes mandatory employer contributions of CHF 4 336 for the CEO and CHF 78 403 for the other Executive Committee members paid by Novartis to governmental social security systems. This amount is out of total employer contributions of CHF 2 847 422 paid in 2018 for all Executive Committee members, and provides a right to the maximum future insured government pension benefit for the Executive Committee member. 2 The portion of the Annual Incentive delivered in equity is rounded up to the nearest share, based on the closing share price on the grant date (January 22, 2019) of CHF 88.14 per Novartis share and USD 88.32 per ADR. 3 The amounts represent the underlying share value of the 294 971 PSUs vesting on January 22, 2019, to the CEO and other Executive Committee members for the performance cycle 2016-2018, inclusive of earned dividend equivalents for the three-year cycle (details on following page). The taxable value is determined using the closing share price on the day the Novartis Board approved the final LTPP and LTRPP performance factors (i.e., January 22, 2019) of CHF 88.14 per Novartis share and USD 88.32 per ADR. Vasant Narasimhan, Shannon Thyme Klinger, Stefan Lang and André Wyss joined the Executive Committee during the course of the performance period 2016-2018, and as such, the information disclosed reflects their pro-rata LTPP 2016-2018 payout attributable to the period they were a member of the Executive Committee. Elizabeth Barrett, Bertrand Bodson, Paul Hudson, Klaus Moosmayer, John Tsai and Robert Weltevreden joined post the 2016 LTPP awards being made and hence did not receive an LTPP award for the 2016-2018 performance period. 4 Includes any other perquisites, benefits in kind, international assignment benefits as per the global mobility policy (e.g., housing, international health insurance, children’s school fees, tax equalization) as well as vested shares under LTPP after the step down date. 5 All amounts are before deduction of the social security contribution and income tax due by the Executive Committee member. 6 Comprises the compensation of the outgoing CEO, General Counsel, CEO of Alcon, and President of Novartis Operations and Country President Switzerland, including the vesting of their Long-Term Incentives for performance cycle 2016-2018, as per the plan rules. See page 150 for details. 7 Amounts for Executive Committee members paid in USD were converted at a rate of UDS 1.00 = CHF 0.978, which is the same average exchange rate used in the Group’s 2018 consolidated financial statements. The 2018 total realized compensation for the CEO was CHF 6 680 288, and included the payouts of the Annual Incentive, LTPP and LTRPP based on actual performance assessed for cycles concluding in 2018. The base sal- ary, pension and other benefits levels below include the compensation for Vasant Narasimhan in the role of Head of Global Drug Development and Chief Medical Officer during the period January 1, 2018, to January 31, 2018, and the LTPP and LTRPP levels reflect grants that were made in 2016, prior to Dr. Narasimhan being appointed CEO. The column titled “Other 2018 compensation” in the 2018 total realized compensation of the Executive Committee includes the following: • 1 443 vested ADRs (USD 123 146) to James Bradner, in lieu of the Long-Term Incentive that he forfeited when leaving his previous employer. • 1 125 vested RSUs (CHF 83 700) and 9 015 vested PSUs (CHF 670 716) to Paul Hudson, in lieu of the Long-Term Incentive that he forfeited when leaving his previous employer. The PSUs had the same performance measures as the LTPP for the 2015-2017 performance cycle (NCVA and long-term innovation). Both awards vested in March 2018. • Buyout payments made to two external newly appointed Executive Committee members, John Tsai and Elizabeth Barrett, totaling CHF 2 461 959 (cash and vested shares) and CHF 837 258 (cash), respectively. 151 Item 6. Directors, Senior Management and Employees The table and information below provide additional details on awards granted as part of the 2016-2018 LTPP and LTRPP performance cycle, including the number of shares awarded and delivered, following the application of the payout factor and the addition of dividend equivalent shares. 2016-2018 performance cycle LTPP PSUs at grant Shares delivered at vesting PSUs (target number) PSUs (target value at grant date) 2 (CHF) Executive Committee members active on December 31, 2018 Performance shares Payout factor Performance shares delivered at vesting equivalent shares delivered at vesting for LTPP delivered at vesting (value at vesting date) delivered at vesting (value at vesting date) (CHF) (CHF) (number) (number) (% of target) Dividend 3 4 Dividend Total shares equivalent shares delivered at vesting (value at vesting date) (CHF) Vasant Narasimhan (CEO from February 1, 2018) 1 Other 16 Executive Committee members, including the four members who stepped down during financial year 2018 5 13 704 1 092 209 136% 18 637 1 642 665 1 744 153 716 1 796 381 185 067 14 634 081 124%–142% 251 021 22 013 199 23 569 2 066 775 24 079 974 Total 198 771 15 726 290 269 658 23 655 864 25 313 2 220 491 25 876 355 1 Vasant Narasimhan, Shannon Thyme Klinger, Stefan Lang and André Wyss joined the Executive Committee during the course of the performance period 2016-2018. As such, the information disclosed reflects their pro-rata LTPP 2016-2018 payout attributable to the period they were a member of the Executive Committee. Elizabeth Barrett, Bertrand Bodson, Paul Hudson, Klaus Moosmayer, John Tsai and Robert Weltevreden joined post the 2016 LTPP awards being made and hence did not receive an LTPP award for the 2016-2018 performance period. 2 The shown amounts represent the underlying share value of the target number of PSUs granted to each Executive Committee member for the performance period 2016-2018, based on the closing share price on the grant date (January 20, 2016) of CHF 79.70 per Novartis share and USD 80.49 per ADR. 3 The shown amounts represent the underlying share value of the target number of PSUs vested for the performance period 2016-2018, based on the last closing share price before the vesting date (i.e., January 22, 2019) of CHF 88.14 per Novartis share and USD 88.32 per ADR. 4 Dividend equivalent shares are calculated on the dividend each member of the Executive Committee would have received, based on the actual number of shares delivered at the end of the performance period 2016-2018. At vesting, the dividend equivalents are credited in shares or ADRs. 5 Includes the LTPP vesting for the outgoing CEO, General Counsel, CEO of Alcon, and President of Novartis Operations and Country President Switzerland for performance cycle 2016-2018, as per the plan rules. See page 148 for further details. 2016-2018 performance cycle LTRPP Under the LTRPP, the award made to the CEO of 4 569 PSUs, and the aggregate award of 96 143 PSUs made to the other Executive Committee members (including those who stepped down during the year) were forfeited, result- ing in no payout, due to the Company’s TSR over the three-year performance period ranking 11 out of 13 peer com- panies. 152 Item 6. Directors, Senior Management and Employees The table and information below provide details of the 2017 realized compensation for the CEO and other Execu- tive Committee members, for comparative purposes. 2017 realized compensation for the CEO and other Executive Committee members 2017 annual base salary 2017 pension benefits 2017 Annual Incentive1 Long-Term Incentives LTPP 2015-2017 cycle LTRPP 2015-2017 cycle Other 2017 compensation2 Currency Cash (amount) Amount Cash Equity 1 Equity (value 2 at vesting date) Equity (value 2 at vesting date) Amount 3 Total realized compensation (incl. share 4 price movement) Executive Committee members active on December 31, 2017 Joseph Jimenez (CEO) CHF 2 100 000 166 397 1 968 750 1 968 792 5 068 337 Aggregate realized compensation of the other 10 ECN members Total 5 9 310 740 CHF CHF 11 410 740 1 675 398 1 841 795 5 841 107 7 809 857 7 743 069 8 355 739 9 711 861 13 424 076 0 0 0 72 186 11 344 462 3 248 419 36 174 472 3 320 605 47 518 934 1 The portion of the Annual Incentive delivered in equity is rounded up to the nearest share, based on the closing share price on the grant date (January 18, 2018) of CHF 82.90 per Novartis share and USD 86.41 per ADR. 2 The amounts represent the underlying share value of the 160 733 PSUs vesting on January 21, 2018, to the CEO and other Executive Committee members for the performance cycle 2015-2017, inclusive of earned dividend equivalents for the three-year cycle. The value is determined using the closing share price on the last trading day (January 19, 2018) before the vesting date of CHF 83.38 per Novartis share and USD 86.94 per ADR. For two members of the Executive Committee, the vesting value is reported pro-rata based on the period they were an Executive Committee member during the performance cycle. 3 Includes any other perquisites, benefits in kind, international assignment benefits as per the global mobility policy (e.g., housing, international health insurance, children’s school fees, tax equalization) 4 All amounts are before deduction of the social security contribution and income tax due by the Executive Committee member. 5 Amounts for Executive Committee members paid in USD were converted at a rate of CHF 1.00 = USD 1.015, which is the same average exchange rate used in the Group’s 2017 consolidated financial statements. Realized compensation for the Executive Committee for 2018 compared to 2017 When comparing 2018 total realized compensation for the Executive Committee, including the CEO, of CHF 66.3 million to the 2017 total realized compensation of CHF 47.5 million, the difference is primarily due to changes in the composition of the Executive Committee. There has been both an increase in the number of Executive Committee members and an overlap of departing and appointed members, including the CEO in 2018. 153 Item 6. Directors, Senior Management and Employees Compensation at grant value In accordance with the Swiss Ordinance against Excessive Compensation in Listed Companies, Novartis continues to disclose total compensation at grant value for the CEO and other Executive Committee members. The tables below disclose for the CEO and other Executive Committee members: • Fixed 2018 compensation (base salary and benefits) • The actual cash portion and the deferred portion granted in equity of the 2018 Annual Incentive • LTPP and LTRPP 2018-2020 performance cycle awards, which are reported at target value at grant date under the assumption that the awards will vest at 100% achievement, excluding any share price movement and dividend equivalents that may be accrued over the performance cycle. The future payout will be determined only after the performance cycle concludes in three years (i.e., end of 2020), with a payout range of 0% to 200% of the target value. • Other compensation for 2018, which includes other benefits and the full amount of compensation for lost entitle- ments from former employers (buyouts), and compensation during the notice period (between the date of step- ping down from the Executive Committee and either December 31 or the end of the contractual notice), either paid in cash or granted in equity in the year To assess CEO actual pay for performance in 2018, including the Annual Incentive payout for the 2018 perfor- mance year and the Long-Term Incentive payouts for the 2016-2018 performance cycle, shareholders should refer to the 2018 realized compensation table on page 151. 154 Item 6. Directors, Senior Management and Employees 2018 compensation at grant value for the CEO and other Executive Committee members Fixed compensation and pension benefits Variable compensation Actual compensation paid or granted for 2018 Long-Term Incentive 2018-2020 cycle grants at target 2018 annual base salary 2018 pension benefits 2018 Annual Incentive (performance achieved) LTPP 2018-2020 cycle LTRPP 2018-2020 cycle Other 2018 compensation Total compensation paid, promised or granted 2018 Currency Cash (amount) Amount 1 Cash (amount) Equity (value at 2 grant date) PSUs (target value 3 at grant date) PSUs (target value 3 at grant date) Amount 4 5 Amount Executive Committee members active on December 31, 2018 Vasant Narasimhan (CEO from February 1, 2018) 6 Steven Baert Elizabeth Barrett (from February 1, 2018, to December 31, 2018) 7 Bertrand Bodson (from April 1, 2018) 8 James Bradner 9 Richard Francis Paul Hudson Harry Kirsch Shannon Thyme Klinger (from April 1, 2018) 8 Steffen Lang (from April 1, 2018) 8 Klaus Moosmayer (from December 1, 2018) John Tsai (from May 1, 2018) Robert Weltevreden (from June 1, 2018) Subtotal CHF CHF 1 491 667 780 000 168 233 152 914 1 594 801 585 000 1 594 805 585 073 3 100 046 1 170 051 1 937 539 468 053 34 401 77 550 9 921 491 3 818 642 CHF 779 167 174 274 0 0 1 360 040 510 057 2 747 859 5 571 397 CHF USD CHF CHF CHF 450 000 1 094 462 850 000 985 000 1 040 000 97 666 257 018 176 368 180 771 173 499 216 986 924 000 382 500 1 007 325 858 000 217 001 924 004 382 528 1 007 352 858 043 440 614 1 870 085 1 360 057 1 683 036 1 768 008 110 174 880 086 510 001 792 027 832 067 146 478 63 313 1 790 428 94 355 58 814 1 678 918 6 012 967 5 451 882 5 749 866 5 588 431 CHF 520 833 103 448 275 770 275 790 619 595 185 862 37 118 2 018 416 CHF 540 000 99 535 260 384 260 454 596 631 179 064 8 595 1 944 663 CHF 41 667 9 704 16 986 17 011 CHF 566 667 126 845 313 801 313 867 0 0 0 808 821 894 189 0 4 590 950 5 912 129 CHF 350 000 9 464 855 70 950 1 785 446 77 392 6 492 171 232 337 671 702 6 647 490 14 597 819 155 003 1 561 099 6 540 145 10 460 974 55 988 900 3 715 Executive Committee members who stepped down during 2018 10 Joseph Jimenez (CEO until January 31, 2018) 178 601 CHF 19 146 133 767 0 0 0 2 357 371 2 688 885 F. Michael Ball (until June 30, 2018) 9 Felix R. Ehrat (until May 31, 2018) André Wyss (until March 31, 2018) 11 Subtotal Total USD CHF 555 397 126 594 333 238 333 231 888 640 388 845 2 970 642 5 596 587 384 740 68 918 153 896 153 892 654 081 230 877 2 346 072 3 992 477 CHF 217 582 1 323 833 10 788 688 45 646 257 458 2 042 904 216 986 830 395 7 322 566 0 479 632 116 060 1 638 802 7 127 122 16 236 621 43 523 654 503 1 375 802 2 015 599 8 983 098 14 167 721 7 194 648 19 444 072 70 156 621 Based on assumption of 100% payout at target. Actual payout (0–200% of target) will be known at the end of the three-year cycle in January 2021. See the next page for 2017 comparative figures. 1 Includes mandatory employer contributions of CHF 4 336 for the CEO and CHF 78 403 for the other Executive Committee members paid by Novartis to governmental social security systems. This amount is out of total employer contributions of CHF 2 847 422 paid in 2018 for all Executive Committee members, and provides a right to the maximum future insured government pension benefit for the Executive Committee member. 2 The portion of the Annual Incentive delivered in equity is rounded up to the nearest share, based on the closing share price on the grant date (January 22, 2019) of CHF 88.14 per Novartis share and USD 88.32 per ADR. 3 The amounts represent the underlying share value of the target number of PSUs granted to Executive Committee members for the performance cycle 2018-2020, based on the closing share price on the grant date (January 18, 2018) of CHF 82.90 per Novartis share and USD 86.41 per ADR for all members except Elizabeth Barrett and Robert Weltevreden. For Ms. Barrett and Mr. Weltevreden, the closing share price on the grant date was respectively CHF 83.52 on February 1, 2018, and CHF 74.70 on June 1, 2018, per Novartis share. 4 Includes any other perquisites, benefits in kind, and international assignment benefits as per the global mobility policy (e.g., housing, international health insurance, children’s school fees, tax equalization) 5 All amounts are before deduction of the social security contribution and income tax due by the Executive Committee member. 6 The figures include Vasant Narasimhan’s compensation of January 2018 as Head of Global Drug Development. 7 Elizabeth Barrett stepped down from the role of CEO, Novartis Oncology and from the Executive Committee as at the end of the 2018 business year. The LTPP and LTRPP grants (16 284 and 6 107 PSUs, respectively) for the 2018-2020 performance cycle, and the 2018 buyout award of 21 267 performance shares, reflected in other compensation, both included in the table above, were forfeited in full upon her departure on December 31, 2018. 8 For those members who joined the Executive Committee in 2018, the information under the columns “2018 annual base salary,” “2018 pension benefits,” “2018 Annual Incentive,” “LTPP” and “LTRPP” includes their pro-rata compensation from the date they joined the Executive Committee to December 31, 2018. 9 Amounts in USD for F. Michael Ball and James Bradner were converted at a rate of CHF 1.00 = USD 0.978, which is the same average exchange rate used in the Group’s 2018 consolidated financial statements. 10 For those members who left the Executive Committee in 2018, the information under the columns “2018 annual base salary,” “2018 pension benefits,” “2018 Annual Incentive,” “LTPP” and “LTRPP” reflects the pro-rata compensation for the period they were an Executive Committee member in 2018. The information under the column “Other 2018 compensation” also includes, inter alia, their pro-rata compensation from the date they stepped down from the Executive Committee to December 31, 2018. More information regarding Executive Committee members who stepped down during 2018 is on page 150. 11 The full number of PSUs under LTPP and LTRPP 2018-2020 granted to André Wyss were 16 985 and 6 370, respectively. The amounts included under LTPP and LTRPP in the table above are disclosed on a pro-rata basis to the end of his notice period (i.e., September 30, 2018), per his contractual agreement and subject to the plan rules. 155 Item 6. Directors, Senior Management and Employees 2017 compensation at grant value for the CEO and other Executive Committee members For comparative purposes, the table below provides the compensation at grant value for 2017. Fixed compensation and pension benefits Variable compensation Actual compensation paid or granted for 2017 Long-Term Incentive 2017-2019 cycle grants at target 2017 annual base salary 2017 pension benefits 2017 Annual Incentive (performance achieved) LTPP 2017-2019 cycle LTRPP 2017-2019 cycle Other 2017 compensation Total compensation paid, promised or granted 2017 Currency Cash (amount) Amount 1 Cash Equity (value at 2 grant date) PSUs (target value 3 at grant date) PSUs (target value 3 at grant date) Amount 4 5 Amount Executive Committee members active on December 31, 2017 6 Joseph Jimenez (CEO) F. Michael Ball Steven Baert James Bradner Felix R. Ehrat Richard Francis Paul Hudson Harry Kirsch Vasant Narasimhan Bruno Strigini (until December 31, 2017) 6 André Wyss Total 7 CHF USD CHF USD CHF CHF CHF CHF CHF 2 100 000 1 120 000 775 000 1 066 385 928 333 841 667 958 333 1 038 333 841 667 166 397 203 546 154 652 117 394 137 334 176 362 203 485 153 854 168 562 1 968 750 873 600 663 000 898 800 223 200 425 000 950 400 800 800 807 500 1 968 792 873 605 663 034 898 837 892 833 425 028 950 449 800 814 807 529 4 200 018 1 792 047 1 170 069 1 819 043 1 581 045 1 360 002 1 536 023 1 768 053 1 360 002 2 625 038 784 043 468 056 856 033 558 028 510 010 672 046 832 012 510 010 72 186 13 101 181 5 940 130 4 013 029 5 702 347 4 335 807 4 851 017 5 467 837 5 452 576 4 545 873 293 289 119 218 45 855 15 034 1 112 948 197 101 58 710 50 603 CHF 898 333 875 000 CHF CHF 11 410 740 210 613 154 339 1 841 795 225 000 0 7 809 857 225 074 1 440 057 1 408 021 1 232 060 9 711 861 19 381 014 540 048 528 061 8 859 147 50 000 70 526 3 589 125 4 268 007 2 080 458 61 094 873 Based on assumption of 100% payout at target. Actual payout (0–200% of target) will be known at the end of the three-year cycle in January 2020. 1 Includes mandatory employer contributions of CHF 4 336 for the CEO and CHF 50 227 for the other Executive Committee members paid by Novartis to governmental social security systems. This amount is out of total employer contributions of CHF 2 710 445 paid in 2017 for all Executive Committee members, and provides a right to the maximum future insured government pension benefit for the Executive Committee member. 2 The portion of the Annual Incentive delivered in equity is rounded up to the nearest share, based on the closing share price on the grant date (January 18, 2018) of CHF 82.90 per Novartis share and USD 86.41 per ADR. 3 The amounts represent the underlying share value of the target number of PSUs granted to Executive Committee members for the performance cycle 2017-2019, based on the closing share price on the grant date (January 17, 2017) of CHF 71.35 per Novartis share and USD 71.99 per ADR. 4 Includes any other perquisites, benefits in kind, and international assignment benefits as per the global mobility policy (e.g., housing, international health insurance, children’s school fees, tax equalization) 5 All amounts are before deduction of the social security contribution and income tax due by the Executive Committee member. 6 Bruno Strigini stepped down from the Executive Committee at the end of the 2017 business year. The LTPP and LTRPP grants for the 2017-2019 performance cycle, included in the table above, will vest at the end of the performance cycle on a pro-rata basis per his contractual agreement and subject to the plan rules. 7 Amounts in USD for F. Michael Ball and James Bradner were converted at a rate of CHF 1.00 = USD 1.015, which is the same average exchange rate used in the Group’s 2017 consolidated financial statements. Compensation at grant value for the Executive Committee for 2018 compared to 2017 When comparing the Executive Committee 2018 total compensation at grant value of CHF 70.2 million to the 2017 total compensation at grant value of CHF 61.0 million, the difference is primarily due to the awards granted in 2018 to external newly appointed members of the Executive Committee – Elizabeth Barrett, John Tsai and Klaus Moos- mayer – as part of their buyout packages when joining Novartis in 2018. However, Elizabeth Barrett forfeited com- pensation amounting to CHF 3.7 million composed of her equity buyout (CHF 1.8 million) and her LTPP and LTRPP grants for the 2018-2020 performance cycle (CHF 1.9 million), as she stepped down from the Executive Commit- tee on December 31, 2018. See page 150 for further details on the changes to the composition of the Executive Committee in 2018. 156 Item 6. Directors, Senior Management and Employees Additional disclosures for the CEO and other Executive Committee members This section provides additional disclosures, including information about the shareholdings of the CEO and the other Executive Committee members. Former Alcon CEO one-off performance award update To avoid any conflict of interest following news of the intention to spin off Alcon, the former Alcon CEO, F. Michael Ball, gave notice to retire from his role and stepped down from the Executive Committee on July 1, 2018, commenc- ing his 12-month contractual notice period that will end on the Alcon spin-off date (or June 30, 2019, if later). During the notice period, Mr. Ball is serving as Chairman-Designate of Alcon, reporting to Vasant Narasimhan and focus- ing on preparing Alcon for the intended spin-off. In this role, Mr. Ball supports the newly appointed Alcon CEO to ensure that the turnaround of the Alcon business continues to accelerate, and that the company will be in a strong position to operate as an independent entity. The Alcon CEO role does not sit on the Novartis Executive Commit- tee given the potential conflict of interest. As disclosed in the 2016 Compensation Report, Mr. Ball received a one-off award of 50 000 performance share units in February 2016 when he joined Novartis, subject to the achievement of targets linked to the turnaround of Alcon during the 2016-2018 performance cycle. In line with his contractual terms, this one-off award will vest in early 2019, subject to performance outcomes versus the targets set. The performance measures are based on financial and non-financial targets, including sales growth ahead of peers, core operating income growth ahead of sales growth, core operating income margin at least in line with the average of peers, and the successful launch of new products. In 2016, performance was tracking below target. However, in 2017 and 2018, Alcon began to close the gap ver- sus the targets. Given that some of the performance measures are assessed relative to peers, the achievements and the final payout of this three-year Long-Term Incentive award will be disclosed in the 2019 Compensation Report, once the final performance is known. Malus and clawback Any incentive compensation paid to Executive Committee members is subject to malus and clawback rules. This means that the Board for the CEO, and the Compensation Committee for the other Executive Committee mem- bers, may decide – subject to applicable law – to retain any unpaid or unvested incentive compensation (malus), or to recover incentive compensation that has been paid or has vested in the past (clawback). This applies in cases where the payout conflicts with internal management standards, including Company and accounting policies, or violates laws. This principle applies to both the short-term Annual Incentive and Long-Term Incentive plans. In 2018, there was no legal or factual basis on which to exercise malus or clawback for current or former Exec- utive Committee members. However, the Compensation Committee and the Board of Directors decided to apply its discretion, as foreseen in the plan rules, to reduce the 2018 Annual Incentive to below-target levels for certain executives in relation to their responsibilities. 157 Item 6. Directors, Senior Management and Employees Number of equity instruments granted to the CEO and other Executive Committee members for financial year 2018 Variable compensation1 2018 Annual Incentive (performance achieved) LTPP 2018-2020 cycle LTRPP 2018-2020 cycle Other Equity (number) 2 PSUs (target number) 3 PSUs (target number) 3 Equity/PSUs (number) Executive Committee members active on December 31, 2018 Vasant Narasimhan (CEO from February 1, 2018) Steven Baert Elizabeth Barrett (from February 1, 2018, to December 31, 2018) 4 Bertrand Bodson (from April 1, 2018) James Bradner Richard Francis Paul Hudson Harry Kirsch Shannon Thyme Klinger (from April 1, 2018) Steffen Lang (from April 1, 2018) Klaus Moosmayer (from December 1, 2018) John Tsai (from May 1, 2018) Robert Weltevreden (from June 1, 2018) Subtotal Executive Committee members who stepped down during 2018 Joseph Jimenez (CEO until January 31, 2018) 5 F. Michael Ball (until June 30, 2018) Felix R. Ehrat (until May 31, 2018) André Wyss (until March 31, 2018) 6 Subtotal Total 18 094 6 638 0 2 462 10 462 4 340 11 429 9 735 3 129 2 955 193 3 561 2 636 75 634 0 7 609 4 221 0 11 830 87 464 37 395 14 114 16 284 5 315 21 642 16 406 20 302 21 327 7 474 7 197 0 0 8 992 176 448 0 10 284 7 890 1 400 19 574 196 022 23 372 5 646 6 107 1 329 10 185 6 152 9 554 10 037 2 242 2 160 0 0 2 075 78 859 0 4 500 2 785 525 7 810 86 669 0 0 21 267 0 0 0 0 0 0 0 8 857 27 381 0 57 505 0 18 865 17 603 3 915 40 383 97 888 See the next page for 2017 comparative figures. 1 The values of the awards are reported in the table “2018 compensation at grant value for the CEO and other Executive Committee members” on page 155. 2 Vested shares, restricted shares and/or RSUs granted under the Annual Incentive for performance period 2018 3 Target number of PSUs granted under the LTPP and LTRPP as applicable for the performance cycle 2018-2020 4 Elizabeth Barrett stepped down from the role of CEO, Novartis Oncology and from the Executive Committee as at the end of the 2018 business year. The LTPP and LTRPP grants (16 284 and 6 107 PSUs, respectively) for the 2018-2020 performance cycle, and the 2018 buyout award of 21 267 performance shares, reflected in other compensation, both included in the table above, were forfeited in full upon her departure on December 31, 2018. 5 Joseph Jimenez received his 2018 Annual Incentive 100% in cash and was not granted LTPP and LTRPP awards for the performance cycle 2018-2020. 6 André Wyss stepped down from the Executive Committee on March 31, 2018, and ended his notice period on September, 30 2018. He received his 2018 Annual Incentive 100% in cash on a pro-rata basis, and the LTPP and LTRPP grants for the 2018-2020 performance cycle, included in the table above, will vest at the end of the performance cycle on a pro-rata basis per his contractual agreement and subject to the plan rules. 158 Item 6. Directors, Senior Management and Employees Number of equity instruments granted to the CEO and other Executive Committee members for financial year 2017 (comparative information) Executive Committee members active on December 31, 2017 Joseph Jimenez (CEO) Steven Baert F. Michael Ball James Bradner Felix R. Ehrat Richard Francis Paul Hudson Harry Kirsch Vasant Narasimhan Bruno Strigini (until December 31, 2017) 4 André Wyss Total Variable compensation1 2017 Annual Incentive (performance achieved) LTPP 2017-2019 cycle LTRPP 2017-2019 cycle Equity (number) 2 PSUs (target number) 3 PSUs (target number) 3 23 749 7 998 10 110 10 402 10 770 5 127 11 465 9 660 9 741 2 715 14 862 116 599 58 865 16 399 24 893 25 268 22 159 19 061 21 528 24 780 19 061 20 183 19 734 36 791 6 560 10 891 11 891 7 821 7 148 9 419 11 661 7 148 7 569 7 401 271 931 124 300 1 The values of the awards are reported in the table “2017 compensation at grant value for the CEO and other Executive Committee members” on page 156. 2 Vested shares, restricted shares and/or RSUs granted under the Annual Incentive for performance period 2017 3 Target number of PSUs granted under the LTPP and LTRPP as applicable for the performance cycle 2017-2019 4 Bruno Strigini stepped down from the Executive Committee at the end of the 2017 business year. The LTPP and LTRPP grants for the 2017-2019 performance cycle, included in the table above, will vest at the end of the performance cycle on a pro-rata basis per his contractual agreement and subject to the plan rules. 159 Item 6. Directors, Senior Management and Employees Share ownership requirements for the CEO and other Executive Committee members Executive Committee members are required to own at least a minimum multiple of their annual base salary in Novartis shares or restricted share units (RSUs) within five years of hire or promotion, as set out in the table below. In the event of a substantial rise or drop in the share price, the Board of Directors may, at its discretion, amend that time period accordingly. FUNCTION OWNERSHIP LEVEL CEO 5 x base compensation Other Executive Committee members 3 x base compensation The determination of equity amounts against the share ownership requirements is defined to include vested and unvested Novartis shares or American Depositary Receipts (ADRs), and RSUs acquired under the Compa- ny’s compensation plans. However, unvested matching shares granted under former matching programs, such as the Leveraged Share Savings Plan (LSSP) and the Employee Share Ownership Plan (ESOP), and any unvested PSUs are excluded. The determination also includes other shares and vested options of Novartis shares or ADRs that are owned directly or indirectly by “persons closely linked” to an Executive Committee member. The Compensation Committee reviews com- pliance with the share ownership guideline on an annual basis. Shares, ADRs and other equity rights owned by Executive Committee members at December 31, 20181 The following table shows, in alphabetical order after the CEO, the total number of shares, ADRs and other equity rights owned by the CEO and the other Executive Committee members and “persons closely linked” to them as of December 31, 2018. As of December 31, 2018, no members of the Executive Committee, either individually or together with “persons closely linked” to them, owned 1% or more of the outstanding shares or ADRs of Novartis. As of December 31, 2018, all members who have served at least five years on the Executive Committee have met or exceeded their personal Novartis share ownership requirements. Vested shares Unvested shares and ADRs and other equity rights 2 as a multiple of Unvested target PSUs (e.g., LTPP/LTRPP) 4 annual base salary 3 Matching shares Total at under the LSSP 5 December 31, 2018 Equity ownership level Vasant Narasimhan (CEO from February 1, 2018) Steven Baert Elizabeth Barrett (from February 1, 2018, to December 31, 2018) 6 Bertrand Bodson (from April 1, 2018) James Bradner Richard Francis Paul Hudson Harry Kirsch Shannon Thyme Klinger (from April 1, 2018) Steffen Lang (from April 1, 2018) Klaus Moosmayer (from December 1, 2018) John Tsai (from May 1, 2018) Robert Weltevreden (from June 1, 2018) 25 240 23 365 0 0 924 48 079 16 756 97 081 57 111 22 598 0 4 600 22 193 19 937 32 589 29 488 14 007 21 705 23 793 14 743 0 0 6 429 16 432 150 0 Total 7 255 824 241 396 4x 4x 0x 0x 1x 6x 4x 10x 4x 4x 0x 2x 0x 56 552 39 461 0 3 914 67 997 47 078 30 585 67 058 4 192 0 0 0 0 0 0 3 756 143 095 85 424 0 8 514 91 114 115 094 79 930 197 383 16 722 1 684 54 118 14 747 4 087 57 370 3 274 2 202 3 690 353 280 0 0 0 13 719 3 274 25 063 3 840 864 219 1 Includes holdings of “persons closely linked” to Executive Committee members (see definition on page 161) 2 Includes unvested shares and ADRs as well as other equity rights applicable for the determination of equity amounts for the share ownership requirements, as per the definition above 3 The multiple is calculated based on the full-year annual base salary and the closing share price as at the end of the 2018 financial year. The share price on the final trading day of 2018 was CHF 84.04 / USD 85.81 as at December 31, 2018. 4 The target number of PSUs is disclosed pro-rata to December 31, 2018, unless the award qualified for full vesting under the relevant plan rules. 5 Matching shares under the Leveraged Share Savings Plan (LSSP) are disclosed pro-rata to December 31, 2018, unless the award qualified for full vesting under the plan rules. LSSP participation for Executive Committee members ceased in 2014, and no new LSSP awards have been made since then. Outstanding awards will vest five years from the grant date, subject to the LSSP plan rules. 6 Elizabeth Barrett stepped down from the role of CEO, Novartis Oncology and from the Executive Committee as at the end of the 2018 business year. The LTPP and LTRPP grants (16 284 and 6 107 PSUs, respectively) for the 2018-2020 performance cycle, and the 2018 buyout award of 21 267 performance shares were forfeited in full upon her departure on December 31, 2018. 7 Joseph Jimenez, F. Michael Ball, Felix Ehrat and André Wyss stepped down from the Executive Committee in 2018. At the time they stepped down from the Executive Committee, Mr. Jimenez owned 4 750 vested shares, and 244 297 unvested shares and other equity rights; Mr. Ball owned no vested shares, and 165 810 unvested shares and other equity rights; Mr. Ehrat owned 236 886 vested shares, and 114 038 unvested shares and other equity rights; and Mr. Wyss owned 81 347 vested shares and 49 344 unvested shares and other equity rights. 160 Item 6. Directors, Senior Management and Employees Fixed and variable compensation The CEO and other Executive Committee members’ annual base salary and variable compensation mix at grant value for financial year 2018: Vasant Narasimhan (CEO) Steven Baert Elizabeth Barrett Bertrand Bodson James Bradner Richard Francis Paul Hudson Harry Kirsch Shannon Thyme Klinger Steffen Lang Klaus Moosmayer John Tsai Robert Weltevreden Total 3 Annual Variable base salary 1 compensation 2 15.3% 21.7% 29.4% 31.4% 19.2% 24.4% 18.0% 19.4% 27.7% 29.4% 55.1% 47.4% 23.5% 21.6% 84.7% 78.3% 70.6% 68.6% 80.8% 75.6% 82.0% 80.6% 72.3% 70.6% 44.9% 52.6% 76.5% 78.4% 1 Excludes pension and other benefits 2 See table “2018 compensation at grant value for the CEO and other Executive Committee members” on page 155 with regard to the disclosure principles of variable compensation. 3 Excludes Joseph Jimenez, F. Michael Ball, Felix Ehrat and André Wyss, who stepped down from the Executive Committee during 2018 Other payments to Executive Committee members During 2018, no other payments or waivers of claims other than those set out in the tables (including their foot- notes) contained in this Compensation Report were made to Executive Committee members or to “persons closely linked” to them. Payments to former Executive Committee members Under the former Executive Committee members’ con- tracts and in line with the Company’s Long-Term Incen- tive plan rules, payments were made to four former mem- bers totaling CHF 8 884 095. One former Executive Committee member who stepped down in 2017 received payments during the contractual notice period in 2018 of salary, pension and other benefits, and an Annual Incentive totaling CHF 2 096 154 per the employment contract. Two former members received payments totaling CHF 6 287 264 in line with the Company’s Long-Term Incentive plan rules. The payments related to the vest- ing of LTPP for the 2016-2018 performance cycle, based on actual performance outcomes plus dividend equiva- lents. No payments were or will be made for the 2016- 2018 LTRPP performance cycle. In addition, in line with the Company’s global mobility policy, during 2018, one former member received a tax equalization payment of CHF 517 474 related to incen- tive compensation granted during an international assignment. Also, four former members received other benefits, for example tax return services, totaling CHF 189 737. No other payments (or waivers of claims) were made to former Executive Committee members or to “persons closely linked” to them during 2018. Loans to Executive Committee members Our policy does not allow loans to be granted to current or former members of the Executive Committee or to “persons closely linked” to them. Therefore, no loans were granted in 2018, and none were outstanding as of December 31, 2018. Persons closely linked “Persons closely linked” are (i) their spouse, (ii) their chil- dren below age 18, (iii) any legal entities that they own or otherwise control, and (iv) any legal or natural person who is acting as their fiduciary. Note 26 to the Group’s audited consolidated financial statements The total expense for the year for compensation awarded to Executive Committee and Board members, using International Financial Reporting Standards (IFRS) mea- surement rules, is presented in Note 26 to the Group’s audited consolidated financial statements. Award and delivery of equity to Novartis associates During 2018, 14.4 million unvested restricted shares (or ADRs), RSUs and target PSUs were granted, and 10.7 million Novartis vested shares (or ADRs) were delivered to Novartis associates under various equity-based par- ticipation plans. Current unvested equity instruments (restricted shares, RSUs and target PSUs) and outstand- ing equity options held by associates represent 1.82% of issued shares. Novartis delivers treasury shares to associates to fulfill these obligations, and aims to offset the dilutive impact from its equity-based participation plans. 161 Item 6. Directors, Senior Management and Employees 2019 Executive Committee compensation system Each year the Executive Committee compensation sys- tem is reviewed by the Board of Directors and Compen- sation Committee to ensure it remains closely aligned with business needs and evolving best practice compen- sation principles, while also taking into consideration feedback from dialogue with shareholders. The Board of Directors and the Compensation Com- mittee decided to focus the 2018 review on the structure and performance measures of the Long-Term Incentive plans, taking into account a desire for simplification and the principle of compensating executives more directly on performance linked to our strategic priorities of accel- erating top- and bottom-line growth. Annual Incentive The Compensation Committee decided to maintain the Annual Incentive structure and the balanced scorecard approach following the changes announced last year, as they continue to align with the key strategic priorities. Values and Behaviors also remain a key component of the Annual Incentive and are embedded in our culture. As such, members of the Executive Committee are expected to demonstrate these to the highest standards. For 2019, the CEO balanced scorecard will be as fol- lows: CEO BALANCED SCORECARD – KEY METRICS Financial targets – 60% of total Annual Incentive, comprising: Group net sales (30%) Group operating income (30%) Group free cash flow (as % of sales) (20%) Share of peers for Novartis Group (20%) Strategic objectives – 40% of total Annual Incentive, comprising: Innovation (20%) Operational excellence (20%) Data and digital (20%) People and culture (20%) (including Values and Behaviors) Building trust with society (20%) (including access to healthcare and reputation) The payout schedule for the Annual Incentive will also remain unchanged, as follows: PERFORMANCE Outstanding Exceeds expectations Meets expectations Partially meets expectations Below expectations PAYOUT 170%–200% 130%–160% 80%–120% 40%–70% 0%–30% Long-Term Incentive Following a thorough evaluation and review of the Long- Term Incentive plan, the Compensation Committee approved the change from two Long-Term Incentive plans to a single Long-Term Incentive plan for perfor- mance cycles beginning in 2019 onward. The perfor- mance measures presented below, each with an equal weighting, have been chosen as the most appropriate measures to best support the objective of transforming Novartis into a leading, focused innovative medicines company over the long term. There will be no increase in target opportunity as a percentage of annual base sal- ary for the CEO and most other members of the Execu- tive Committee (exceptions are on page 164). THREE-YEAR PERFORMANCE MEASURES WEIGHTING Net sales, CAGR 1 Core operating income, CAGR 1 Innovation Relative TSR 1. CAGR = compound annual growth rate 25% 25% 25% 25% Financial measures: net sales CAGR and core operating income CAGR The Compensation Committee has determined that the appropriate financial measures to replace NCVA for the 2019-2021 performance cycle are net sales growth and core operating income growth. These are simpler, more transparent measures, which will better align the Long- Term Incentive with the evolving Group strategic imper- atives of accelerating growth and margin expansion to drive long-term value. The net sales growth and core operating income growth targets will be based on the Novartis three-year strategic plan, taking into account peer growth and exter- nal consensus levels, and will be set at the beginning of each performance cycle. Actual performance will then be assessed at the end of the three-year performance cycle against these targets. Core operating income is a non-IFRS measure, and its definition can be found on page 109 of this Annual Report. Payout levels will range from 0% to 200% of target opportunity. A formulaic payout schedule will apply to three payout ranges: 40% to 80%, 80% to 120%, and 120% to 200% of target opportunity. For 80% to 120% payout, a ±1% net sales CAGR and ±2% core operating income CAGR range around the performance targets will apply. Between 40% to 80% and 120% to 200% pay- out, the slope will be two times steeper to penalize or reward material under or over performance, respectively. There will be no payout below 40% of target opportu- nity. The committee will review performance outcomes in the context of overall business performance and the healthcare industry as a whole. In certain circumstances, the committee can apply discretion to adapt payout lev- 162 Item 6. Directors, Senior Management and Employees Additional information Performance shares granted under the Long-Term Incentive do not carry voting rights but do carry dividend equivalents that are paid in shares at the end of the per- formance period. There will be pro-rata vesting for all departing Exec- utive Committee members who are considered “good leavers” (including those who are retiring) for Long-Term Incentive awards granted from 2019 onward, as announced in last year’s Compensation Report. There will continue to be malus and clawback, applicable to any incentive compensation paid to Executive Committee members. Disclosure of performance targets The three-year forward-looking targets will be disclosed to shareholders at the end of the performance cycle. Dis- closing these long-term targets before the end of the relevant performance cycle would give substantial insight into the Company’s confidential strategies and could place the Company and its shareholders at a competi- tive disadvantage. Therefore, prospective disclosure was not preferred. We understand that with this approach, the share- holder cannot assess performance targets until the per- formance cycle has ended. To mitigate this, throughout each cycle, we will provide information on how financial and innovation performance is tracking against the tar- gets set at the beginning of the cycles. We will also pro- vide a yearly relative TSR performance update. els, to ensure there is appropriate alignment between payout levels and overall Company performance for the relevant period. Where discretion is applied, the commit- tee will explain the rationale in the relevant Compensa- tion Report. The Compensation Committee considered the use of another return-based performance measure and determined that it is not appropriate at this time. This is to ensure that decisions on research and development and future acquisitions and divestments are based on long-term value creation. Innovation The innovation performance measure aligns with the Novartis mission to reimagine medicine to improve and extend people’s lives. To simplify the assessment of this objective, innovation targets will be set in relation to eight to 10 key research and development programs. The pay- out ranges remain unchanged, with 0% to 150% payout for the achievement of the target milestones, and 150% to 200% of target for truly exceptional performance. Relative TSR Relative TSR continues to play an important role in assessing our performance versus the external market. Therefore, the Compensation Committee elected to retain relative TSR within the new single plan Long-Term Incentive structure. Relative TSR will continue to be assessed against our global healthcare peer group com- panies. The payout ranges are unchanged and summa- rized below. NOVARTIS POSITION IN THE PEER GROUP Positions 1–2 Positions 3–5 Positions 6–8 Positions 9–16 PAYOUT RANGE (% OF TARGET) 170%–200% 130%–160% 80%–120% 0% 163 Item 6. Directors, Senior Management and Employees 2019 Executive Committee compensation 2019 Executive Committee total compensation changes All Executive Committee members, except those outlined below, were awarded increases of between 0% and 3%. For context, the average of all Novartis employee annual base salary increases was 1.3% in Switzerland and 3% in the US. Consistent with our Executive Committee appointments compensation policy (see page 141), the members outlined below were appointed to the Executive Committee in recent years with total target compensation below external market median level. The total target compensation for these members has been assessed, and increases in line with proven performance have been made, as disclosed below. Vasant Narasimhan, CEO Vasant Narasimhan quickly established himself as CEO. He delivered a good first year of financial results and ini- tiated many activities, which have already had an impact on the Company performance and its culture. Dr. Nara- simhan was appointed on a salary significantly below that of his predecessor and the market, with the intention (communicated in last year’s Compensation Report) to increase his compensation to a more competitive level, sub- ject to strong performance and proven ability in the role. This prudent approach is in line with our reward principles for Executive Committee members and all other associates. Given this context, Dr. Narasimhan will receive an annual base salary increase of 8% as from March 1, 2019 (from CHF 1 550 000 to CHF 1 674 000). There will be no change to his target Annual Incentive and his target Long-Term Incentive (325% of base salary in total). Over- all, his 2019 total target compensation will be increased by 8% compared to 2018. Paul Hudson, CEO, Novartis Pharmaceuticals During 2018, Paul Hudson delivered above-target performance against his financial targets, led cross-functional transformation in launch excellence, scaled pioneering efforts in digital, and drove culture change. Mr. Hudson will receive an annual base salary increase of 4% as from March 1, 2019, and his target Long-Term Incentive will be increased from 250% of annual base salary to 270% of annual base salary as from 2019. There will be no change to his Annual Incentive target. Overall, his 2019 total target compensation will be increased by 8.6% compared to 2018. Shannon Thyme Klinger, Group General Counsel Shannon Thyme Klinger was appointed on a package significantly below that of her predecessor and the market. It was the Compensation Committee’s intention to increase her compensation to a more competitive level, subject to strong performance. Ms. Klinger delivered a very strong contribution in her role. She launched an important stra- tegic and functional transformation of the legal team, managed critical mergers and acquisitions and led culture change. Ms. Klinger will therefore receive an annual base salary increase of 14.3% as from March 1, 2019 (from CHF 700 000 to CHF 800 000), and her target Long-Term Incentive will be increased from 180% of annual base salary to 200% of annual base salary as from 2019. There will be no change to her Annual Incentive. Overall, her 2019 total target compensation will be increased by 20.5%. Steffen Lang, Global Head of Novartis Technical Operations and Quality During 2018, Steffen Lang delivered on the technical operations transformation, financial targets and new technol- ogies. Mr. Lang will receive an annual base salary increase of 4.2% as from March 1, 2019. There will be no change to his Annual Incentive and his Long-Term Incentive targets. Susanne Schaffert, CEO, Novartis Oncology Susanne Schaffert was promoted internally to CEO, Novartis Oncology, and became a member of the Novartis Executive Committee as of January 1, 2019. Her annual base salary is CHF 850 000, her target Annual Incentive is 100% of base salary, and her target Long-Term Incentive is 220% of base salary. 164 Item 6. Directors, Senior Management and Employees Alcon spin-off equity restoration plan If and when the Alcon spin-off occurs in the first half of 2019, holders of unvested awards in the form of restricted Novartis shares will receive a dividend in kind resulting from the spin-off. Holders of unvested RSUs and PSUs will not receive the dividend in kind resulting from the spin-off. Consequently, RSUs and PSUs held by Novartis employ- ees – including the members of the Executive Committee – will be devalued, as they do not participate in the dis- tribution. To compensate for the lost value, Novartis will grant equity awards (called Keep Whole awards) to its employees, including the Executive Committee members, following the spin-off. This will be done in accordance with the Alcon equity restoration plan, as follows: • The Keep Whole awards will have a value equivalent to the value of the dividend in kind resulting from the spin- off that each award would have received had it been a Novartis share. • The Keep Whole awards will be granted in the same equity instrument (i.e., PSUs or RSUs) and will have the same vesting terms and performance conditions (if applicable) as the underlying award. • The Keep Whole awards aim to ensure that Novartis employees who have been granted RSUs or PSUs, includ- ing Executive Committee members, are not disadvantaged by the spin-off relative to Novartis shareholders. 165 Item 6. Directors, Senior Management and Employees 2018 Board compensation Philosophy and benchmarking Other Board members Aligned with market practice in Switzerland, the Board of Directors sets compensation for its members at a level that allows for the attraction of high-caliber individuals, including both Swiss and international members, who have global experience. Board members do not receive variable compensa- tion, in line with their focus on corporate strategy, super- vision and governance. Each year at the AGM, share- holders are requested to approve, in a binding vote, the total compensation of the Board until the following AGM. The Board of Directors sets the level of compensa- tion for its Chairman and the other members to be in line with relevant benchmark companies, which include other large Switzerland-based multinational companies: ABB, Credit Suisse, Lafarge Holcim, Nestlé, Roche and UBS. This peer group was chosen for Board of Directors com- pensation due to the comparability of Swiss legal require- ments, including broad personal and individual liabilities under Swiss law (and new criminal liability under Swiss rules regarding Board of Directors and Executive Com- mittee compensation related to the Ordinance against Excessive Compensation in Listed Companies), and under US law (due to the Company’s secondary listing on the New York Stock Exchange). The Board of Direc- tors reviews the compensation of its members, including the Chairman, each year based on a proposal by the Compensation Committee and on advice from its inde- pendent advisor, including relevant benchmarking infor- mation. The peer group used for the Board of Directors is different than that used for the Executive Committee to ensure independence of decision-making. Chairman of the Board As Chairman, Joerg Reinhardt receives total annual com- pensation valued at CHF 3.8 million. The total compen- sation is comprised equally of cash and shares, as fol- lows: • Cash compensation: CHF 1.9 million per year • Share compensation: annual value equal to CHF 1.9 million of unrestricted Novartis shares For 2018, the Chairman voluntarily waived the increase in compensation to which he is contractually entitled, which is an amount not lower than the average annual compensation increase awarded to associates based in Switzerland (1.3% for 2018). The annual fee rates for Board membership and addi- tional functions are included in the table below. These were approved by the Board of Directors with effect from the 2018 AGM. Aggregate Board compensation is aligned with other large Swiss companies. CHF 000s Chairman of the Board Board membership Vice Chairman Chair of the Audit and Compliance Committee Chair of the Compensation Committee Chair of the following committees: • Governance, Nomination and Corporate Responsibilities Committee • Research & Development Committee • Risk Committee Membership of the Audit and Compliance Committee Membership of the following committees: • Compensation Committee • Governance, Nomination and Corporate Responsibilities Committee • Research & Development Committee • Risk Committee AGM 2018-2019 annual fee 3 800 280 50 130 90 70 70 40 In addition, the following policies apply regarding Board compensation: • 50% of compensation is delivered in cash, paid on a quarterly basis in arrears. Board members may choose to receive more of their compensation in shares instead of cash. • At least 50% of compensation is delivered in shares in two installments: one six months after the AGM, and one 12 months after the AGM. Board members bear the full cost of their employee social security contributions, if any, and do not receive share options or pension benefits. 2019 Board compensation The Board of Directors compensation system and fee levels will remain unchanged in 2019. 166 Item 6. Directors, Senior Management and Employees Board member total compensation earned for the financial year 2018 Governance, Nomination Board membership Committee Audit and and Corporate Research & Compliance Compensation Responsibilities Development Committee Committee Committee Risk Committee Shares 1 (number) Cash (CHF) (A) Shares (CHF) (B) Other (CHF) 2 (C) Total (CHF) 3 (A)+(B)+(C) Board members active on December 31, 2018 Joerg Reinhardt 4 Enrico Vanni Nancy Andrews Dimitri Azar Ton Buechner Srikant Datar Elizabeth Doherty Ann Fudge Frans van Houten Andreas von Planta Charles L. Sawyers William T. Winters Subtotal Chair Chair 23 889 1 900 000 1 900 000 4 336 3 804 336 Vice Chair • Chair • • • • • • • • • • • 5 • Chair • • • • • • 5 • Chair • • • • 5 • 4 854 41 667 483 334 3 475 528 476 2 262 180 000 180 000 – 360 000 2 359 182 500 182 500 – 365 000 4 270 – 346 667 4 336 351 003 • • 6 Chair 2 859 229 167 229 167 – 458 334 • • • 2 828 225 000 225 000 – 450 000 2 481 199 167 199 167 – 398 334 2 334 148 333 168 333 – 316 666 2 859 229 167 229 167 4 336 462 670 2 262 180 000 180 000 – 360 000 4 087 – 321 667 – 321 667 57 344 3 515 001 4 645 002 16 483 8 176 486 Board members who stepped down at the 2018 AGM Pierre Landolt (until March 2, 2018) 7 Subtotal Total • • 6 2 131 2 131 – – 55 000 3 475 58 475 55 000 3 475 58 475 59 475 3 515 001 4 700 002 19 958 8 234 961 See page 168 for 2017 comparative figures. 1 The shown amounts represent the gross number of shares delivered to each Board member in 2018 for the respective Board member’s service period. The number of shares reported in this column represent: (i) the second and final equity installment delivered in February 2018 for the services from the 2017 AGM to the 2018 AGM, and (ii) the first of two equity installments delivered in August 2018 for the services from the 2018 AGM to the 2019 AGM. The second and final equity installment for the services from the 2018 AGM to the 2019 AGM will take place in February 2019. 2 Includes an amount of CHF 19 958 for mandatory employer contributions for all Board members paid by Novartis to governmental social security systems. This amount is out of total employer contributions of CHF 383 864, and provides a right to the maximum future insured government pension benefit for the Board member. 3 All amounts are before deduction of the social security contribution and income tax due by the Board member. 4 No additional committee fees for chairing the Research & Development Committee were delivered to Joerg Reinhardt. 5 From March 2, 2018 6 Until March 2, 2018 7 According to Pierre Landolt, the Sandoz Family Foundation is the economic beneficiary of the compensation. 167 Item 6. Directors, Senior Management and Employees Board member total compensation earned for the financial year 2017 Governance, Nomination Board membership Committee Audit and and Corporate Research & Compliance Compensation Responsibilities Development Committee Committee Committee Risk Committee Shares 1 (number) Cash (CHF) (A) Shares (CHF) (B) Other (CHF) 2 (C) Total (CHF) 3 (A)+(B)+(C) Board members active on December 31, 2017 Joerg Reinhardt 4 Enrico Vanni Nancy Andrews Dimitri Azar Ton Buechner Srikant Datar Elizabeth Doherty Ann Fudge Pierre Landolt 6 Frans van Houten (from February 28, 2017) Andreas von Planta Charles L. Sawyers William T. Winters Total • • • 7 Chair 5 • Chair Vice Chair • • • • • • • • • • • Chair 24 407 1 900 000 1 900 000 4 336 3 804 336 Chair • 3 210 250 000 250 000 3 475 503 475 • • • • • 5 2 311 180 000 180 000 – 360 000 2 504 195 000 195 000 – 390 000 4 039 – 325 000 – 325 000 Chair 5 2 989 227 500 227 500 – 455 000 • 5 • 2 591 217 500 217 500 – 435 000 2 504 195 000 195 000 – 390 000 4 238 – 330 000 3 475 333 475 1 305 75 000 175 000 – 250 000 • 8 2 989 227 500 227 500 4 336 459 336 2 311 180 000 180 000 – 360 000 4 238 – 330 000 – 330 000 59 636 3 647 500 4 732 500 15 622 8 395 622 • • • • • Chair • 1 The shown amounts represent the gross number of shares delivered to each Board member in 2017 for the respective Board member’s service period. The number of shares reported in this column represent: (i) the second and final equity installment delivered in February 2017 for the services from the 2016 AGM to the 2017 AGM, and (ii) the first of two equity installments delivered in August 2017 for the services from the 2017 AGM to the 2018 AGM. The second and final equity installment for the services from the 2017 AGM to the 2018 AGM will take place in February 2018. 2 Includes an amount of CHF 15 622 for mandatory employer contributions for all Board members paid by Novartis to Swiss governmental social security systems. This amount is out of total employer contributions of CHF 298 206, and provides a right to the maximum future insured government pension benefit for the Board member. 3 All amounts are before deduction of the social security contribution and income tax due by the Board member. 4 No additional committee fees for chairing the Research & Development Committee were delivered to Mr. Reinhardt. 5 From February 28, 2017 6 According to Pierre Landolt, the Sandoz Family Foundation is the economic beneficiary of the compensation. 7 Until February 27, 2017, Chair of the Audit and Compliance Committee 8 Until February 27, 2017, Chair of the Risk Committee 168 Item 6. Directors, Senior Management and Employees Loans to Board members Our policy does not allow loans to be granted to current or former members of the Board of Directors or to “per- sons closely linked” to them. Therefore, no loans were granted in 2018, and none were outstanding as of Decem- ber 31, 2018. Other payments to Board members During 2018, no payments (or waivers of claims) other than those set out in the Board member compensation table (including its footnotes) on page 167 were made to current members of the Board or to “persons closely linked” to them. Payments to former Board members During 2018, no payments (or waivers of claims) were made to former Board members or to “persons closely linked” to them, except for the payments reported in Note 26 to the Group’s audited consolidated financial state- ments. Additional disclosures Share ownership requirements for Board members The Chairman is required to own a minimum of 30 000 Novartis shares, and other members of the Board of Directors are required to own at least 5 000 Novartis shares within five years after joining the Board of Direc- tors, to ensure their interests are aligned with those of shareholders. Board members are prohibited from hedging or pledging their ownership positions in Novartis shares that are part of their guideline share ownership require- ment, and are required to hold these shares for 12 months after retiring from the Board of Directors. As of Decem- ber 31, 2018, all current and former members of the Board of Directors who were required to meet the mini- mum share ownership requirements did so. Shares, ADRs and share options owned by Board members The total number of vested Novartis shares and ADRs owned by members of the Board of Directors and “per- sons closely linked” to them as of December 31, 2018, is shown in the table below. As of December 31, 2018, no members of the Board, either individually or together with “persons closely linked” to them, owned 1% or more of the outstanding shares (or ADRs) of Novartis. As of the same date, no members of the Board of Directors held any share options to purchase Novartis shares. Number of shares at December 31, 2018 1,2 Joerg Reinhardt Enrico Vanni Nancy Andrews Dimitri Azar Ton Buechner Srikant Datar Elizabeth Doherty Ann Fudge Frans van Houten Andreas von Planta Charles L. Sawyers William T. Winters Total 3 542 199 23 500 5 739 14 863 8 069 39 383 4 882 14 818 2 728 133 493 9 460 15 371 814 505 1 Includes holdings of “persons closely linked” to Board members (see definition on page 161) 2 Each share provides entitlement to one vote. 3 Pierre Landolt stepped down from the Board of Directors on March 2, 2018. On March 2, 2018, Mr. Landolt owned 62 520 shares. According to Mr. Landolt, the Sandoz Family Foundation is the economic beneficiary of the shares. 169 Item 6. Directors, Senior Management and Employees Compensation governance Legal framework The Swiss Code of Obligations and the Corporate Gov- ernance Guidelines of the SIX Swiss Exchange require listed companies to disclose certain information about the compensation of Board and Executive Committee members, their equity participation in the Group, and loans made to them. This Annual Report fulfills that requirement. In addition, the Annual Report is in line with the principles of the Swiss Code of Best Practice for Corporate Governance of the Swiss Business Federa- tion (economiesuisse). Risk management principles The Compensation Committee, with support from its independent advisor, reviews market trends in compen- sation, and changes in corporate governance rules and best practices. Together with the Risk Committee, it also reviews the Novartis compensation systems to ensure that they do not encourage inappropriate or excessive risk-taking, and instead encourage behaviors that sup- port sustainable value creation. A summary of the risk management principles is outlined below. RISK MANAGEMENT PRINCIPLES • Rigorous performance • Contractual notice period of management process, with approval of targets and evaluation of performance for the CEO by the Board • Balanced mix of short-term and long-term variable com- pensation elements • Values and Behaviors are a 12 months • Post-contractual non- compete limited to a maximum of 12 months from the end of employment (annual base salary and Annual Incentive of the prior year only) as per contract, if applicable key component of the Annual Incentive and are embedded in our culture • Good and bad leaver provisions apply to variable compensation of leavers • Clawback and malus principles apply to all elements of the variable compensation • Performance-vesting Long- Term Incentives only, with three-year cycles • All variable compensation is capped at 200% of target • No severance payments or change-of-control clauses • Share ownership requirements; no hedging or pledging of Novartis share ownership Executive Committee employment contracts provide for a notice period of up to 12 months and contain no change- of-control clauses or severance provisions (for example, agreements concerning special notice periods, lon- ger-term contracts, “golden parachutes,” waiver of lock-up periods for equities and bonds, shorter vesting periods, and additional contributions to occupational pension schemes). For share ownership requirements, please refer to page 160. Compensation decision-making authorities Authority for decisions related to compensation is gov- erned by the Articles of Incorporation, Board Regulations and the Compensation Committee Charter, which are all published on the Company website: www.novartis.com/ investors/company-overview/corporate-governance. The Compensation Committee serves as the supervi- sory and governing body for compensation policies and plans within Novartis, and has overall responsibility for determining, reviewing and proposing compensation pol- icies and plans for approval by the Board in line with the Compensation Committee Charter. A summary of dis- cussions and conclusions of each committee meeting is delivered to the full Board. A summary of the compen- sation decision-making authorities is set out below. Compensation authorization levels within the parameters set by the shareholders’ meeting DECISION ON DECISION-MAKING AUTHORITY Compensation of Chairman and other Board members Compensation of CEO Compensation of other Executive Committee members Board of Directors Board of Directors Compensation Committee Committee member independence The Compensation Committee is composed exclusively of members of the Board of Directors who meet the inde- pendence criteria set forth in the Board Regulations. From the 2018 AGM, the Compensation Committee had the following four members: Ann Fudge, Srikant Datar, Enrico Vanni and William Winters. Mr. Vanni has served as a member since 2011 and as Chair since 2012. Role of the Compensation Committee’s independent advisor The Compensation Committee retained Mercer Limited during the financial year 2018 as its independent exter- nal compensation advisor. The advisor was hired directly by the Compensation Committee in 2017, and the Com- pensation Committee has been fully satisfied with the performance and independence of the advisor since its engagement. In determining whether or not to renew the engagement with the advisor, the Compensation Com- mittee evaluates, at least annually, the quality of the con- sulting service, the independence of the advisor, and the benefits of rotating advisors. Compensation Committee meetings held in 2018 In 2018, the Compensation Committee held seven for- mal meetings, one extraordinary meeting, and two addi- tional joint meeting with the Research & Development Committee to review and endorse for approval by the Board of Directors the innovation targets and achieve- ments of the LTPP and Annual Incentive. The Compen- sation Committee conducted a self-evaluation in 2018. 170 Item 6. Directors, Senior Management and Employees Report of the statutory auditor on the Compensation Report of Novartis AG To the General Meeting of Novartis AG, Basel We have audited the 2018 CEO and other Executive Committee members’ realized compensation on pages 151-153, the 2018 CEO and other Executive Committee members’ compensation at grant value on pages 154- 156, and additional disclosures on pages 157-161, as well as the 2018 Board compensation on pages 166-168 and the additional disclosures on page 169 of the accompa- nying Compensation Report of Novartis AG for the year ended December 31, 2018. Board of Directors’ responsibility The Board of Directors is responsible for the prepara- tion and overall fair presentation of the Compensation Report in accordance with Swiss law and the Ordinance against Excessive Compensation in Stock Exchange Listed Companies (Ordinance). The Board of Directors is also responsible for designing the remuneration sys- tem and defining individual remuneration packages. Auditor’s responsibility Our responsibility is to express an opinion on the accom- panying Compensation Report. We conducted our audit in accordance with Swiss Auditing Standards. Those standards require that we comply with ethical require- ments, and plan and perform the audit to obtain reason- able assurance about whether the Compensation Report complies with Swiss law and articles 14-16 of the Ordi- nance. An audit involves performing procedures to obtain audit evidence on the disclosures made in the Compensation Report with regard to compensation, loans and credits in accordance with articles 14-16 of the Ordinance. The procedures selected depend on the auditor’s judgment, including the assessment of the risks of material mis- statements in the Compensation Report, whether due to fraud or error. This audit also includes evaluating the rea- sonableness of the methods applied to value compo- nents of remuneration, as well as assessing the overall presentation of the Compensation Report. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our opinion. Opinion In our opinion, the Compensation Report of Novartis AG for the year ended December 31, 2018, complies with Swiss law and articles 14-16 of the Ordinance. PricewaterhouseCoopers AG Martin Kennard Audit expert Auditor in charge Stephen Johnson Global relationship partner Basel, January 29, 2019 171 Item 6. Directors, Senior Management and Employees 6.C Board practices Corporate governance Corporate governance overview Our corporate governance framework Governance bodies General Meeting of Shareholders Approves operating and financial review, Novartis Group consolidated financial statements and financial statements of Novartis AG; decides appropriation of available earnings and dividend; approves compensation of Board and Executive Committee; elects Board members, Chairman, Compensation Committee members, Independent Proxy and external auditors; adopts and modifies Articles of Incorporation Audit and Compliance Committee Compensation Committee Board of Directors Governance, Nomi nation and Corporate Responsibilities Committee Research & Development Committee Risk Committee Sets strategic direction of Novartis, appoints and oversees key executives, approves major transactions and investments Executive Committee Responsible for operational management of Novartis External auditor Provides opinion on compliance of Novartis Group consolidated financial statements and the financial statements of Novartis AG with applicable standards and Swiss law, on compliance of the Compensation Report with applicable law, on effectiveness of internal controls over financial reporting, and on the corporate responsibility reporting of Novartis Our corporate governance framework consists of rules that support sustainable financial performance and long- term value creation for our shareholders and that are aligned with our Values and Behaviors (www.novartis. com/investors/company-overview/corporate-gover- nance). Developments are continuously monitored and result in enhanced principles, processes and disclosures in line with our commitment to maintaining the highest standards. Laws and regulations Novartis AG is subject to and compliant with the laws and regulations of Switzerland (in particular, Swiss company and securities laws, SIX Swiss Exchange rules and the Swiss Code of Best Practice for Corporate Governance) and the securities laws of the United States, including New York Stock Exchange (NYSE) rules, as applicable to foreign private issuers of securities. The NYSE listing standards on corporate governance require Novartis AG to describe any material ways in which its corporate gov- ernance practices differ from those of domestic listed US companies. These differences are: • Novartis AG shareholders do not receive written reports directly from Board committees. • External auditors are appointed by shareholders at the Annual General Meeting of Shareholders (AGM), as opposed to being appointed by the Audit and Compli- ance Committee. • While shareholders cannot vote on all equity compen- sation plans, they are entitled to hold separate, yearly binding votes on Board and Executive Committee com- pensation. • The Board has set up a separate Risk Committee that is responsible for business risk oversight, as opposed to delegating this responsibility to the Audit and Com- pliance Committee. • The full Board is responsible for overseeing the performance evaluation of the Board and Executive Committee. • The full Board is responsible for setting objectives rele- vant to the CEO’s compensation and for evaluating his performance. 172 Item 6. Directors, Senior Management and Employees Board and Executive Committee compensation Information on Board and Executive Committee com- pensation is outlined in our Compensation Report (see “—Item 6.B Compensation”). Please also refer to articles 29-35 of the Articles of Incorporation (www.novartis. com/investors/company-overview/corporate-gover- nance) stipulating the Board and Executive Committee compensation provisions. According to the general com- pensation principles as outlined in the Articles of Incor- poration, the compensation of the non-executive Board members comprises fixed compensation elements only (no Company contributions to any pension plan, no per- formance-related elements and no financial instruments). Compensation to Executive Committee members com- prises fixed and variable, performance-related compen- sation. Fixed compensation is comprised of the base sal- ary and may include other elements and benefits such as contributions to pension plans. Variable compensa- tion may comprise short-term and long-term compen- sation elements. If the maximum aggregate amount of compensation already approved by the AGM is not suf- ficient to cover the compensation of newly appointed or promoted Executive Committee members, Novartis may pay out compensation, in a total amount up to 40% of the total maximum aggregate amount last approved for the Executive Committee per compensation period, to newly appointed or promoted Executive Committee members. 173 Item 6. Directors, Senior Management and Employees Our Group structure and shareholders Our Group structure Novartis AG and Group companies Novartis AG, with its registered office at Lichtstrasse 35, CH-4056 Basel, Switzerland, is a corporation orga- nized under Swiss law that has issued registered shares. As the holding company, Novartis AG owns or con- trols directly or indirectly all entities worldwide belong- ing to the Novartis Group and conducting its business operations. The principal Novartis subsidiaries and asso- ciated companies are listed in Note 31 to the Group’s consolidated financial statements. Divisions The Novartis business is divided on a worldwide basis into three operating divisions: Innovative Medicines, with the two business units Novartis Pharmaceuticals and Novartis Oncology; Sandoz (generics); and Alcon (eye care). These businesses are supported by a number of global organizations, including the Novartis Institutes for BioMedical Research (NIBR), which focuses on discov- ering new drugs; the Global Drug Development organi- zation, which oversees the clinical development of new medicines; and Novartis Operations, which includes Novartis Technical Operations (the global manufactur- ing organization) and Novartis Business Services (which consolidates support services across Novartis). On June 29, 2018, Novartis announced plans to separate the Alcon business from the rest of Novartis by means of a spin-off subject to an approval by the shareholders at the AGM on February 28, 2019. u ti c Pharm a c e e functio n s t a r o p r o C a l s Busin e s s s e r v i c e s ( N B S ) y g o ol c n O S a n d o z M anufacturin g ( N T O ) Alcon Majority holdings in publicly traded Group companies The Novartis Group owns 70.7% of Novartis India Ltd., with its registered office in Mumbai, India, and listed on the Bombay Stock Exchange (ISIN INE234A01025, symbol: HCBA). The total market value of the 29.3% free float of Novartis India Ltd. was USD 74.7 million at December 31, 2018, using the quoted market share price at year-end. Applying this share price to all the shares of the com- pany, the market capitalization of the whole company was USD 254.8 million, and that of the shares owned by Novartis was USD 180.1 million. Significant minority shareholding owned by the Novartis Group The Novartis Group owns 33.3% of the bearer shares of Roche Holding AG, with its registered office in Basel, Switzerland, and listed on the SIX Swiss Exchange (ISIN CH0012032113, symbol: RO). The market value of the Group’s interest in Roche Holding AG, as of December 31, 2018, was USD 12.9 billion. The total market value of Roche Holding AG was USD 212.2 billion. Novartis does not exercise control over Roche Holding AG, which is independently governed, managed and operated. Our shareholders Significant shareholders According to the Novartis Share Register, as of Decem- ber 31, 2018, the following registered shareholders (includ- ing nominees and the ADS depositary) held more than 2% of the total share capital of Novartis AG, with the right to vote all their Novartis shares based on an exemption granted by the Board (see “—Item 6.C Board practices— Shareholder participation rights—Voting rights, restric- tions and representation”):1 • Shareholders: Novartis Foundation for Employee Partici- pation, with its registered office in Basel, holding 2.3%; Emasan AG, with its registered office in Basel, holding 3.5%; and UBS Fund Management (Switzerland) AG, with its registered office in Basel, holding 2.2% • Nominees: Chase Nominees Ltd., London, holding 9.8%; Nortrust Nominees Ltd., London, holding 3.6%; and The Bank of New York Mellon, New York, holding 4.1% through its nominees, The Bank of New York Mel- lon, Everett, holding 2.1%, The Bank of New York Mel- lon, New York, holding 1.3% and the and The Bank of New York Mellon SA/NV, Brussels, holding 0.7% • ADS depositary: JPMorgan Chase Bank, N.A., New York, holding 13.3% 1 Excluding 4.6% of the share capital held as treasury shares by Novartis AG or its fully owned subsidiaries 174 Item 6. Directors, Senior Management and Employees According to a disclosure notification filed with Novartis AG, Norges Bank (Central Bank of Norway), Oslo, held 2.1% of the share capital of Novartis AG but was not reg- istered in the Novartis Share Register as of December 31, 2018. According to disclosure notifications filed with Novartis AG and the SIX Swiss Exchange, each of the following shareholders held between 3% and 5% but was not reg- istered or registered with less than 2% of the share cap- ital of Novartis AG as of December 31, 2018: - BlackRock Inc., New York - The Capital Group Companies Inc., Los Angeles Disclosure notifications pertaining to shareholdings in Novartis AG that were filed with Novartis AG and the SIX Swiss Exchange are published on the latter’s elec- tronic publication platform and can be accessed via: www.six-exchange-regulation.com/en/home/publica- tions/significant-shareholders.html. Cross shareholdings Novartis AG has no cross shareholdings in excess of 5% of capital, or voting rights with any other company. Distribution of Novartis shares The information in the following tables relates only to registered shareholders and does not include holders of unregistered shares. Also, the information provided in the tables cannot be assumed to represent the entire Novartis AG investor base because nominees and JPMorgan Chase Bank, N.A., as ADS depositary, are registered as shareholders for a large number of beneficial owners. Number of shares held As of December 31, 2018 1–100 101–1 000 1 001–10 000 10 001–100 000 100 001–1 000 000 1 000 001–5 000 000 5 000 001 or more 1 Number of registered shareholders % of registered share capital 25 193 98 629 35 458 3 130 458 62 30 0.06 1.61 3.86 3.18 5.41 4.89 50.22 69.23 30.77 100.00 Total registered shareholders/shares 162 960 Unregistered shares Total 1 Including significant registered shareholders as listed above Registered shareholders by type As of December 31, 2018 Shareholders in % Shares in % Individual shareholders Legal entities 1 Nominees, fiduciaries and ADS depositary Total 96.36 3.58 0.06 100.00 12.87 32.58 54.55 100.00 1 Excluding 4.6% of the share capital held as treasury shares by Novartis AG or its fully owned subsidiaries As of December 31, 2018, Novartis AG had approxi- Registered shareholders by country mately 163 000 registered shareholders. As of December 31, 2018 Shareholders in % Shares in % Belgium France Germany Japan Luxembourg Switzerland 1 United Kingdom United States Other countries Total 0.12 2.04 5.39 0.19 0.05 88.17 0.52 0.36 3.16 1.23 0.29 1.83 0.73 0.53 42.11 24.64 26.81 1.83 100.00 100.00 Registered shares held by nominees are shown in the country where the company/ affiliate entered in the Novartis Share Register as shareholder has its registered seat. 1 Excluding 4.6% of the share capital held as treasury shares by Novartis AG or its fully owned subsidiaries 175 Item 6. Directors, Senior Management and Employees Our capital structure Our share capital As of December 31, 2018, the share capital of Novartis AG is CHF 1 275 312 410 fully paid-in and divided into 2 550 624 820 registered shares (Novartis share). Each Novartis share has a nominal value of CHF 0.50. Novartis shares are listed on the SIX Swiss Exchange (ISIN CH0012005267, symbol: NOVN) and on the NYSE in the form of American Depositary Receipts (ADRs) rep- resenting Novartis American Depositary Shares (ADSs) (ISIN US66987V1098, symbol: NVS). Authorized and conditional share capital No authorized and conditional capital exists as of Decem- ber 31, 2018. Changes in capital Over the past three years, the share capital of Novartis AG changed as follows: By completing the sixth share repurchase program in 2016, Novartis AG reduced its share capital by CHF 24.9 million (from CHF 1 338 496 500 to CHF 1 313 557 410) by canceling 49 878 180 Novartis shares repurchased on the second trading line during 2015 (at an average price of CHF 93.24 per Novartis share). At the 2016 AGM, shareholders approved the seventh share repurchase program authorizing the Board to repurchase Novartis shares up to a maximum of CHF 10 billion. In 2017, Novartis AG reduced its share capital by CHF 5.1 million (from CHF 1 313 557 410 to CHF 1 308 422 410) by canceling 10 270 000 Novartis shares repurchased on the second trading line during 2016 (at an average price of CHF 74.67 per Novartis share). In 2018, Novartis AG reduced its share capital by CHF 33.11 million (from CHF 1 308 422 410 to CHF 1 275 312 410) by canceling 66 220 000 Novartis shares repurchased on the second trading line during 2017 (at an average price of CHF 78.34 per Novartis share). In 2018, a total of 23.3 million Novartis shares were purchased at an average price of CHF 79.08 per Novartis share. The Board will propose to the sharehold- ers at the 2019 AGM to cancel the Novartis shares repur- chased in 2018 and to approve the eighth repurchase program, authorizing the Board to repurchase Novartis shares up to a maximum of CHF 10 billion until the 2022 AGM. Capital changes Number of shares Year 2016 2017 2018 As of Jan 1 Changes in shares As of Dec 31 Changes in CHF 2 676 993 000 – 49 878 180 2 627 114 820 – 24 939 090 2 627 114 820 – 10 270 000 2 616 844 820 – 5 135 000 2 616 844 820 – 66 220 000 2 550 624 820 – 33 110 000 A table with additional information on changes in the Novartis AG share capital can be found in Note 8 to the financial statements of Novartis AG. Shares, participation certificates, non-voting equity securities, profit- sharing certificates Novartis shares are issued as uncertificated securities (in the sense of the Swiss Code of Obligations) and as book entry securities (in terms of the Swiss Act on Intermediated Securities). All Novartis shares have equal voting rights and carry equal entitlements to dividends. No participa- tion certificates, non-voting equity securities (Genusss- cheine) or profit-sharing certificates have been issued. Transferability and nominee registration No transferability restrictions are imposed on Novartis shares. The registration of shareholders in the Novartis Share Register or in the ADR register kept by JPMor- gan Chase Bank, N.A., does not affect the tradability of Novartis shares or ADRs. The Articles of Incorporation provide that no nomi- nee shall be registered with the right to vote for more than 0.5% of the registered share capital (for registra- tion of shareholders, see “—Item 6.C Board practices— Shareholder participation rights—Voting rights, restric- tions and representation”). The Board may, upon request, grant an exemption from this restriction if the nominee discloses the names, addresses and number of shares of the individuals for whose account it holds 0.5% or more of the registered share capital. Exemptions are in force for the nominees listed in “—Item 6.C Board prac- tices—Our Group structure and shareholders—Our share- holders—Significant shareholders,” and for the nominee Citibank, London, which in 2015 requested an exemp- tion, but as of December 31, 2018, was not registered in the Novartis Share Register. The same restrictions indirectly apply to holders of ADRs. Shareholders, ADR holders, or nominees who are linked to each other or who act in concert to circumvent registration restrictions are treated as one person or nominee for the purposes of the restrictions on registra- tion. The registration restrictions may be changed by resolution of the General Meeting of Shareholders (Gen- eral Meeting), with approval of at least two-thirds of the votes represented at the meeting (see “—Item 6.C Board practices—Shareholder participation rights—Statutory quorums”). 176 Item 6. Directors, Senior Management and Employees Convertible securities and options Novartis AG has not issued convertible or exchangeable bonds, warrants, options or other securities granting rights to Novartis shares, other than options (or similar instruments such as stock appreciation rights) granted under or in connection with equity-based participation plans of Novartis associates. Novartis AG does not grant any new stock options under these plans. Key Novartis share data Issued shares Treasury shares 1 Outstanding shares at December 31 2018 2017 2016 2 550 624 820 2 616 844 820 2 627 114 820 239 453 391 299 388 321 253 055 807 2 311 171 429 2 317 456 499 2 374 059 013 Weighted average number of shares outstanding 2 319 322 369 2 345 783 843 2 378 474 555 1 Approximately 122 million treasury shares (2017: 131 million; 2016: 135 million) are held in Novartis entities that restrict their availability for use. Per-share information1 Basic earnings per share (USD) Diluted earnings per share (USD) Operating cash flow (USD) Year-end equity for Novartis AG shareholders (USD) Dividend (CHF) 2 1 Calculated on the weighted average number of shares outstanding, except year-end equity 2 2018: proposal to shareholders for approval at the Annual General Meeting on February 28, 2019 2018 5.44 5.38 6.15 2017 3.28 3.25 5.38 34.01 32.00 2.85 2.80 2016 2.82 2.80 4.82 32.46 2.75 Key ratios – December 31 Share price (CHF) Price/earnings ratio 1 Enterprise value/EBITDA Dividend yield (%) 1 2018 15.7 14 3.4 2017 25.7 15 3.4 2016 25.7 13 3.7 Year-end share price High 1 Low 1 2018 84.04 91.84 72.42 2017 82.40 85.15 69.55 2016 74.10 86.45 68.15 1 Based on the Novartis share price at December 31 of each year Key data on ADRs issued in the US Year-end ADR price (USD) High 1 Low 1 Number of ADRs outstanding 2 2018 85.81 93.91 72.44 2017 83.96 86.65 70.03 2016 72.84 86.21 67.59 338 641 387 320 833 039 315 349 314 1 Based on the daily closing prices 2 The depositary, JPMorgan Chase Bank, N.A., holds one Novartis AG share for every ADR issued. Year-end market capitalization (USD billions) 2 Year-end market capitalization (CHF billions) 2 197.0 195.5 172.0 194.2 191.0 175.9 1 Based on the daily closing prices 2 Market capitalization is calculated based on the number of shares outstanding (excluding treasury shares). Market capitalization in USD is based on the market capitalization in CHF converted at the year-end CHF/USD exchange rate. 177 Item 6. Directors, Senior Management and Employees Our Board of Directors Composition of the Board of Directors and its committees (as per December 31, 2018) Chairman: J. Reinhardt Vice Chairman: E. Vanni Board of Directors N. Andrews D. Azar T. Buechner S. Datar E. Doherty A. Fudge F. van Houten A. von Planta C. Sawyers W. Winters Audit and Compliance Committee Compensation Committee Governance, Nominat ion and Corporate Respon- sibilities Committee Research & Development Committee Risk Committee E. Doherty (Chair) T. Buechner S. Datar A. von Planta E. Vanni E. Vanni (Chair) S. Datar A. Fudge W. Winters A. von Planta (Chair) D. Azar A. Fudge C. Sawyers E. Vanni J. Reinhardt (Chair) N. Andrews D. Azar F. van Houten C. Sawyers S. Datar (Chair) N. Andrews E. Doherty A. Fudge A. von Planta Election and term of office At the General Meeting, Board members (including the Chairman) and Compensation Committee members are individually elected or re-elected by shareholders for a term of one year. There is no mandatory term limit for Board members, enabling the Company to benefit from the insight and knowledge that long-serving Board members have devel- oped about the Company’s operations and practices. However, Board members must retire after reaching age 70. Under special circumstances, shareholders may grant an exemption from this rule and re-elect a Board mem- ber for additional terms of office. Name Joerg Reinhardt, Ph.D. Enrico Vanni, Ph.D. Nancy C. Andrews, M.D., Ph.D. Dimitri Azar, M.D. Ton Buechner Srikant Datar, Ph.D. Elizabeth Doherty Ann Fudge Frans van Houten Andreas von Planta, Ph.D. Charles L. Sawyers, M.D. William T. Winters Nationality Year of birth First election at AGM D CH US/CH US NLD/CH US GB US NLD CH US GB/US 1956 1951 1958 1959 1965 1953 1957 1951 1960 1955 1959 1961 2013 2011 2015 2012 2016 2003 2016 2008 2017 2006 2013 2013 178 Item 6. Directors, Senior Management and Employees Board profile Board composition and profile of individual Board members The composition of the Board aligns with our status as a listed company as well as our business portfolio, geo- graphic reach and culture. To ensure appropriate strate- gic oversight, we seek Board members who have diverse skills and experience. Collectively, the Board must have background and expertise in one or several of the fol- lowing areas: • Leadership, senior management/executive-level expe- rience • Medicine and healthcare • Finance and accounting • Law • Engineering and technology • Marketing Diversity is critical to Board effectiveness and an import- ant criterion for the Governance, Nomination and Corpo- rate Responsibilities Committee (GNCRC) when identi- fying new Board member candidates. Board members’ biographies (see “—Item 6.C Board prac- tices—Our Board of Directors—Board of Directors”) high- light the specific qualifications that led the Board to con- clude that members are qualified to serve on the Board and will add value. Board members should also have the following personal qualities: • Interact with other Board members to build an effec- tive and complementary Board • Establish trusting relationships • Apply independence of thought and judgment • Be challenging but supportive in the boardroom • Influence without creating conflict by applying a con- structive, non-confrontational style • Listen well and offer advice based on sound judgment • Be able and willing to commit adequate time to Board and committee responsibilities • Be open to personal feedback and seek to be respon- sive • Do not have existing board memberships or hold other positions that could lead to a permanent conflict of interest • Understand and respect the boundaries of the role, leaving the operational management of the Company to the CEO and the Executive Committee Diversity Nationality AMERICAN 40 % DUTCH 13 % GERMAN 7 % BRITISH 13 % SWISS 27 % Background/experience LEADERSHIP MANAGEMENT 21 % ENGINEERING/TECHNOLOGY 16 % MARKETING 5 % LAW 5 % FINANCE/ACCOUNTING 21 % MEDICINE/HEALTHCARE/R&D 32 % Gender MALE 75 % FEMALE 25 % Age >66 17 % 61–65 33 % <55 8 % 55–60 42 % Tenure 7–9 Y 8 % <3 Y 25 % >9 Y 25 % 3–6 Y 42 % 179 Item 6. Directors, Senior Management and Employees Board succession planning The Chairman, supported by the GNCRC, ensures effec- tive succession plans for the Board, the CEO and the Executive Committee. These plans are discussed by the Board in private meetings without management (the suc- cession plan for the Chairman is discussed in a meet- ing without him). A search for a new Board member is launched – normally with the support of a professional executive search company – based on the established target profile. Candidates are interviewed by the Chair- man and other Board members, and evaluated by the GNCRC. The GNCRC then makes a recommendation to the full Board, and the Board ultimately decides who should be proposed to shareholders for election at the upcoming AGM. Role of the Board and its committees The Board is responsible for the overall direction and oversight of management, and holds the ultimate decision-making authority for Novartis AG, with the excep- tion of decisions reserved for shareholders. The Board has delegated certain of its duties and respon- sibilities to its five committees led by a Board-elected Chairman, as set out in their written charter (www.novartis. com/sites/www.novartis.com/files/regulations-en.pdf). In some cases, these responsibilities are of an advisory or preparatory nature (A/P). In other cases, the commit- tee has decision-making power that is subject to final Board approval (FBA), or the responsibilities have been fully delegated to the committee (FD). The committees enable the Board to work in an efficient and effective manner, ensuring a thorough review and discussion of issues while giving the Board more time for deliberation and decision-making on other matters. Moreover, com- mittees ensure that only Board members who are inde- pendent oversee audit and compliance, governance and compensation – as only independent Board members are members of the respective committees. Any Board member may request a Board or commit- tee meeting and the inclusion of an agenda item. Before meetings, Board members receive materials to help them prepare the discussions and decision-making. 180 Item 6. Directors, Senior Management and Employees Responsibilities Board of Directors The primary responsibilities of the Board of Directors include: — Setting the strategic direction of the Group — Appointing, overseeing and dismissing key executives, and planning their succession — Approving transactions and investments of fundamental importance to Novartis and all in excess of USD 500 million — Determining the organizational structure and governance of the Group — Determining and overseeing financial planning, accounting, reporting and controlling — Approving annual financial statements and corresponding financial results releases Members Number of meetings held in 2018/ approximate average duration (hrs) of each meeting/ attendance 12/6:15 Documents/ link Joerg Reinhardt1 Enrico Vanni Nancy C. Andrews Dimitri Azar Ton Buechner Srikant Datar Elizabeth Doherty Ann Fudge Frans van Houten 12 12 12 12 11 10 12 11 11 Andreas von Planta 12 Charles L. Sawyers 11 William T. Winters 11 Articles of Incorporation of Novartis AG Regulations of the Board of Directors, its Committees and the Executive Committee of Novartis AG (Board regulations) www.novartis.com/ investors/ company-overview/ corporate-governance Charter of the Audit and Compliance Committee www.novartis.com/ investors/ company-overview/ corporate-governance Audit and Compliance Committee 7/2:45 The primary responsibilities of this committee include: — Supervising external auditors (FD),** and selecting and nominating external auditors for election by the meeting of shareholders (FBA)*** — Overseeing internal auditors (FD)** — Overseeing accounting policies, financial controls, and compliance with accounting and internal control standards (FD)** — Approving quarterly financial statements and financial results releases (FBA)*** — Overseeing internal control and compliance processes and procedures (FD)** — Overseeing compliance with laws, and external and internal regulations (FD)** The Audit and Compliance Committee has the authority to retain external consultants and other advisors. Ton Buechner3 Elizabeth Doherty1,2 7 5 7 Srikant Datar2 Andreas von Planta 7 Enrico Vanni 7 Compensation Committee 7/2:00 The primary responsibilities of this committee include: — Designing, reviewing and recommending to the Board the compensation policies and programs (FBA)*** — Advising the Board on the compensation of Board members and the CEO (A/P)* — Deciding on the compensation of Executive Committee members (FD)** — Preparing the Compensation Report and submitting it to the Board for approval (FBA)*** The Compensation Committee has the authority to retain external consultants and other advisors. Enrico Vanni1 Srikant Datar Ann Fudge William T. Winters 7 7 7 7 Charter of the Compensation Committee www.novartis.com/ investors/ company-overview/ corporate-governance 1 Chairman 2 Audit Committee Financial Expert 3 ACC member after 2018 AGM * A/P = advisory or preparatory task ** FD = fully delegated task *** FBA = task subject to final Board approval 181 Item 6. Directors, Senior Management and Employees Responsibilities Members Governance, Nomination and Corporate Responsibilities Committee The primary responsibilities of this committee include: — Designing, reviewing and recommending to the Board corporate governance principles (FBA)*** — Identifying candidates for election as Board members (FBA)*** — Assessing existing Board members and recommending to the Board whether they should stand for re-election (FBA)*** — Preparing and reviewing the succession plan for the CEO (FBA)*** — Developing and reviewing an onboarding program for new Board members, and an ongoing education plan for existing Board members (FD)** — Reviewing on a regular basis the Articles of Incorporation, with a view to reinforcing shareholder rights (FD)** — Reviewing on a regular basis the composition and size of the Board and its committees (FBA)*** — Reviewing annually the independence status of each Board member (FBA)*** — Reviewing directorships and agreements of Board members for conflicts of interest, and dealing with conflicts of interest (FD)** — Overseeing the Company’s strategy and governance on corporate responsibility (FBA)*** The Governance, Nomination and Corporate Responsibilities Committee has the authority to retain external consultants and other advisors. Number of meetings held in 2018/ approximate average duration (hrs) of each meeting/ attendance Documents/ link 3/2:00 Andreas von Planta1 3 3 3 Dimitri Azar Ann Fudge Charles L. Sawyers 3 Enrico Vanni 3 Charter of the Governance, Nomination and Corporate Responsibilities Committee www.novartis.com/ investors/ company-overview/ corporate-governance Research & Development Committee 3/8:00 The primary responsibilities of this committee include: — Monitoring research and development, and bringing recommendations to the Board (FBA)*** — Assisting the Board with oversight and evaluation related to research and development (FD)** — Informing the Board on a periodic basis about the research and development strategy, the effectiveness and competitiveness of the research and development function, emerging scientific trends and activities critical to the success of research and development, and the pipeline (A/P)* — Advising the Board on scientific, technological, and research and development matters (A/P)* — Providing counsel and know-how to management in the area of research and development (A/P)* — Reviewing such other matters in relation to the Company’s research and development as the committee may, in its own discretion, deem desirable in connection with its responsibilities (A/P)* The Research & Development Committee has the authority to retain external consultants and other advisors. Joerg Reinhardt1 Nancy C. Andrews Dimitri Azar Frans van Houten 3 3 3 3 Charles L. Sawyers 3 Charter of the Research & Development Committee www.novartis.com/ investors/ company-overview/ corporate-governance Risk Committee 4/2:15 Srikant Datar1 Nancy C. Andrews Elizabeth Doherty Ann Fudge 4 4 4 4 Andreas von Planta 4 Charter of the Risk Committee www.novartis.com/ investors/ company-overview/ corporate-governance The primary responsibilities of this committee include: — Ensuring that Novartis has implemented an appropriate and effective risk management system and process (FBA)*** — Ensuring that all necessary steps are taken to foster a culture of risk-adjusted decision-making without constraining reasonable risk-taking and innovation (FBA)*** — Approving guidelines and reviewing policies and processes (FBA)*** — Reviewing with management, internal auditors and external auditors the identification, prioritization and management of risks; the accountabilities and roles of the functions involved in risk management; the risk portfolio; and the related actions implemented by management (FBA)*** The Risk Committee has the authority to retain external consultants and other advisors. 1 Chairman * A/P = advisory or preparatory task ** FD = fully delegated task *** FBA = task subject to final Board approval 182 Item 6. Directors, Senior Management and Employees Chairman Joerg Reinhardt has been the independent, non-executive Chairman since August 1, 2013. He has both industry and Novartis experience. As independent Chairman, he leads the Board to represent the interests of all stake holders. The independent chairmanship also ensures an appropri- ate balance of power between the Board and the Exec- utive Committee. In this role, Mr. Reinhardt: • Provides leadership to the Board • Supports and mentors the CEO • Ensures that the Board and its committees work effectively • Sets the agenda, style and tone of Board discus- sions, promoting constructive dialogue and effective decision-making • Supported by the GNCRC, ensures that all Board com- mittees are properly established, composed and oper- ated • Supported by the GNCRC, ensures effective succession plans for the Board and the Executive Committee • Ensures onboarding programs for new Board mem- bers, and continuing education and specialization for all Board members • Ensures that the Board’s performance is annually eval- uated • Promotes effective relationships and communication between Board and Executive Committee members • Ensures effective communication with the Company’s shareholders Vice Chairman Enrico Vanni has been the independent, non-executive Vice Chairman since February 22, 2013. In this role, Mr. Vanni: • Leads the Board in case and as long as the Chairman is incapacitated • Chairs the sessions of independent Board members, and leads independent Board members if and as long as the Chairman is not independent • Leads the yearly session of the Board members eval- uating the performance of the Chairman, during which the Chairman is not present No separate meetings of the independent Board mem- bers were held in 2018. Honorary Chairmen Dr. Alex Krauer and Dr. Daniel Vasella have been appointed Honorary Chairmen in recognition of their significant achievements on behalf of Novartis. They are not pro- vided with Board documents and do not attend Board meetings. Board meetings Subject to additional special meetings, the Board and Board committee meetings take place in January, April, June, August, October and December. Typically, these meetings last two days, with the first day allocated to Board committee meetings, and the second day allocated to the meeting of the full Board. Key activities of our Board and committees in 2018 The following overview summarizes Board and commit- tee activities over the course of the year. Although by no means exhaustive, the lists below provide a flavor of the discussions and debates held, and detail some of the key topics addressed. Board of Directors: In 2018, the Board focused on strengthening the opera- tions of Novartis, expanding our therapeutic platforms, and accelerating our push into the data and digital health- care space to increase our ability to develop breakthrough therapies and improve patient outcomes. The Board also discussed the Alcon spin-off, our investments in break- through technologies (including the acquisitions of Endo- cyte, Inc., AveXis, Inc. and Advanced Accelerator Appli- cations S.A.), as well as the divestments of a part of the US-based generics business of Sandoz and the selling of our remaining consumer healthcare stake to joint ven- ture partner GlaxoSmithKline. Additional topics were the restructuring of our technical operations and business services to become a leaner and more agile organization, our corporate culture as a key driver for the Company, and an evaluation of the impact of external perspectives on our strategy. Topics addressed during private meet- ings included Board self-evaluation and the performance assessment of the Executive Committee members, as well as CEO and Executive Committee succession planning. Audit and Compliance Committee: • Evaluated the impact of adopting new reporting require- ments and guidelines • Focused on acquisitions as well as divestments • Evaluated the performance of the external auditors • Discussed the reorganization of Internal Audit Compensation Committee: • Decided on compensation related to the changes in Executive Committee membership during the year • Reviewed the variable compensation programs for Exec- utive Committee members, including financial metrics • Discussed compensation principles and governance regarding the proposed Alcon spin-off • Reviewed shareholder feedback from the roadshows • Discussed potential enhanced disclosures in the 2018 Compensation Report Governance, Nomination and Corporate Responsibilities Committee: • Reviewed our corporate responsibility activities • Reviewed the composition of the Board and its com- mittees • Evaluated the AGM • Reflected on the role of companies in society • Discussed corporate governance developments • Discussed corporate responsibility reporting changes 183 Item 6. Directors, Senior Management and Employees Research & Development Committee: • Discussed the Sandoz biosimilar portfolio • Discussed Global Drug Development clinical functions • Reviewed an external assessment of the portfolio and productivity of Novartis research and development • Discussed technical research and development func- tions Risk Committee: • Assessed main risks and mitigations in Innovative Medicines, NIBR and IT • Discussed data privacy • Analyzed pricing • Evaluated risks and opportunities associated with the digital status and strategy • Reviewed status and measures regarding cybersecu- rity • Reviewed the Enterprise Risk Management Report Independence of Board members All Board members are non-executive and independent. The independence of Board members is a key topic in corporate governance. An independent Board member is one who is independent of management and has no business or relationship that could materially interfere with the exercise of objective, unfettered and indepen- dent judgment. Only with a majority of Board members being independent can the Board fulfill its obligation to represent the interests of shareholders, being account- able to them and creating sustainable value through the effective governance of Novartis. Accordingly, Novartis established independence criteria based on international best practice standards: www.novartis.com/sites/www.novartis.com/files/inde- pendence-criteria-board-of-directors-and-its-commit- tees.pdf • The majority of Board members and any member of the Audit and Compliance Committee, the Compensation Committee, and the GNCRC must meet the Compa- ny’s independence criteria. These include, inter alia, (i) a Board member not having received direct compensa- tion of more than USD 120 000 per year from Novartis, except for dividends or Board compensation, within the last three years; (ii) a Board member not having been an employee of Novartis within the last three years; (iii) a family member not having been an executive officer of Novartis within the last three years; (iv) a Board mem- ber or family member not being employed by the exter- nal auditor of Novartis; (v) a Board member or family member not being a board member, employee or 10% shareholder of an enterprise that has made payments to, or received payments from, Novartis in excess of the greater of USD 1 million or 2% of that enterprise’s gross revenues. For the Audit and Compliance Com- mittee and the Compensation Committee members, even stricter rules apply. • In addition, Board members are bound by the Novartis Conflict of Interest Policy, which prevents a Board mem- ber’s potential personal interests from influencing the decision-making of the Board. • The GNCRC annually submits to the Board a proposal concerning the determination of the Board members’ independence. For this assessment, the committee con- siders all relevant facts and circumstances of which it is aware – not only the explicit formal independence cri- teria. This includes an assessment of whether a Board member is truly independent, in character and judgment, from any member of senior management and from any of his/her current or former colleagues. Relationship of non-executive Board members with Novartis No Board member is or was a member of the manage- ment of Novartis AG or of any other Novartis Group com- pany in the last three financial years up to December 31, 2018. There are no significant business relationships of any Board member with Novartis AG or with any other Novartis Group company. Mandates outside the Novartis Group According to article 34 of the Articles of Incorpora- tion (www.novartis.com/investors/company-overview/ corporate-governance), no Board member may hold more than 10 additional mandates in other companies, of which no more than four shall be in other listed compa- nies. Chairmanships of the boards of directors of other listed companies count as two mandates. Each of these mandates is subject to Board approval. The following mandates are not subject to these limitations: a) Mandates in companies that are controlled by Novartis AG b) Mandates that a Board member holds at the request of Novartis AG or companies controlled by it. No Board member shall hold more than five such mandates. c) Mandates in associations, charitable organizations, foundations, trusts and employee welfare founda- tions. No Board member may hold more than 10 such mandates. “Mandates” means those in the supreme governing body of a legal entity that is required to be registered in the commercial register or a comparable foreign register. Mandates in different legal entities that are under joint control are deemed one mandate. The Board may issue regulations that determine addi- tional restrictions, taking into account the position of the respective member. Loans and credits No loans or credits are granted to Board members. 184 Item 6. Directors, Senior Management and Employees Board performance and effectiveness evaluation Annually, the Board conducts a review to evaluate its per- formance, the performance of its committees, and the performance of each Board member. This review covers topics including Board composition, purpose, scope and responsibilities; Board processes and governance; Board meetings and pre-reading material; and team effective- ness, leadership and culture. As part of this process, each Board member completes a questionnaire, which lays the groundwork for a qualitative review led by the Chairman. The Chairman of the Board and the committees each lead a qualitative review with their colleagues and then with the entire Board. Also, the Board, without its Chairman, discusses the perfor- mance of the Chairman. Any suggestion for improvement is recorded, and actions are agreed upon. The results of the 2018 review were discussed at the December 2018 and January 2019 meetings. It was concluded that the Board and its committees operate effectively. Periodically, this process is conducted by an inde- pendent consultant. This last happened in 2017. Information and control systems of the Board vis-à-vis management Information on management The Board ensures that it receives sufficient information from the Executive Committee to perform its supervisory duty and undertake the non-delegable decisions. The Board obtains this information through several means: • The CEO informs the Board regularly about current developments. • Executive Committee meeting minutes are made avail- able to the Board. • Meetings or teleconferences are held as required between Board members and the CEO. • The Board and Board committees regularly meet with the CEO and other Executive Committee members, and occasionally with other senior management members. • The Board receives detailed written updates from each division and business unit head via the CEO Report on a monthly basis and via a yearly presentation from each division and business unit head. • By invitation, other members of management attend Board meetings to report on areas of the business for which they are responsible. • Board members are entitled to request information from Executive Committee members or any other Novartis associate, and they may visit any Novartis site. To get an outside view, the Board and Board committees occasionally invite external advisors to attend and/or represent a specific topic at Board meetings. In particu- lar, the independent advisor of the Compensation Com- mittee is regularly invited to partly attend meetings. The Chief Financial Officer (CFO), the Group General Coun- sel, the Global Head of Novartis Business Assurance & Advisory/Internal Audit, the Head of Group Financial Reporting & Accounting, the Chief Ethics, Risk and Com- pliance Officer, and representatives of the external audi- tors are invited to partly attend each Audit and Compli- ance Committee meeting. Additionally, the Global Head of the SpeakUp Office and the Head of Novartis Group Quality report on a regular basis to the Audit and Com- pliance Committee. Novartis management information system Novartis produces comprehensive, consolidated (unau- dited) financial statements on a monthly basis for the Group and its operating divisions. These are typically available within 10 days after the end of the month, and include the following: • Consolidated income statement of the month and year-to-date in accordance with International Financial Reporting Standards (IFRS), as well as adjustments to arrive at core results, as defined by Novartis (see “Item 5. Operating and Financial Review and Prospects—Item 5.A Operating results—Non-IFRS measures as defined by Novartis”). The IFRS and core figures are compared to the prior-year period and targets in both USD and on a constant currency basis. • Supplementary data on a monthly and year-to-date basis, such as free cash flow, gross and net debt, head- count, personnel costs, working capital, and earnings per share on a USD basis where applicable An explanation of non-IFRS measures can be found in “Item 5. Operating and Financial Review and Prospects— Item 5.A Operating results—Non-IFRS measures as defined by Novartis.” Management information related to the consolidated income statements and free cash flow is made available to Board members on a monthly basis through the CEO Report. An analysis of key deviations from the prior year or target is also provided. Prior to the release of each quarter’s results, the Board receives the actual consolidated financial statement infor- mation and an outlook of the full-year results in accor- dance with IFRS and “core” results (as defined by Novartis), together with related commentary. On an annual basis in the middle of the year, the Board also reviews and approves the Company’s strategic plan for the next three years. In the fourth quarter of the year, the Board receives and approves the operating targets for the following year as well as the financial targets for the following three-year period, including a projected consolidated income statement in USD prepared in accor- dance with IFRS and non-IFRS measures as defined by Novartis (“core results”). The Board does not have direct access to the Com- pany’s financial and management reporting systems but can, at any time, request more detailed financial infor- mation on any aspect that is presented to it. Internal Audit The purpose of the Internal Audit function is to assist the Board and the Executive Committee in discharging their governance responsibilities by providing indepen- dent assurance, advice and insights on the effective- ness and efficiency of processes and controls that sup- port Novartis in achieving its objectives, identifying and managing its major risks, and ensuring compliance with applicable policies, laws and regulations. The execution of the Audit and Compliance Commit- tee-approved audit plan via audit and advisory engage- ments happens at both the Group and individual entity 185 Item 6. Directors, Senior Management and Employees levels, depending on the risk exposure. Internal Audit reports the results to the audited units, the Audit and Compliance Committee, and the Executive Committee. Additionally, the Audit and Compliance Committee and the Executive Committee receive consolidated results (including a root cause analysis). Internal Audit also shares best practices as well as recurring findings with the busi- ness to foster learning and continuous improvement. Any material irregularities, whether actual or suspected, are directly escalated to the SpeakUp Office for investiga- tion and to the Audit and Compliance Committee. Action plans to implement necessary changes and enhance- ments are developed together with the business and/or the auditee, and their closure is monitored by Internal Audit. In case of major findings, a follow-up audit is planned to ensure proper remediation. All issues and recommen- dations are stored in a single application to enable effi- cient follow-up monitoring. Internal Audit has performed 82 audits from its annual plan, and has conducted 31 advisory engagements and site visits. Overall progress has mainly been identified in the area of compliance. Remediation plans to address information security, data privacy and business continu- ity risks are on track. Recurring observations identified across various functions and business units relate to improving third-party management, cross-functional col- laboration, legacy systems and complex processes. Risk management In 2018, we combined our risk management and com- pliance functions into a single organizational umbrella to provide the businesses with a better view of the risks we face as an organization, and how those risks could impact our ability to deliver on strategic priorities. Our approach to risk management includes streamlining the risk assessment and monitoring process to ensure that we have a single risk approach throughout Novartis, fully supported by online tools and data analytics. In 2018, we launched our newly harmonized Integrity & Compli- ance Risk Assessment and Monitoring (RAM) process. The RAM process integrates current risk assessments, self-assessments, control activities and monitoring into a single, continuous, cyclical process. Organizational and process measures have been designed to identify and mitigate risks at an early stage. Organi- zationally, the responsibility for risk assessment and management is allocated to the divisions, organizational units and functions, with specialized corporate functions – such as Group Finance; Group Legal; Group Quality Assurance; Corporate Health, Safety and Environment; Business Continuity Management; Integrity and Compli- ance; and the SpeakUp Office – providing support and controlling the effectiveness of the risk management in these respective areas. The Risk Committee assists the Board of Directors in ensuring that risks are properly assessed and profes- sionally managed by overseeing the risk management system and processes, as well as by reviewing the risk portfolio and related actions implemented by manage- ment. For this purpose, the Group Risk Office and the risk owners of the divisions report on a regular basis to the Risk Committee. The Risk Committee ensures that all necessary steps are taken to foster a culture of risk-ad- justed decision-making without constraining reasonable risk-taking and innovation. The Risk Committee also assumes responsibility for approving guidelines and reviewing guidelines and processes, and informs the Board on a periodic basis about the risk management system as well as the most significant risks and how they are managed. Together with management, internal audi- tors and external auditors, the Risk Committee reviews the identification, prioritization and management of the risks; the accountabilities and roles of the functions involved with risk management; the risk portfolio; and the related actions implemented by management. The Group General Counsel, the Head of the Group Risk Office, the Global Head of Novartis Business Assurance & Advisory/ Internal Audit, the Chief Ethics, Risk and Compliance Officer, and other senior executives are invited to the meetings of the Risk Committee. The Compensation Committee works closely with the Risk Committee to ensure that the compensation system does not lead to excessive risk-taking by management (for details, see “—Item 6.B Compensation”). 186 Item 6. Directors, Senior Management and Employees Board of Directors Joerg Reinhardt, Ph.D. Chairman of the Board of Directors | Nationality: German | Year of Birth: 1956 Joerg Reinhardt, Ph.D., has been Chairman of the Board of Directors since 2013. He is also Chairman of the Research & Development Committee and Chairman of the Board of Trustees of the Novartis Foundation. Mr. Reinhardt is chairman of the board of trustees of the Institute of Molecular and Clinical Ophthalmology Basel (IOB), Switzerland. From 2010 to mid-2013, he was chairman of the board of management and the executive committee of Bayer HealthCare, Germany. Prior to that, he was Chief Operating Officer of Novartis from 2008 to 2010, and Head of the Vaccines and Diagnostics Division of Novartis from 2006 to 2008. Mr. Reinhardt is a non-executive board member of Swiss Re, Switzerland, and a member of the European Advi- sory Panel of Temasek, Singapore. Additionally, he was a member of the board of directors of Lonza Group AG in Switzerland from 2012 to 2013, Chairman of the Board of the Genomics Institute of the Novartis Research Foundation in the United States from 2000 to 2010, and a member of the supervisory board of MorphoSys AG in Germany from 2001 to 2004. Mr. Reinhardt graduated with a doctorate in pharmaceutical sciences from Saarland University in Germany. He joined Sandoz Pharma Ltd. in 1982 and held various positions at Sandoz and later Novartis, including Head of Development. Enrico Vanni, Ph.D. Vice Chairman of the Board of Directors | Nationality: Swiss | Year of Birth: 1951 Enrico Vanni, Ph.D., has been a member of the Board of Directors since 2011 and qualifies as an independent Non-Executive Director. He is Vice Chairman of the Board of Directors and Chairman of the Compensation Committee. He is also a member of the Audit and Compliance Committee and the Governance, Nomina- tion and Corporate Responsibilities Committee. Mr. Vanni retired as director of McKinsey & Company in 2007. He is a board member of several companies in industries from healthcare to private banking, including Advanced Oncotherapy PLC in the United King- dom, and non-listed companies such as Lombard Odier SA and Banque Privée BCP (Suisse) SA – both based in Switzerland. He previously served on the boards of Eclosion2 in Switzerland from 2009 to 2017, Alcon Inc. in Switzerland from 2010 to 2011, and Actavis PLC in Ireland in 2010. Mr. Vanni holds an engineering degree in chemistry from the Federal Polytechnic School of Lausanne, Swit- zerland; a doctorate in chemistry from the University of Lausanne; and a Master of Business Administration from INSEAD in Fontainebleau, France. He began his career as a research engineer at the International Busi- ness Machines Corp. (IBM) in California, United States, and joined McKinsey in Zurich in 1980. He managed the Geneva office for McKinsey from 1988 to 2004, and consulted for companies in the pharmaceutical, con- sumer and finance sectors. He led McKinsey’s European pharmaceutical practice and served as a member of the firm’s partner review committee prior to his retirement. From 2008 to 2015, he was an independent consultant, supporting leaders of pharmaceutical and biotechnology companies on core strategic chal- lenges facing the healthcare industry. Nancy C. Andrews, M.D., Ph.D. Member of the Board of Directors | Nationality: American/Swiss | Year of Birth: 1958 Nancy C. Andrews, M.D., Ph.D., has been a member of the Board of Directors since 2015. She qualifies as an independent Non-Executive Director and is a member of the Research & Development Committee and the Risk Committee. Dr. Andrews is dean emerita of the Duke University School of Medicine and vice chancellor emerita for aca- demic affairs at Duke University in the United States. She served as dean and vice chancellor from 2007 to 2017. She is a professor of pediatrics, pharmacology and cancer biology at Duke, and was elected as a fel- low of the American Association for the Advancement of Science and to membership in the US National Academy of Sciences, the National Academy of Medicine, and the American Academy of Arts and Sciences. She is chair of the board of directors of the American Academy of Arts and Sciences, a member and former chair of the board of directors of the Burroughs Wellcome Fund, a member of the Massachusetts Institute of Technology (MIT) Corporation, and former president of the American Society for Clinical Investigation. Additionally, she serves on the council of the National Academy of Medicine, on the Scientific Management Review Board of the National Institutes of Health and on the Scientific Advisory Board of Dyne Therapeu- tics, all in the US. Dr. Andrews holds a doctorate in biology from MIT and a doctor of medicine from Harvard Medical School, both in the US. She completed her residency and fellowship trainings in pediatrics and hematology/oncology at Boston Children’s Hospital and the Dana-Farber Cancer Institute, also in the US, and served as an attend- ing physician at Boston Children’s Hospital. Prior to joining Duke, Dr. Andrews was director of the Harvard/ MIT M.D.-Ph.D. Program, and dean of basic sciences and graduate studies as well as professor of pediatrics at Harvard Medical School. From 1993 to 2006, she was a biomedical research investigator of the Howard Hughes Medical Institute in the US. Her research expertise is in iron homeostasis and mouse models of human diseases. 187 Item 6. Directors, Senior Management and Employees Dimitri Azar, M.D. Member of the Board of Directors | Nationality: American | Year of Birth: 1959 Dimitri Azar, M.D., has been a member of the Board of Directors since 2012. He qualifies as an independent Non-Executive Director and is a member of the Governance, Nomination and Corporate Responsibilities Committee and the Research & Development Committee. Dr. Azar is senior director of ophthalmological innovation at Alphabet Verily Life Sciences. He also serves as distinguished professor of ophthalmology, bioengineering and pharmacology at the University of Illinois at Chicago (UIC) College of Medicine in the United States, and was dean of the UIC College of Medicine from 2011 to 2018. From 2006 to 2011, he was head of the Department of Ophthalmology and Visual Sciences at UIC. He is a member of the American Ophthalmological Society, a board member of the Chicago Medical Society, and former president of the Chicago Ophthalmological Society. Additionally, he is on the board of the Tear Film and Ocular Surface Society, the board of Verb Surgical Inc., and the scientific board of Verily – all based in the US. Dr. Azar began his career at the American University of Beirut Medical Center in Lebanon, and completed his fellowship and residency training at the Massachusetts Eye and Ear Infirmary at Harvard Medical School in the US. His research on matrix metalloproteinases in corneal wound healing and angiogenesis has been funded by the US National Institutes of Health since 1993. Dr. Azar practiced at the Wilmer Eye Institute at the Johns Hopkins Hospital School of Medicine in the US, and then returned to the Massachusetts Eye and Ear Infirmary as director of cornea and external disease. He became professor of ophthalmology with ten- ure at Harvard Medical School in 2003. Dr. Azar holds a master’s degree from Harvard and an Executive Master of Business Administration from the University of Chicago Booth School of Business in the US. Ton Buechner Member of the Board of Directors | Nationality: Dutch/Swiss | Year of Birth: 1965 Ton Buechner has been a member of the Board of Directors since 2016. He qualifies as an independent Non-Executive Director and is a member of the Audit and Compliance Committee. Mr. Buechner most recently served as chairman and CEO of the executive board of Dutch multinational Akzo- Nobel from 2012 to 2017. Prior to joining AkzoNobel, he spent almost two decades at the Sulzer Corporation in Switzerland, where he was appointed divisional president in 2001 and served as president and CEO from 2007 to 2011. Mr. Buechner’s early career was spent in the oil and gas construction industry, and included roles at Allseas Engineering in the Netherlands and at Aker Kvaerner in Singapore. He served as a member of the supervisory board of Voith GmbH & Co. KGaA in Germany from 2014 to 2018, and continues to serve on Voith’s presidential and shareholder committees. Mr. Buechner is an engineer by training. He received his master’s degree in civil engineering from Delft Uni- versity of Technology in the Netherlands in 1988, specializing in offshore construction technology and coastal engineering. Mr. Buechner holds a Master of Business Administration from IMD business school in Lausanne, Switzerland. Srikant Datar, Ph.D. Member of the Board of Directors | Nationality: American | Year of Birth: 1953 Srikant Datar, Ph.D., has been a member of the Board of Directors since 2003 and qualifies as an indepen- dent Non-Executive Director. He is Chairman of the Risk Committee, as well as a member of the Audit and Compliance Committee and the Compensation Committee. The Board of Directors has appointed him as Audit Committee Financial Expert. Since 1996, Mr. Datar has been the Arthur Lowes Dickinson professor of business administration at Harvard Business School in the United States. Additionally, since 2015, he has been faculty chair of the Harvard Inno- vation Lab and senior associate dean for university affairs at Harvard Business School. He is a member of the boards of directors of ICF International Inc., Stryker Corp. and T-Mobile US, all in the US. He previously served on the boards of HCL Technologies Ltd. (2012 to 2014) and KPIT Cummins Infosystems Ltd. (2007 to 2012), both based in India. Mr. Datar graduated in 1973 with distinction in mathematics and economics from the University of Bombay in India. He is a chartered accountant, and holds two master’s degrees and a doctorate from Stanford Uni- versity in the US. Mr. Datar has worked as an accountant and planner in industry, and as a professor at Car- negie Mellon University, Stanford University and Harvard University, all in the US. His research interests are in the areas of cost management, measurement of productivity, new product development, innovation, time- based competition, incentives and performance evaluation. He is the author of many scientific publications and has received several academic awards and honors. Mr. Datar has also advised and worked with numer- ous companies in research, development and training. 188 Item 6. Directors, Senior Management and Employees Elizabeth (Liz) Doherty Member of the Board of Directors | Nationality: British | Year of Birth: 1957 Elizabeth (Liz) Doherty has been a member of the Board of Directors since 2016. She qualifies as an inde- pendent Non-Executive Director and is Chairman of the Audit and Compliance Committee and a member of the Risk Committee. The Board of Directors has appointed her as Audit Committee Financial Expert. Ms. Doherty is a senior independent director and chairman of the audit and risk committee of Dunelm Group PLC in the United Kingdom, and a member of the supervisory board and audit committee of Corbion NV in the Netherlands. She is a fellow of the Chartered Institute of Management Accountants; a non-executive board member of the UK Ministry of Justice; a non-executive board member of Her Majesty’s Courts and Tribunals Service in the UK; and an advisor to GBfoods and Affinity Petcare SA, subsidiaries of Agrolimen SA. She previously served as a non-executive director and audit committee member at Delhaize Group in Belgium and Nokia Corp. in Finland, and as a non-executive director at SABMiller PLC in the UK. Ms. Doherty received her bachelor’s degree in liberal studies in science (physics) from the University of Man- chester in the UK. She began her career as an auditor and has held senior finance and accounting roles at Unilever PLC and Tesco PLC. Her previous positions also include interim chief financial officer (CFO) of Cog- nita Schools Ltd. from 2014 to 2015, CFO and board member of Reckitt Benckiser Group PLC from 2011 to 2013, interim CFO of City Inn in 2010, and CFO of Brambles Ltd. from 2007 to 2009. Ann Fudge Member of the Board of Directors | Nationality: American | Year of Birth: 1951 Ann Fudge has been a member of the Board of Directors since 2008. She qualifies as an independent Non-Ex- ecutive Director and is a member of the Compensation Committee; the Governance, Nomination and Cor- porate Responsibilities Committee; and the Risk Committee. Ms. Fudge is chair of the United States Program Advisory Panel of the Bill & Melinda Gates Foundation, and vice chairman of Boston-based WGBH Public Media. She is also a non-executive director of Northrop Grum- man Corporation in the US, and a member of the visiting committee of Harvard Business School in the US. She served as a non-executive director of Unilever, London and Rotterdam, from 2009 to 2018, and as vice chairman and senior independent director of Unilever from 2015 to 2018. Additionally, she was a board mem- ber of General Electric Co. in the US from 1999 to 2015. Ms. Fudge received her bachelor’s degree from Simmons College in the US and her Master of Business Administration from Harvard Business School. She is former chairman and CEO of Young & Rubicam Brands, New York. Before that, she served as president of the Beverages, Desserts and Post Division of Kraft Foods Inc. Frans van Houten Member of the Board of Directors | Nationality: Dutch | Year of Birth: 1960 Frans van Houten has been a member of the Board of Directors since February 2017. He qualifies as an inde- pendent Non-Executive Director and is a member of the Research & Development Committee. Mr. van Houten is CEO and chairman of the executive committee and the board of management of Royal Philips, a position he has held since 2011. Under his leadership, Philips has transformed itself into a focused health technology company. From May 2016 through December 2017, he also served as vice chairman and a member of the supervisory board of Philips Lighting. Mr. van Houten holds a master’s degree in economics and business management from Erasmus University Rotterdam in the Netherlands. He joined Philips in 1986 and has held multiple global senior leadership posi- tions. In 2009 and 2010, he was a consultant to the boards of companies such as ING Group NV and ASM International NV. Before that, he was CEO of NXP Semiconductors (a Philips spin-off) from 2004 to 2009. 189 Item 6. Directors, Senior Management and Employees Andreas von Planta, Ph.D. Member of the Board of Directors | Nationality: Swiss | Year of Birth: 1955 Andreas von Planta, Ph.D., has been a member of the Board of Directors since 2006. He qualifies as an independent Non-Executive Director and is Chairman of the Governance, Nomination and Corporate Respon- sibilities Committee. He is also a member of the Audit and Compliance Committee and the Risk Committee. Mr. von Planta provides senior counsel to the law firm Lenz & Staehelin AG, where he was a partner from 1988 through 2017. He is chairman of HSBC Private Bank (Suisse) SA, chairman of the regulatory board of the SIX Swiss Exchange AG, and a board member of Helvetia Holding AG in Switzerland. He also serves on the boards of various Swiss subsidiaries of foreign companies and other non-listed Swiss companies, includ- ing Burberry (Suisse) SA, A.P. Moller Finance SA and Socotab Frana SA. He previously served on the boards of Raymond Weil SA (2007 to 2018) and Lenz & Staehelin (1996 to 2018), both based in Switzerland. Mr. von Planta holds a doctorate in law from the University of Basel in Switzerland, and a Master of Laws from Columbia Law School in the United States. He passed his bar examinations in Basel in 1982, and specializes in corporate law, corporate governance, corporate finance, company reorganizations, and mergers and acqui- sitions. He served as chairman of Clinique Générale-Beaulieu SA from 2011 to 2016, and as a director there from 2008 to 2016. Additionally, he was chairman of Swiss National Insurance Company Ltd. (Nationale Suisse) from 2011 to 2015, a director at Nationale Suisse from 1997 to 2015, and a director at Holcim Ltd. from 2003 to 2014. Charles L. Sawyers, M.D. Member of the Board of Directors | Nationality: American | Year of Birth: 1959 Charles L. Sawyers, M.D., has been a member of the Board of Directors since 2013. He qualifies as an independent Non-Executive Director and is a member of the Governance, Nomination and Corporate Respon- sibilities Committee and the Research & Development Committee. In the United States, Dr. Sawyers is chair of the Human Oncology and Pathogenesis Program at Memorial Sloan Kettering Cancer Center, professor of medicine and of cell and developmental biology at the Weill Cor- nell Graduate School of Medical Sciences, and an investigator at the Howard Hughes Medical Institute. He was appointed to the US National Cancer Advisory Board, and is former president of the American Associ- ation for Cancer Research and of the American Society for Clinical Investigation. He is also a member of the US National Academy of Sciences, the National Academy of Medicine, and the American Academy of Arts and Sciences. He serves as a science advisor for the following companies: Agios Pharmaceuticals Inc., Housey Pharmaceutical Research Laboratories, Nextech Invest Ltd., Blueprint Medicines Corporation, Bei- Gene Ltd., The Column Group, ORIC Pharmaceuticals Inc., KSQ Therapeutics Inc., Foghorn Therapeutics Inc. and PMV Pharmaceuticals Inc. Dr. Sawyers received his doctor of medicine from the Johns Hopkins University School of Medicine in the US, and worked at the Jonsson Comprehensive Cancer Center at the University of California, Los Angeles, for nearly 18 years before joining Memorial Sloan Kettering in 2006. An internationally acclaimed cancer researcher, he co-developed the Novartis cancer drug Gleevec/Glivec and has received numerous honors and awards, including the Lasker-DeBakey Clinical Medical Research Award in 2009. William T. Winters Member of the Board of Directors | Nationality: British/American | Year of Birth: 1961 William T. Winters has been a member of the Board of Directors since 2013. He qualifies as an independent Non-Executive Director and is a member of the Compensation Committee. Mr. Winters is CEO and a board member of Standard Chartered, based in London. He also serves on the board of Colgate University in the United States, and on the boards of the International Rescue Committee and the Print Room theater in the United Kingdom. Mr. Winters received his bachelor’s degree from Colgate University and his Master of Business Administra- tion from the Wharton School of the University of Pennsylvania in the US. From 2011 to 2015, he was chair- man and CEO of Renshaw Bay, an alternative asset management firm. Prior to that, he was co-CEO of JPMor- gan’s investment bank from 2003 to 2010. He joined JPMorgan in 1983 and has held management roles across several market areas and in corporate finance. Additionally, he was a commissioner on the UK Inde- pendent Commission on Banking in 2010 and 2011, and was awarded the title of Commander of the Order of the British Empire in 2013. Honorary Chairmen Alex Krauer, Ph.D. Daniel Vasella, M.D. Corporate Secretary Charlotte Pamer-Wieser, Ph.D. 190 Item 6. Directors, Senior Management and Employees Our management Composition of the Executive Committee (as per December 31, 2018) Vasant Narasimhan Chief Executive Officer Steven Baert Chief People & Organization Officer Elizabeth Barrett CEO, Novartis Oncology (until December 31, 2018)1 Bertrand Bodson Chief Digital Offier James Bradner President of the Novartis Institutes for BioMedical Research (NIBR) Richard Francis CEO, Sandoz Paul Hudson CEO, Novartis Pharmaceuticals Harry Kirsch Chief Financial Officer Shannon Thyme Klinger Group General Counsel Steffen Lang Global Head of Novartis Technical Operations Klaus Moosmayer Chief Ethics, Risk and Compliance Officer John Tsai Head of Global Drug Development and Chief Medical Officer Robert Weltevreden Head of Novartis Business Services 1 Susanne Schaffert was appointed CEO Novartis Oncology and a member of the Executive Committee, effective January 1, 2019. Executive Committee composition CEO The Executive Committee is led by the CEO. Its mem- bers are appointed by the Board. There are no contracts between Novartis and third parties whereby Novartis would delegate any business management tasks to such third parties. In addition to other Board-assigned duties, the CEO leads the Executive Committee, building and maintain- ing an effective executive team. With the support of the Executive Committee, the CEO: • Is responsible for the operational management of Executive Committee role and functioning The Board has delegated to the Executive Committee overall responsibility for and oversight of the operational management of Novartis. This includes: • Recruiting, appointing and promoting senior management • Ensuring the efficient operation of the Group and the achievement of optimal results • Promoting an active internal and external communications policy • Developing policies and strategic plans for Board approval, and implementing those approved • Submitting the following to the Board for approval: invest- ments, divestments, transactions, contracts and litiga- tions with a value exceeding USD 500 million, import- ant capital market and other financing transactions, as well as all (other) matters of fundamental significance for the Novartis Group • Preparing and submitting quarterly and annual reports to the Board and its committees • Informing the Board of all matters of fundamental sig- nificance to the businesses • Dealing with any other matters delegated by the Board Novartis • Develops strategy proposals to be recommended to the Board, and ensures that approved strategies are implemented • Plans human resourcing to ensure that Novartis has the capabilities and means to achieve its plans, and that robust management succession and management deve lopment plans are in place and presented to the Board • Develops an organizational structure, and establishes processes and systems to ensure the efficient organi- zation of resources • Ensures that financial results, business strategies and, when appropriate, targets and milestones are commu- nicated to the investment community – and generally develops and promotes effective communication with shareholders and other stakeholders • Ensures that the business performance is consistent with business principles as well as high legal and eth- ical standards, and that the culture of Novartis is con- sistent with the Novartis Values and Behaviors • Develops processes and structures to ensure that cap- ital investment proposals are reviewed thoroughly, that associated risks are identified, and that appropriate steps are taken to manage these risks • Develops and maintains an effective framework of inter- nal controls over risk in relation to all business activi- ties of the Company • Ensures that the flow of information to the Board is accurate, timely and clear 191 Item 6. Directors, Senior Management and Employees Mandates outside the Novartis Group According to article 34 of the Articles of Incorpora- tion (www.novartis.com/investors/company-overview/ corporate-governance), no Executive Committee mem- ber may hold more than six additional mandates in other companies, of which no more than two additional man- dates shall be in other listed companies. Each of these mandates is subject to Board approval. Executive Com- mittee members are not allowed to hold chairmanships of the boards of directors of other listed companies. The following mandates are not subject to these limitations: a) Mandates in companies that are controlled by Novartis AG b) Mandates that an Executive Committee member holds at the request of Novartis AG or companies controlled by it. No Executive Committee member shall hold more than five such mandates. c) Mandates in associations, charitable organizations, foundations, trusts and employee welfare founda- tions. No Executive Committee member may hold more than 10 such mandates. “Mandates” means those in the supreme governing body of a legal entity that is required to be registered in the commercial register or a comparable foreign register. Mandates in different legal entities that are under joint control are deemed one mandate. The Board may issue regulations that determine addi- tional restrictions, taking into account the position of the respective member. Loans and credits No loans or credits shall be granted to Executive Com- mittee members. 192 Item 6. Directors, Senior Management and Employees Executive Committee Vasant (Vas) Narasimhan, M.D. Chief Executive Officer of Novartis | Nationality: American | Year of Birth: 1976 Vasant (Vas) Narasimhan, M.D., has been Chief Executive Officer (CEO) of Novartis since February 1, 2018. Dr. Narasimhan previously was Global Head of Drug Development and Chief Medical Officer for Novartis. He has also served as Global Head of Development for Novartis Pharmaceuticals, Global Head of the Sandoz Biopharmaceuticals and Oncology Injectables business unit, Global Head of Development for Novartis Vac- cines, North America Region Head for Novartis Vaccines, and United States Country President for Novartis Vaccines and Diagnostics. Before joining Novartis in 2005, he worked at McKinsey & Company. Dr. Narasimhan received his medical degree from Harvard Medical School in the US, a master’s degree in public policy from Harvard’s John F. Kennedy School of Government, and a bachelor’s degree in biological sciences from the University of Chicago in the US. During and after his medical studies, he worked exten- sively on a range of public health issues in developing countries. He is an elected member of the US National Academy of Medicine and serves on the board of fellows of Harvard Medical School. Steven Baert Chief People & Organization Officer of Novartis | Nationality: Belgian | Year of Birth: 1974 Steven Baert has been Chief People & Organization Officer of Novartis since 2014. He is a member of the Executive Committee of Novartis. Mr. Baert joined Novartis in 2006 as Head of Human Resources Global Functions in Switzerland. He has held other leadership roles at Novartis, including Head of Human Resources for Emerging Growth Markets; Head of Human Resources, United States and Canada, for Novartis Pharmaceuticals Corporation; and Global Head of Human Resources for Novartis Oncology. Prior to joining Novartis, he held HR positions at Bristol-Myers Squibb Co. and Unilever. Mr. Baert studied in Belgium and received a Master of Business Administration from Vlerick Business School in Ghent, a Master of Laws from the Katholieke Universiteit Leuven, and a Bachelor of Laws from the Katho- lieke Universiteit Brussels. He serves on the board of WeSeeHope USA, and from 2015 to 2018, he repre- sented Novartis on the board of GlaxoSmithKline Consumer Healthcare Holdings Ltd. Elizabeth (Liz) Barrett (until December 31, 2018) CEO, Novartis Oncology | Nationality: American | Year of Birth: 1962 Elizabeth (Liz) Barrett was appointed CEO of Novartis Oncology on February 1, 2018. On December 31, 2018, she stepped down as CEO of Novartis Oncology and as a member of the Executive Committee of Novartis. Ms. Barrett previously served as global president of oncology at Pfizer Inc. Since joining Pfizer in 2009, she has held other leadership positions, including president of Global Innovative Pharma for Europe, president of the specialty care business unit for North America, and president of United States oncology. Prior to Pfizer, she was vice president and general manager of the oncology business unit at Cephalon Inc. from 2006 to 2009, and before that, she worked at Johnson & Johnson. She started her career at Kraft Foods Group Inc. in 1984. Ms. Barrett holds a Bachelor of Science from the University of Louisiana and a Master of Business Admin- istration from Saint Joseph’s University, both in the US. Bertrand Bodson Chief Digital Officer of Novartis | Nationality: Belgian | Year of Birth: 1975 Bertrand Bodson has been Chief Digital Officer of Novartis since January 1, 2018. He is a member of the Executive Committee of Novartis. From 2013 to 2017, Mr. Bodson served as chief digital and marketing officer of Sainsbury’s Argos, where he led Argos’ successful transformation from a traditional catalogue business to the third-largest online retailer in the United Kingdom. Prior to that, he was executive vice president of the global digital business at EMI Music from 2010 to 2013. He co-founded Bragster.com, a social networking and content sharing website, and has also held senior roles at Amazon. Mr. Bodson earned a Master of Business Administration from Harvard Business School in the United States, where he was a Baker Scholar, and a master’s degree in commercial engineering from the Solvay Business School (Belgium)/McGill University (Canada). He is a member of the board of directors of Electrocompo- nents PLC. James (Jay) Bradner, M.D. President of the Novartis Institutes for BioMedical Research (NIBR) | Nationality: American | Year of Birth: 1972 James (Jay) Bradner, M.D., has been President of the Novartis Institutes for BioMedical Research (NIBR) since 2016. He is a member of the Executive Committee of Novartis. From 2005 through 2015, Dr. Bradner served on the research faculty of Harvard Medical School and as an attending physician in stem cell transplantation within the Department of Medical Oncology at the Dana-Far- ber Cancer Institute in the United States. He has co-founded five biotechnology companies and has co-au- thored more than 200 scientific publications and 30 US patent applications. Dr. Bradner is a graduate of Harvard College and the University of Chicago Medical School in the US. He completed his residency in medicine at Brigham and Women’s Hospital, his fellowship in medical oncology and hematology at the Dana-Farber Cancer Institute, and his postdoctoral training in chemistry and chemi- cal biology at Harvard University. He has received many honorific awards and was elected into the American Society for Clinical Investigation in 2011 and the Alpha Omega Alpha Honor Medical Society in 2013. 193 Item 6. Directors, Senior Management and Employees Richard Francis CEO, Sandoz | Nationality: British | Year of Birth: 1968 Richard Francis has been CEO of Sandoz since 2014. He is a member of the Executive Committee of Novartis. Mr. Francis joined Novartis from Biogen Idec, where he held global and country leadership positions during his 13-year career with the company. Most recently, he was senior vice president of the company’s United States commercial organization. From 1998 to 2001, he was at Sanofi in the United Kingdom, and held vari- ous marketing roles across the company’s urology, analgesics and cardiovascular products. He also held sales and marketing positions at Lorex Synthélabo and Wyeth. Mr. Francis is a member of the board of directors of Mettler-Toledo International Inc., based in the US. He received a Bachelor of Arts in economics from Manchester Metropolitan University in the UK. Paul Hudson CEO, Novartis Pharmaceuticals | Nationality: British | Year of Birth: 1967 Paul Hudson has been CEO of Novartis Pharmaceuticals since 2016. He is a member of the Executive Com- mittee of Novartis. Mr. Hudson joined Novartis from AstraZeneca PLC, where he most recently was president, AstraZeneca United States and executive vice president, North America. He also served as representative director and president of AstraZeneca K.K. in Japan; as president of AstraZeneca’s business in Spain; and as vice pres- ident and primary care director, United Kingdom. Before joining AstraZeneca in 2006, Mr. Hudson held roles of increasing responsibility at Schering-Plough, including leading biologics global marketing. He began his career in sales and marketing roles at GlaxoSmithKline UK and Sanofi-Synthélabo UK. Mr. Hudson holds a degree in economics from Manchester Metropolitan University (MMU) in the UK and a diploma in marketing from the Chartered Institute of Marketing in the UK. In 2018, he was awarded an hon- orary doctorate in business administration from MMU. He is a board member of the European Federation of Pharmaceutical Industries and Associations (EFPIA) and vice chair of the Innovation Board Sponsored Com- mittee of EFPIA. Harry Kirsch Chief Financial Officer of Novartis | Nationality: German/Swiss | Year of Birth: 1965 Harry Kirsch has been Chief Financial Officer (CFO) of Novartis since 2013. He is a member of the Execu- tive Committee of Novartis. Mr. Kirsch joined Novartis in 2003 and, prior to his current position, served as CFO of the Pharmaceuticals Division. Under his leadership, the division’s core operating income margin increased, in constant currencies, every quarter of 2011 and 2012 despite patent expirations. At Novartis, he also served as CFO of Pharma Europe, and as Head of Business Planning & Analysis and Financial Operations for the Pharmaceuticals Divi- sion. Mr. Kirsch joined Novartis from Procter & Gamble (P&G) in the United States, where he was CFO of P&G’s global pharmaceutical business. Prior to that, he held finance positions in various categories of P&G’s consumer goods business, technical operations, and Global Business Services organization. Mr. Kirsch holds a diploma degree in industrial engineering and economics from the University of Karlsruhe in Germany. From 2015 to 2018, he represented Novartis on the board of GlaxoSmithKline Consumer Health- care Holdings Ltd. Shannon Thyme Klinger Group General Counsel of Novartis | Nationality: American | Year of Birth: 1971 Shannon Thyme Klinger has been Group General Counsel of Novartis since June 1, 2018. She is a member of the Executive Committee of Novartis. Ms. Klinger most recently served as Chief Ethics, Risk and Compliance Officer, and was appointed to the Executive Committee of Novartis in this role. Before that, she was Chief Ethics and Compliance Officer and Global Head of Litigation. She joined Novartis in 2011 as General Counsel, North America, for Sandoz in the United States and later became the Global Head of Legal and General Counsel for Sandoz International GmbH. Prior to Novartis, Ms. Klinger worked in the US as a partner at Mayer Brown LLP from 2010 to 2011, senior vice president and general counsel for Solvay Pharmaceuticals Inc. from 2008 to 2010, and vice pres- ident of marketing compliance and associate counsel for Barr Laboratories/Duramed Pharmaceuticals from 2005 to 2007. She was also a partner at Alston & Bird LLP, where she focused on litigation and antitrust, pharmaceutical legal and regulatory matters. Ms. Klinger holds a juris doctor with honors from the University of North Carolina at Chapel Hill and a bach- elor’s degree in psychology from the University of Notre Dame (both in the US). She is a member of the board of directors of the SIX Group. Steffen Lang, Ph.D. Global Head of Novartis Technical Operations | Nationality: German/Swiss | Year of Birth: 1967 Steffen Lang, Ph.D., has been Global Head of Novartis Technical Operations since April 2017. He is a mem- ber of the Executive Committee of Novartis. Prior to his current appointment, Mr. Lang served as Global Head of Biologics Technical Development and Manufacturing within Novartis Technical Operations. He joined Novartis in 1994 as Head of Laboratory in Research, and over the years has held positions of increasing responsibility within Pharmaceuticals Devel- opment, including Head of Biotechnology Development and Global Head of Technical Research and Devel- opment. Mr. Lang holds a doctorate in pharmaceutical technology from the Swiss Federal Institute of Technology (ETH Zurich) in Switzerland, and a master’s degree in pharmaceutical sciences from the University of Hei- delberg in Germany. 194 Item 6. Directors, Senior Management and Employees Klaus Moosmayer, Ph.D. Chief Ethics, Risk and Compliance Officer of Novartis | Nationality: German | Year of Birth: 1968 Klaus Moosmayer, Ph.D., has been Chief Ethics, Risk and Compliance Officer of Novartis since December 1, 2018. He is a member of the Executive Committee of Novartis. Mr. Moosmayer previously was chief compliance officer of Siemens AG, a position he held since 2014. During his 18-year career at Siemens, Mr. Moosmayer also served as chief counsel compliance, compliance oper- ating officer and corporate legal counsel. Before joining Siemens, he practiced law in Germany, specializing in white-collar crime, litigation and business law. Mr. Moosmayer received his doctor of jurisprudence from the University of Freiburg in Germany and is inter- nationally recognized in the field of compliance. He is chair of the Anti-Corruption Task Force of the Busi- ness and Industry Advisory Committee at the Organization for Economic Co-operation and Development (OECD); co-founder and chair of the European Chief Compliance and Integrity Officers’ Forum; former co-chair of the B20 Integrity & Compliance Task Force under the G20 presidency of Argentina; and former chair of the task force under the G20 presidency of Germany. Mr. Moosmayer lectures on compliance at the University of St.Gallen in Switzerland. John Tsai, M.D. Head of Global Drug Development and Chief Medical Officer for Novartis | Nationality: American | Year of Birth: 1967 John Tsai, M.D., has been Head of Global Drug Development and Chief Medical Officer for Novartis since May 1, 2018. He is a member of the Executive Committee of Novartis. Dr. Tsai joined Novartis from Amgen Inc., where he was chief medical officer and senior vice president of Global Medical, overseeing all clinical and medical functions across multiple sites worldwide. Before joining Amgen in 2017, he spent 11 years at Bristol-Myers Squibb Co. (BMS), most recently as global head of clinical development for marketed products. During his time at BMS, Dr. Tsai also served as a full development team lead in oncology, head of Worldwide Medical, chief medical officer for Europe, vice president of US Medical, and vice president of Cardiovascular Medical. Prior to BMS, he was a cardiovascular group leader at Pfizer Inc. He started his career as an electrical engineer at General Electric Co. Dr. Tsai holds a medical degree from the University of Louisville School of Medicine in the United States. He received a Bachelor of Science in electrical engineering from Washington University in St. Louis, also in the US. Robert Weltevreden Head of Novartis Business Services (NBS) | Nationality: Dutch | Year of Birth: 1969 Robert Weltevreden has been Head of Novartis Business Services (NBS) since June 1, 2018. He is a mem- ber of the Executive Committee of Novartis. Mr. Weltevreden previously worked at Syngenta AG as head of its business services organization. He joined Syngenta in 2003 and has held other leadership positions, including head of business process management; head of finance services; and chief financial officer (CFO) of the Asia-Pacific region for Syngenta Crop Pro- tection AG. Prior to Syngenta, Mr. Weltevreden worked at Newell Rubbermaid Inc. as vice president/control- ler of Rubbermaid Europe and as CFO of the Germany, Benelux and Scandinavia markets. He started his career as a corporate business analyst at Curver and later became CFO of the Iberia region. Mr. Weltevreden holds a master’s degree in international finance, economics and business administration from Erasmus University Rotterdam in the Netherlands. He also holds a Master of Business Administration in financial management from Vlerick Business School in Ghent, Belgium. Member of the Executive Committee, effective January 1, 2019 Susanne Schaffert, Ph.D. CEO, Novartis Oncology | Nationality: German | Year of Birth: 1967 Susanne Schaffert, Ph.D., has been CEO of Novartis Oncology since January 1, 2019. She is a member of the Executive Committee of Novartis. Ms. Schaffert was appointed Chairperson and President of Advanced Accelerator Applications when it was acquired by Novartis in January 2018, and will remain President until her successor is in place. She joined Novartis more than 20 years ago and served as Region Head, Novartis Oncology Europe, from 2012 to 2018. Prior to that, she was Head of Investor Relations for Novartis. She has also held other leadership positions during her career at Novartis, including Global Franchise Head for Immunology and Infectious Diseases, General Manager of Novartis Oncology in Northern and Central Europe, and General Manager of Novartis Oncology in Germany. Ms. Schaffert holds a doctorate in organic chemistry from the University of Erlangen in Germany. She is a mem- ber of the Board of Novartis AG Germany, and previously served on the board of GlaxoSmithKline Consumer Healthcare Holdings Ltd. Secretary Katja Roth Pellanda, Ph.D. 195 Item 6. Directors, Senior Management and Employees Shareholder participation rights Shareholders have the right to receive dividends, to vote and to execute all other rights as granted under Swiss law and the Articles of Incorporation (see, in particular, articles 17 and 18 of the Articles of Incorporation: www.novartis.com/investors/company-overview/ corporate-governance). Voting rights, restrictions and representation Each Novartis share registered with the right to vote entitles the holder to one vote at General Meetings. To be registered with voting rights, a shareholder must declare that he or she acquired the shares in his or her own name and for his or her own account. According to article 5, paragraph 3 of the Articles of Incorporation (www.novartis.com/investors/company-overview/cor- porate-governance), the Board may register nominees with the right to vote (for registration of nominees, see “— Item 6.C Board practices—Our capital structure—Trans- ferability and nominee registration”). The Articles of Incorporation provide that no share- holder shall be registered with the right to vote for more than 2% of the registered share capital. Given that share- holder representation at General Meetings traditionally has been rather low in Switzerland, Novartis AG consid- ers registration restrictions ne cessary to prevent a minority shareholder from dominating a General Meeting. The Board may, upon request, grant an exemption from this restriction. Considerations include whether the share- holder supports the Novartis goal of creating sustain- able value and has a long-term investment horizon. Exemp- tions are in force for the registered significant shareholders listed in “—Item 6.C Board practices—Our Group structure and shareholders—Our shareholders— Significant shareholders,” and for Norges Bank (Central Bank of Norway), Oslo, which as of December 31, 2018, was not registered in the share register but according to a disclosure notification filed with Novartis AG, held 2.1% of the share capital of Novartis AG. No further exemp- tions were requested in 2018. The same registration and voting restrictions indi- rectly apply to holders of ADRs. Shareholders, ADR hold- ers, or nominees who are linked to each other or who act in concert to circumvent registration restrictions are treated as one person or nominee for the purposes of the restrictions on registration. Shareholders can vote their Novartis shares by them- selves or appoint another shareholder or the Indepen- dent Proxy to vote on their behalf. All shareholders (who are not yet registered on the online platform; see below) receive a General Meeting invitation letter with a proxy appointment form for the appointment of the Indepen- dent Proxy. On this form, shareholders can instruct the Independent Proxy to vote on alternative or additional motions related to the agenda items either (i) following the recommendations of the Board for such alternative or additional motions, or (ii) against such alternative or additional motions. They can also abstain from voting. Novartis AG offers shareholders the opportunity to use an online platform (the Sherpany Platform) to receive invitations to future General Meetings exclusively by email and to electronically give their instructions to the Inde- pendent Proxy, grant powers of attorney to other share- holders, and order their admission cards online. The General Meeting registration form enables shareholders who are not yet registered on the Sherpany Platform to order detailed documents related to opening an account. They may also do so by contacting the Novartis Share Registry. Shareholders can deactivate their online account at any time and again receive invitations in paper form. An ADR holder has the rights enumerated in the deposit agreement (such as the right to give voting instructions and to receive dividends). The ADS depositary of Novartis AG – JPMorgan Chase Bank, N.A., New York – holds the Novartis shares underlying the ADRs and is registered as a shareholder in the Novartis Share Register. An ADR is not a Novartis share, and an ADR holder is not a Novartis AG shareholder. Each ADR represents one Novartis share. ADR holders exercise their voting rights by instructing the depositary to exercise their voting rights. JPMorgan Chase Bank, N.A., exercises the voting rights for regis- tered Novartis shares underlying ADRs for which no vot- ing instructions have been given by providing a discre- tionary proxy to an uninstructed independent designee. Such designee has to be a Novartis AG shareholder. Powers of the General Meeting The following powers are vested exclusively in the General Meeting: • Adoption and amendment of the Articles of Incorpora- tion • Election and removal of the Chairman of the Board, Board and Compensation Committee members, the Independent Proxy and external auditors • Approval of the management report (if required) and of the consolidated financial statements • Approval of the financial statements of Novartis AG, and decision on the appropriation of available earn- ings shown on the balance sheet, including dividends • Approval of the maximum aggregate amounts of com- pensation of the Board (for the period from an AGM until the next AGM) and of the Executive Committee (for the financial year following the AGM) • Grant of discharge to Board and Executive Committee members • Decision on other matters that are reserved by law or by the Articles of Incorporation (e.g., advisory vote on the Compensation Report) to the General Meeting of Shareholders Statutory quorums The General Meeting passes resolutions and elections with the absolute majority of the votes represented at the meeting. However, under article 18 of the Articles of 196 Item 6. Directors, Senior Management and Employees Incorporation (www.novartis.com/investors/company - overview/corporate-governance), the approval of two-thirds of the votes represented at the meeting is required for: • Alteration of the purpose of Novartis AG • Creation of shares with increased voting powers • Implementation of restrictions on the transfer of registe- red shares, and the removal of such restrictions • Authorized or conditional increase of the share capital • Increase of the share capital out of equity, by contribu- tion in kind, for the purpose of an acquisition of prop- erty or the grant of special rights • Restriction or suspension of rights or options to sub- scribe • Change of location of the registered office of Novartis AG • Dissolution of Novartis AG Extraordinary General Meetings may be convened upon the request of the Board, the auditors, or shareholders representing at least 10% of the Novartis share capital. Agenda Shareholders representing Novartis shares with an aggregate nominal value of at least CHF 1 million may request that an item be included in a General Meeting agenda. Such requests must be made in writing at least 45 days before the meeting, specify the agenda item to be included, and contain the proposal on which the shareholder requests a vote. In addition, the law provides for a qualified majority for other resolutions, such as a merger or demerger. Registration in the Novartis Share Register Convocation of General Meetings The AGM must be held within six months after the close of the financial year (December 31), and normally takes place at the end of February or the beginning of March. The Novartis Share Register is an internal, non-public register subject to statutory confidentiality, and privacy and data protection imposed on Novartis to protect reg- istered shareholders. Novartis shares can only be voted if they are registered with voting rights in such register by the third business day before the General Meeting. 197 Item 6. Directors, Senior Management and Employees Change-of-control and defense measures Duty to make an offer Clauses on change of control According to the Swiss Federal Act on Financial Infra- structures, anyone who – directly, indirectly or acting in concert with third parties – acquires equity securities exceeding 33 1/3% of the voting rights of a company (whether or not such rights are exercisable) is required to make an offer to acquire all listed equity securities of that company. A company may raise this threshold up to 49% of the voting rights (“opting up”) or may, under cer- tain circumstances, waive the threshold (“opting out”). Novartis AG has not adopted any such measures. In accordance with good corporate governance and the rules of the Ordinance against Excessive Compensa- tion in Listed Companies, there are no change-of-con- trol clauses and “golden parachute” agreements bene- fiting Board members, Executive Committee members, or other members of senior management. Furthermore, employment contracts with Executive Committee mem- bers are either for a fixed term not exceeding one year or for an indefinite period of time with a notice period not exceeding 12 months, and do not contain commissions for the acquisition or transfer of enterprises or sever- ance payments. 198 Item 6. Directors, Senior Management and Employees Auditors Duration of the mandate and terms of office of the auditors Based on a recommendation by the Audit and Compli- ance Committee, the Board nominates an independent auditor for election at the AGM. Pricewaterhouse Coopers (PwC) assumed its existing auditing mandate for Novartis in 1996. Luc Schulthess, auditor in charge, began serving in his role in 2018, and Stephen Johnson, global relation- ship partner, began serving in his role in 2014. The Audit and Compliance Committee together with PwC ensures that these partners are rotated at least every five years. Auditing fees and additional fees PwC fees for professional services related to the 12-month periods ended December 31, 2018, and December 31, 2017, are as follows: Audit services Audit-related services Tax services Other services Total 2018 USD million 2017 USD million 25.6 13.4 0.7 2.4 42.1 24.6 7.2 0.8 1.4 34.0 Audit services include work performed to issue opinions on consolidated financial statements and parent com- pany financial statements of Novartis AG, to issue opin- ions related to the effectiveness of the Group’s internal control over financial reporting, and to issue reports on local statutory financial statements. Also included are audit services that generally can only be provided by the statutory auditor, such as the audit of the Compensation Report, audits of the adoption of new accounting poli- cies, audits of information systems and the related con- trol environment, as well as reviews of quarterly finan- cial results. Audit-related services include other assurance ser- vices provided by the independent auditor but not restricted to those that can only be provided by the stat- utory auditor. They include services such as audits of pension and other employee benefit plans, audits in con- nection with non-recurring transactions, including audit services related to the Alcon strategic review, contract audits of third-party arrangements, corporate responsi- bility assurance, and other audit-related services. Tax services represent tax compliance, assistance with historical tax matters, and other tax-related services. Other services include procedures related to corpo- rate integrity agreements, training in the finance area, benchmarking studies, and license fees for use of account- ing and other reporting guidance databases. Information to the Board and the Audit and Compliance Committee The Audit and Compliance Committee, acting on behalf of the Board, is responsible for overseeing the activities of PwC. In 2018, this committee held seven meetings. PwC was invited to all of these meetings to attend the discussions on auditing matters and any other matters relevant to its audit. The Audit and Compliance Committee recommended to the Board to approve the audited consolidated finan- cial statements and the separate parent company finan- cial statements of Novartis AG for the year ended Decem- ber 31, 2018. The Board proposed the acceptance of these financial statements for approval by the sharehold- ers at the next AGM. The Audit and Compliance Committee regularly eval- uates the performance of PwC and, based on this, once a year determines whether PwC should be proposed to the shareholders for election. To assess the performance of PwC, the Audit and Compliance Committee holds pri- vate meetings with the CFO and the Global Head of Novartis Business Assurance & Advisory/Internal Audit and, if necessary, obtains an independent external assess- ment. Criteria applied for the performance assessment of PwC include an evaluation of its technical and opera- tional competence; its independence and objectivity; the sufficiency of the resources it has employed; its focus on areas of significant risk to Novartis; its willingness to probe and challenge; its ability to provide effective, prac- tical recommendations; and the openness and effective- ness of its communications and coordination with the Audit and Compliance Committee, the Internal Audit func- tion and management. Once a year, the auditor in charge and the global rela- tionship partner report to the Board on PwC’s activities during the current year and on the audit plan for the com- ing year. On an annual basis, PwC provides the Audit and Compliance Committee with written disclosures required by the US Public Company Accounting Oversight Board, and the committee and PwC discuss PwC’s indepen- dence from Novartis. 199 Item 6. Directors, Senior Management and Employees Information policy Novartis is committed to open and transparent communication with shareholders, financial analysts, customers, suppliers and other stakeholders. Novartis disseminates information about material developments in its businesses in a broad and timely manner that complies with the rules of the SIX Swiss Exchange and the NYSE. Shareholder relations The CEO, with the CFO and Investor Relations team, supported by the Chairman, are responsible for ensuring effective communication with shareholders to keep them informed of the Company’s strategy, prospects, business operations and governance. Through communi cation, the Board also learns about and addresses sharehold- ers’ expectations and concerns. Topics discussed with shareholders may include strat- egy, business performance and corporate governance, while fully respecting all applicable laws and stock exchange rules. At the AGM, the Chairman and other Board members, the CEO and other Executive Committee members, and representatives of the external auditors are present and can answer shareholders’ questions. Information for our stakeholders Communications Novartis publishes this Annual Report to provide infor- mation on the Group’s results and operations. Novartis discloses financial results in accordance with IFRS on a quarterly basis, and issues press releases from time to time regarding business developments. Novartis furnishes press releases related to financial results and material events to the SEC via Form 6-K. An archive containing Annual Reports, US Securities and Exchange Commission Form 20-F, quarterly results releases, and all related materials – including presenta- tions and conference call webcasts – is on the Novartis website at www.novartis.com/investors. Novartis also publishes a Novartis in Society report, available on the Novartis website at www.novartis.com/ our-company/corporate-responsibility, which details progress and demonstrates the Company’s commitment to be a leader in corporate responsibility. This report reflects the best-in-class reporting standard, the Global Reporting Initiative’s G4 guidelines, and fulfills the Com- pany’s reporting requirement as a signatory of the UN Global Compact. Information contained in reports and releases issued by Novartis is only correct and accurate at the time of release. Novartis does not update past releases to reflect subsequent events, and advises against relying on them for current information. Investor Relations program Investor Relations manages the Group’s interactions with the international financial community. Several events are held each year to provide institutional investors and analysts with various opportunities to learn more about Novartis. Investor Relations is based at the Group’s head quarters in Basel. Part of the team is located in the US to coor- dinate interaction with US investors. More information is available on the Novartis website: www.novartis.com/investors. Investors are also welcome to subscribe to a free email service on this site. Website information Topic Share capital Shareholder rights Board regulations Executive Committee Novartis code for senior financial officers Novartis in Society Additional information Information Articles of Incorporation of Novartis AG www.novartis.com/investors/company-overview/corporate-governance Novartis key share data www.novartis.com/key-share-data Articles of Incorporation of Novartis AG www.novartis.com/investors/company-overview/corporate-governance Investor Relations information www.novartis.com/investors Board regulations www.novartis.com/investors/company-overview/corporate-governance Executive Committee www.novartis.com/our-company/executive-committee Novartis Code of Ethical Conduct for CEO and Senior Financial Officers www.novartis.com/investors/company-overview/corporate-governance Novartis in Society www.novartis.com/nisreport2018 Novartis Investor Relations www.novartis.com/investors 200 Item 6. Directors, Senior Management and Employees 6.D Employees The table below sets forth the breakdown of the total year-end number of our full-time equivalent employees by main category of activity and geographic area for the past three years. For the year ended December 31, 2018 (full-time equivalents) USA Canada and Latin America Europe Asia/Africa/Australasia Total For the year ended December 31, 2017 (full-time equivalents) USA Canada and Latin America Europe Asia/Africa/Australasia Total For the year ended December 31, 2016 (full-time equivalents) USA Canada and Latin America Europe Asia/Africa/Australasia Total Marketing and Production and Research and supply development sales General and NBS 1 administration 6 825 4 584 7 524 6 700 1 467 960 508 19 608 21 397 10 049 20 099 6 636 3 977 Total 23 427 7 441 911 490 2 780 58 679 1 289 35 614 51 116 36 517 21 234 10 824 5 470 125 161 Marketing and Production and Research and supply development sales General and NBS 1 administration 6 563 4 477 7 095 1 305 6 803 1 680 557 726 471 18 665 20 412 10 173 19 005 6 970 3 883 2 469 56 622 1 154 34 398 48 710 35 782 21 416 10 869 4 820 121 597 Marketing and Production and Research and supply development sales General and NBS 1 administration 6 615 4 430 6 836 1 404 7 363 1 517 516 706 491 18 034 19 807 10 208 17 825 7 029 3 504 2 473 55 205 1 104 32 469 46 904 35 076 21 591 10 048 4 774 118 393 899 4 845 3 613 900 4 903 3 386 841 4 683 3 007 Total 22 867 7 710 Total 23 037 7 682 1 NBS relates to full-time equivalent employees from our Novartis Business Services organizational unit. A significant number of our associates are represented by unions or works councils. We have not experienced any material work stoppages in recent years, and we consider our employee relations to be good. 6.E Share ownership The aggregate amount of our shares owned by our Direc- tors and the members of our Executive Committee in 2018 (including persons closely linked to them) as of December 31, 2018, was 1,295,974 shares. This excludes certain unvested equity rights (such as restricted share units, performance share units and similar instruments) but includes unvested restricted shares because our unvested restricted shares can be voted. With respect to any Directors and members of our Executive Commit- tee who stepped down during 2018, this information is reported as of the date they stepped down. For more information on the Novartis shares, share options and other equity-based instruments owned by individual members of our Executive Committee and by our current Directors, see the information set forth under “Item 6. Directors, Senior Management and Employees— Item 6.B Compensation—Compensation Report—2018 Executive Committee compensation—Additional disclo- sures—Shares, ADRs and other equity rights owned by Executive Committee members at December 31, 2018” and under “Item 6. Directors, Senior Management and Employees—Item 6.B Compensation—Compensation Report—2018 Board compensation—Additional disclo- sures—Shares, ADRs and share options owned by Board members,” which are incorporated by reference. For more information on our equity-based participation plans, see the information set forth under “Item 18. Finan- cial Statements—Note 25. Equity-based participation plans for associates,” which is incorporated by reference. 201 Item 7. Major Shareholders and Related Party Transactions Item 7. Major Shareholders and Related Party Transactions 7.A Major shareholders Novartis shares are widely held. As of December 31, 2018, Novartis had approximately 163,000 shareholders listed in the Novartis AG Share Register, representing approximately 69.2% of issued shares. Based on the Novartis AG Share Register and excluding treasury shares, approximately 42.1% of the shares registered by name were held in Switzerland, and approximately 26.8% were held in the US. Approximately 12.9% of the shares registered in our share register were held by individual investors, while approximately 32.6% were held by legal entities (excluding 4.6% of our share capital held as trea- sury shares by Novartis AG and its subsidiaries), nomi- nees, fiduciaries and the ADS depositary. Based on our share register, we believe that we are not directly or indirectly owned or controlled by another corporation or government, or by any other natural or legal persons. There are no arrangements that may result in a change of control. 2018 According to our share register, as of December 31, 2018, excluding 4.6% of our share capital held as treasury shares by Novartis AG and its subsidiaries, the following registered shareholders (including nominees and the ADS depositary) held more than 2% of the total share capital of Novartis with the right to vote all their Novartis shares based on an exemption granted by the Board of Directors: • Shareholders: Novartis Foundation for Employee Par- ticipation, with its registered office in Basel, Switzer- land, holding 2.3%; Emasan AG, with its registered office in Basel, Switzerland, holding 3.5%; and UBS Fund Management (Switzerland) AG, with its registered office in Basel, Switzerland, holding 2.2%; • Nominees: Chase Nominees Ltd., London, England (holding 9.8%); Nortrust Nominees Ltd., London, England (holding 3.6%); and The Bank of New York Mellon, New York, NY (holding 4.1%) through its nomi- nees, The Bank of New York Mellon, Everett, MA (hold- ing 2.1%), The Bank of New York Mellon, New York, holding 1.3%, and The Bank of New York Mellon, SA/ NV, Brussels, Belgium (holding 0.7%); and • ADS depositary: JPMorgan Chase Bank, N.A., New York, NY (holding 13.3%). According to a disclosure notification filed with Novartis AG, Norges Bank (Central Bank of Norway), Oslo, Nor- way, held 2.1% of the share capital of Novartis AG as of December 31, 2018, with the right to vote all its Novartis shares, but was not registered in our share register as of December 31, 2018. According to a disclosure notification filed with Novartis AG and the SIX Swiss Exchange, each of Black- Rock, Inc., New York, NY, and Capital Group Companies, Inc., Los Angeles, CA, held between 3% and 5% of the share capital of Novartis AG but was registered with less than 2% of the share capital in our share register as of December 31, 2018. As of December 31, 2018, no other shareholder was registered as owner of more than 2% of the registered share capital. The Articles of Incorporation provide that no share- holder shall be registered with the right to vote shares comprising more than 2% of the registered share capi- tal. The Board of Directors may, upon request, grant an exemption from this restriction. Considerations include whether the shareholder supports the Novartis goal of creating sustainable value and has a long-term invest- ment horizon. Exemptions are in force for the registered major shareholders as described above. Novartis has not entered into any agreement with any shareholder regarding the voting or holding of Novartis shares. 2017 According to our share register, as of December 31, 2017, excluding 6.4% of our share capital held as treasury shares by Novartis AG and its subsidiaries, the following registered shareholders (including nominees and the ADS depositary) held more than 2% of the total share capital of Novartis with the right to vote all their Novartis shares based on an exemption granted by the Board of Directors: • Shareholders: Novartis Foundation for Employee Par- ticipation, with its registered office in Basel, Switzer- land, holding 2.5%; Emasan AG, with its registered office in Basel, Switzerland, holding 3.4%; and UBS Fund Management (Switzerland) AG, with its registered office in Basel, Switzerland, holding 2.0%; • Nominees: Chase Nominees Ltd., London, England (holding 7.8%); Nortrust Nominees Ltd., London, England (holding 3.8%); and The Bank of New York Mellon, New York, NY (holding 4.3%) through its nom- inees, The Bank of New York Mellon, Everett, MA (hold- ing 2.0%), and The Bank of New York Mellon, SA/NV, Brussels, Belgium (holding 2.3%); and • ADS depositary: JPMorgan Chase Bank, N.A., New York, NY (holding 12.3%). According to a disclosure notification filed with Novartis AG, Norges Bank (Central Bank of Norway), Oslo, Nor- 202 Item 7. Major Shareholders and Related Party Transactions way, held 2.1% of the share capital of Novartis AG as of December 31, 2017, with the right to vote all its Novartis shares, but was not registered in our share register as of December 31, 2017. According to a disclosure notification filed with Novartis AG and the SIX Swiss Exchange, Black- Rock, Inc., New York, NY, held between 3% and 5% of the share capital of Novartis AG but was registered with less than 2% of the share capital in our share register as of December 31, 2017. As of December 31, 2017, no other shareholder was registered as owner of more than 2% of the registered share capital. The Articles of Incorporation provide that no share- holder shall be registered with the right to vote shares comprising more than 2% of the registered share capi- tal. The Board of Directors may, upon request, grant an exemption from this restriction. Considerations include whether the shareholder supports the Novartis goal of creating sustainable value and has a long-term invest- ment horizon. Exemptions are in force for the registered major shareholders as described above. Novartis has not entered into any agreement with any shareholder regarding the voting or holding of Novartis shares. 2016 According to our share register, as of December 31, 2016, excluding 4.5% of our share capital held as treasury shares by Novartis AG and its subsidiaries, the following registered shareholders (including nominees and the ADS depositary) held more than 2% of the total share capital of Novartis with the right to vote these shares: • Shareholders: Novartis Foundation for Employee Par- ticipation, with its registered office in Basel, Switzer- land, holding 2.6%; Emasan AG, with its registered office in Basel, Switzerland, holding 3.4%; and UBS Fund Management (Switzerland) AG, with its registered office in Basel, Switzerland, holding 2.1%; • Nominees: Chase Nominees Ltd., London, England (holding 8.5%); Nortrust Nominees, London, England (holding 3.9%); and The Bank of New York Mellon, New York, NY (holding 4.4%) through its nominees, Mellon Bank, Everett, MA (holding 1.8%) and The Bank of New York Mellon, Brussels, Belgium (holding 2.6%); and • ADS depositary: JPMorgan Chase Bank, New York, NY (holding 12%). According to a disclosure notification filed with Novartis AG, Norges Bank (Central Bank of Norway), Oslo, Nor- way, held 2.02% of the share capital of Novartis AG as of December 31, 2016, with the right to vote all its Novartis shares, but was not registered in our share register as of December 31, 2016. According to disclosure notifications filed with Novartis AG and the SIX Swiss Exchange, each of the following shareholders held between 3% and 5% of the share cap- ital of Novartis AG as of December 31, 2016: • Capital Group Companies, Inc., Los Angeles, CA; and • BlackRock, Inc., New York, NY. As of December 31, 2016, no other shareholder was reg- istered as owner of more than 2% of the registered share capital. Novartis has not entered into any agreement with any shareholder regarding the voting or holding of Novartis shares. 7.B Related party transactions The information set forth under “Item 18. Financial Statements—Note 26. Transactions with related parties” is incor- porated by reference. 7.C Interests of experts and counsel Not applicable. 203 Item 8. Financial Information Item 8. Financial Information 8.A Consolidated statements and other financial information See “Item 18. Financial Statements.” Dividend policy Subject to the dividend policy described below, our Board of Directors expects to recommend the payment of a dividend in respect of each financial year. If approved by our shareholders at the relevant annual shareholders’ meeting, the dividends will be payable shortly following such approval. Any shareholder who purchases our shares before the ex-dividend date and holds the shares until that date shall be deemed to be entitled to receive the dividends approved at that meeting. Dividends are reflected in our financial statements in the year in which they are approved by our shareholders. Our dividend policy is to pay a growing annual divi- dend in Swiss francs. This policy is subject to our finan- cial conditions and outlook at the time, the results of our operations, and other factors. The Board will propose a dividend of CHF 2.85 per share to the shareholders for approval at the Annual General Meeting to be held on February 28, 2019. Because we pay dividends in Swiss francs, exchange rate fluctuations will affect the US dollar amounts received by holders of ADRs. For a summary of dividends we paid in the past five years, see “Item 3. Key Informa- tion—Item 3.A Selected financial data—Cash dividends per share.” See also “Item 3. Key Information—Item 3.D Risk factors—The price of our ADRs and the US dollar value of any dividends may be negatively affected by fluc- tuations in the US dollar/Swiss franc exchange rate.” Disclosure pursuant to Section 219 of the Iran Threat Reduction & Syria Human Rights Act (ITRA) At Novartis, our purpose is to reimagine medicine to improve and extend people’s lives, regardless of where they live. This includes the compliant sale of medicines and other healthcare products worldwide. To help us ful- fill this mission, we have two representative offices located in Iran. As of October 18, 2010, a non-US affiliate within our Innovative Medicines Division entered into a non-bind- ing Memorandum of Understanding (MoU) with the Min- istry of Health and Medical Education of the Islamic Republic of Iran. Pursuant to the MoU, the Iranian Minis- try of Health acknowledges certain benefits that may apply to sales of certain Innovative Medicines Division medicines by third-party distributors in Iran. These include fast-track registration, market exclusivity, end-user subsidies, and exemptions from customs tar- iffs. Novartis receives no payments from the Iranian Min- istry of Health under the MoU, and the MoU creates no obligations on the part of either Novartis or the Iranian Ministry of Health. From time to time, including in 2018, non-US affiliates in our Innovative Medicines and Sandoz Divisions made payments to government entities in Iran related to pat- ents, trademarks, exit fees and other transactions ordi- narily incident to travel by doctors and other medical pro- fessionals resident in Iran to attend conferences or other events outside Iran. From time to time, including in 2018, non-US affiliates in our Innovative Medicines and Sandoz Divisions enter into agreements with hospitals, research institutes, med- ical associations and universities in Iran to provide grants and sponsor congresses, seminars and symposia, and with doctors and other healthcare professionals for con- sulting services, including participation in advisory boards and investigator services for observational (non-interventional) studies. Some of these hospitals and research institutes are owned or controlled by the gov- ernment of Iran, and some of these doctors and health- care professionals are employed by hospitals that may be public or government-owned. Because our Innovative Medicines and Sandoz Divi- sions have operations in Iran, including employees, they obtain services and have other dealings incidental to their activities in that country, including paying taxes and salaries either directly or indirectly through a service pro- vider, and obtaining office rentals, insurance, electricity, water and telecommunications services, office and sim- ilar supplies, and customs-related services from Iranian companies that may be owned or controlled by the gov- ernment of Iran. In addition, from time to time, represen- tatives of our non-US affiliates participate in meetings with Iranian officials to discuss issues relevant to our business and the pharmaceutical industry. In 2018, a non-US affiliate in our Sandoz Division coor- dinated a training of government pharmaceutical regu- lators at a one-day workshop requested by the Iranian Food and Drug Organization to discuss regulatory path- ways for biosimilar medicines in Iran. Non-US affiliates in our Innovative Medicines and Sandoz Divisions maintain local accounts at banks that are, as of November 5, 2018, on the Specially Designated Nationals and Blocked Persons List (SDN List). These non-US affiliates make local transactions for employee payroll and local vendor payment purposes only with SDN-listed Iranian banks that are not subject to second- ary sanctions. Payments to employees and vendors are only made to accounts in Iranian banks that are not sub- ject to secondary sanctions. 204 Item 8. Financial Information 8.B Significant changes None. 205 Item 9. The Offer and Listing Item 9. The Offer and Listing 9.A Offer and listing details Our shares are listed in Switzerland on the SIX Swiss Exchange (SIX). Stock Exchange (NYSE) since May 2000 and are traded under the symbol NVS. American Depositary Shares (ADSs), each repre- senting one share, have been available in the US through an American Depositary Receipt (ADR) program since December 1996. This program was established pursu- ant to a deposit agreement that we entered into with JPMorgan Chase Bank, N.A., as depositary (Deposit Agreement). Our ADRs have been listed on the New York The depositary has informed us that as of January 22, 2019, there were 337 million ADRs outstanding, each representing one Novartis share (approximately 13% of total Novartis shares issued). On January 22, 2019, the closing price per share on the SIX was CHF 88.14 and USD 88.32 per ADR on the NYSE. 9.B Plan of distribution Not applicable. 9.C Markets See “—Item 9.A Offer and listing details.” 9.D Selling shareholders Not applicable. 9.E Dilution Not applicable. 9.F Expenses of the issue Not applicable. 206 Item 10. Additional Information Item 10. Additional Information 10.A Share capital Not applicable. 10.B Memorandum and articles of association The following is a summary of certain provisions of our Articles of Incorporation (“Articles”), our Regulations of the Board of Directors (“Board Regulations”) and of Swiss law, particularly the Swiss Code of Obligations (“Swiss CO”). This is not a summary of all the significant provisions of the Articles, the Board Regulations or of Swiss law and does not purport to be complete. This description is qualified in its entirety by reference to the Articles and the Board Regulations, which are an exhibit to this Form 20-F, and to Swiss law. 10.B.1 Company purpose Novartis AG is registered in the commercial register of the canton of Basel-Stadt, Switzerland, under number CHE-103.867.266. Our business purpose, as stated in Article 2 of the Articles, is to hold interests in enterprises in the area of healthcare or nutrition. We may also hold interests in enterprises in the areas of biology, chemis- try, physics, information technology or related areas. We may acquire, mortgage, liquidate or sell real estate and intellectual property rights in Switzerland or abroad. In pursuing our business purpose, we strive to create sus- tainable value. 10.B.2 Directors (a) According to our Board Regulations, a member of our Board (“Director”) may not participate in deliberations or resolutions on matters that affect, or reasonably might affect, the Director’s interests or the interests of a person close to the Director. In addition, the Swiss CO sets forth that if, in connection with the conclu- sion of a contract, Novartis AG is represented by the person with whom it is concluding the contract, such contract shall be in writing. Furthermore, the Swiss CO requires directors and members of senior man- agement to safeguard the interests of the corpora- tion and, in this connection, imposes a duty of care and a duty of loyalty on such individuals. This rule is generally interpreted to mean that directors and mem- bers of senior management are disqualified from par- ticipating in decisions that affect them personally. (b) A Board resolution requires the affirmative majority of the votes cast. As with any Board resolution, Direc- tors may not vote on their own compensation unless at least a majority of the Directors are present. The compensation of the Directors is subject to the approval of the aggregate amounts of such compen- sation by a shareholders’ resolution under the Ordi- nance against Excessive Compensation in Public Companies of the Swiss Federal Council. (c) The Articles prohibit the granting of loans or credits to Directors. (d) Directors who have turned 70 years of age at the date of the General Meeting of Shareholders may no lon- ger be elected as members of the Board. The Gen- eral Meeting of Shareholders may, under special cir- cumstances, grant an exemption from this rule. (e) Our Directors are not required to be shareholders under our Articles. 10.B.3 Shareholder rights Because Novartis AG has only one class of registered shares, the following information applies to all sharehold- ers. (a) The Swiss CO requires that, among other things, at least 5% of our annual profit be retained as general reserves, so long as these reserves amount to less than 20% of our registered share capital. Swiss law and the Articles permit us to accrue additional reserves. Under the Swiss CO, we may only pay dividends out of balance sheet profits, out of reserves created for this purpose, or out of free reserves. In any event, under the Swiss CO, while the Board may propose that a dividend be paid, we may only pay dividends upon shareholders’ approval at a General Meeting of Shareholders. Our auditors must confirm that the div- idend proposal of our Board conforms with the Swiss CO and the Articles. Our Board intends to propose a dividend once each year. See “Item 3. Key Informa- tion—Item 3.A. Selected financial data—Cash divi- dends per share” and “Item 8. Financial Information— Item 8.A. Consolidated statements and other financial information—Dividend policy.” Dividends are usually due and payable shortly after the shareholders have passed a resolution approving the payment. Dividends that have not been claimed within five years after the due date revert to us, and are allocated to our general reserves. For information about deduction of the withholding tax or other duties from dividend payments, see “—Item 10.E Taxation.” (b) Each share is entitled to one vote at a General Meet- ing of Shareholders. Voting rights may only be exer- cised for shares registered with the right to vote on 207 Item 10. Additional Information the record date for the applicable General Meeting of Shareholders. In order to do so, the shareholder must file a share registration form with us, setting forth the shareholder’s name, address and citizenship (or, in the case of a legal entity, its registered office). If the shareholder has not timely filed the form, then the shareholder may not vote at, or participate in, Gen- eral Meetings of Shareholders. To vote its shares, the shareholder must also explicitly declare that it has acquired the shares in its own name and for its own account. If the shareholder refuses to make such a declaration, the shares may not be voted unless the Board recognizes such share- holder as a nominee. The Articles provide that no shareholder shall be registered with the right to vote shares comprising more than 2% of the registered share capital. The Board may, upon request, grant an exemption from this restriction. Considerations include whether the shareholder supports our goal of creating sustainable value and has a long-term investment horizon. Fur- thermore, the Articles provide that no nominee shall be registered with the right to vote shares compris- ing more than 0.5% of the registered share capital. The Board may, upon request, grant an exemption from this restriction if the nominee discloses the names, addresses and number of shares of the per- sons for whose account it holds more than 0.5% of the registered share capital. The same restrictions indirectly apply to holders of ADRs. We have in the past granted exemptions from the 2% rule for share- holders and the 0.5% rule for nominees. Under the Articles, the Board may delegate the power to grant such exemptions. The Board has delegated this power to the Chairman of the Board. For purposes of the 2% rule for shareholders and the 0.5% rule for nominees, groups of companies and groups of shareholders acting in concert are consid- ered to be one shareholder. These rules also apply to shares acquired or subscribed by the exercise of sub- scription, option or conversion rights. After hearing the registered shareholder or nom- inee, the Board may cancel, with retroactive effect as of the date of registration, the registration of the shareholders if the registration was effected based on false information. Registration restrictions in the Articles may only be removed upon a resolution carrying a two-thirds majority of the votes represented at a General Meet- ing of Shareholders. Except as noted in the paragraph immediately below, shareholders’ resolutions require the approval of a majority of the votes present at a General Meet- ing of Shareholders. As a result, abstentions have the effect of votes against such resolutions. Some exam- ples of shareholders’ resolutions requiring a vote by such “absolute majority of the votes” are (1) amend- ments to the Articles; (2) elections of Directors, the Chairman, the Compensation Committee members, the Independent Proxy and the statutory auditors; (3) approval of the management report and the finan- cial statements; (4) setting the annual dividend, if any; (5) approval of the aggregate amounts of compensa- tion of the Directors and the members of the Execu- tive Committee; (6) decisions to discharge Directors and management from liability for matters disclosed to the General Meeting of Shareholders; and (7) the ordering of an independent investigation into specific matters proposed to the General Meeting of Share- holders. As a matter of Swiss law, certain other mat- ters require a supermajority as well, including certain mergers, scissions and transformations under the Swiss Merger Act. According to the Articles and Swiss law, the fol- lowing types of shareholders’ resolutions require the approval of a “supermajority” of at least two-thirds of the votes present at a General Meeting of Sharehold- ers: (1) an alteration of our corporate purpose; (2) the creation of shares with increased voting powers; (3) an implementation of restrictions on the transfer of registered shares and the removal of such restric- tions; (4) an authorized or conditional increase of the share capital; (5) an increase of the share capital by conversion of equity, by contribution in kind, or for the purpose of an acquisition of property or the grant of special rights; (6) a restriction or an exclusion of shareholders’ pre-emptive rights; (7) a change of our registered office; (8) our dissolution; or (9) any amend- ment to the Articles that would create or eliminate a supermajority requirement. Our shareholders are required to annually elect all of the members of the Board, as well as the Chair- man of the Board, the members of the Compensation Committee, and the Independent Proxy. The Articles do not provide for cumulative voting of shares. At General Meetings of Shareholders, sharehold- ers can be represented by proxy. However, a proxy must either be: the shareholder’s legal representative, another shareholder with the right to vote, or the Inde- pendent Proxy. Votes are taken either by a show of hands or by electronic voting, unless the General Meet- ing of Shareholders resolves to have a ballot or where a ballot is ordered by the chairman of the meeting. American Depositary Shares (ADSs), each repre- senting one Novartis AG share and evidenced by American Depositary Receipts (ADRs), are issued by our depositary JPMorgan Chase Bank, N.A., New York, and not by us. The ADR is vested with rights defined and enumerated in the Deposit Agreement (such as the rights to vote, to receive a dividend and to receive a share of Novartis AG in exchange for a certain number of ADRs). The enumeration of rights, including any limitations on those rights in the Deposit Agreement, is final. There are no other rights given to the ADR holders. Only the ADS depositary, holding our shares underlying the ADRs, is registered as shareholder in our share register. An ADR is not a Novartis AG share and an ADR holder is not a Novartis AG shareholder. The Deposit Agreement between our depositary, the ADR holder and us has granted certain indirect rights to vote to the ADR holders. ADR holders may not attend Novartis AG general meetings in person. ADR holders exercise their voting rights by instruct- ing JPMorgan Chase Bank, N.A., our depositary, to exercise the voting rights attached to the registered shares underlying the ADRs. Each ADR represents one Novartis AG share. JPMorgan Chase Bank exer- 208 Item 10. Additional Information cises the voting rights for registered shares underly- ing ADRs for which no voting instructions have been given by providing a discretionary proxy to an unin- structed independent designee pursuant to para- graph 13 of the form of ADR. Such designee has to be a shareholder of Novartis AG. The same voting restrictions apply to ADR holders as to those holding Novartis AG shares (i.e., the right to vote up to 2% of the Novartis AG registered share capital – unless oth- erwise granted an exemption by the Board – and the disclosure requirement for nominees). (c) Shareholders have the right to allocate the profit shown on our balance sheet and to distribute divi- dends by vote taken at the General Meeting of Share- holders, subject to the legal requirements described in “Item 10.B.3(a) Shareholder rights.” (d) Under the Swiss CO, any surplus arising out of a liq- uidation of Novartis AG (i.e., after the settlement of all claims of all creditors) would be distributed to the shareholders in proportion to the paid-in nominal value of their shares. (e) The Swiss CO limits a corporation’s ability to hold or repurchase its own shares. We and our subsidiaries may only repurchase shares if we have freely dispos- able equity, in the amount necessary for this purpose, available. The aggregate nominal value of all Novartis AG shares held by us and our subsidiaries may not exceed 10% of our registered share capital. However, it is accepted that a corporation may repurchase its own shares beyond the statutory limit of 10%, if the repurchased shares are clearly earmarked for can- cellation. In addition, we are required to recognize a negative position for own shares acquired by Novartis AG or if our subsidiaries acquire our shares, to cre- ate a special reserve on our balance sheet, in each case in the amount of the purchase price of the acquired shares. Repurchased shares held by us or our subsidiaries do not carry any rights to vote at a General Meeting of Shareholders, but are entitled to the economic benefits generally connected with the shares. The definition of subsidiaries, and therefore, treasury shares, for purposes of the above described reserves requirement and voting restrictions differs from the definition of subsidiaries for purposes of consolidation in our consolidated financial state- ments. The definition in the consolidated financial statements requires consolidation for financial report- ing purposes of special purpose entities in instances where we have the power to govern the financial and operating policies of the entity so as to obtain bene- fits from its activities. Therefore, our consolidated financial statements include special purpose entities, mainly foundations, which do not qualify as subsid- iaries subject to the reserve requirements and voting restrictions of the Swiss CO because we do not hold a majority participation in these special purpose enti- ties. Accordingly, no reserve requirements apply to shares held by such special purpose entities, and such entities are not restricted from independently voting their shares. Under the Swiss CO, we may not cancel treasury shares without the approval of a capital reduction by our shareholders. (f) Not applicable. (g) Since all of our issued and outstanding shares have been fully paid in, we can make no further capital calls on our shareholders. (h) See “—Item 10.B.3(b) Shareholder rights” and “— Item 10.B.7 Change in control.” 10.B.4 Changes to shareholder rights Under the Swiss CO, we may not issue new shares with- out the prior approval of a capital increase by our share- holders. If a capital increase is approved, then our share- holders would generally have certain pre-emptive rights to obtain newly issued shares in an amount proportional to the nominal value of the shares they already hold. These pre-emptive rights could be modified in certain limited circumstances with the approval of a resolution adopted at a General Meeting of Shareholders by a supermajority of two-thirds of the votes. In addition, we may not create shares with increased voting powers or place restrictions on the transfer of registered shares without the approval of a resolution adopted at a Gen- eral Meeting of Shareholders by a supermajority of votes. In addition, see “—Item 10.B.3(b) Shareholder rights” with regard to the Board’s ability to cancel the registration of shares under limited circumstances. 10.B.5 Shareholder meetings Under the Swiss CO and the Articles, we must hold an annual ordinary General Meeting of Shareholders within six months after the end of our financial year. General Meetings of Shareholders may be convened by the Board or, if necessary, by the statutory auditors. The Board is further required to convene an extraordinary General Meeting of Shareholders if so resolved by a Gen- eral Meeting of Shareholders, or if so requested by shareholders holding an aggregate of at least 10% of the share capital, specifying the items for the agenda and their proposals. Shareholders holding shares with an aggregate nominal value of at least CHF 1 000 000 (i.e., 2 000 000 Novartis AG shares) or at least 10% of the share capital have the right to request that a specific pro- posal be put on the agenda and voted upon at the next General Meeting of Shareholders. A General Meeting of Shareholders is convened by publishing a notice in the Swiss Official Gazette of Commerce (Schweizerisches Handelsamtsblatt) at least 20 days prior to such meet- ing. Shareholders may also be informed by mail. There is no provision in the Swiss CO or the Articles requiring a quorum for the holding of a General Meeting of Share- holders. In addition, see “—Item 10.B.3(b) Shareholder rights” regarding conditions for exercising a sharehold- er’s right to vote at a General Meeting of Shareholders. 10.B.6 Limitations There are no limitations under the Swiss CO or our Arti- cles on the right of non-Swiss residents or nationals to own or vote shares other than the restrictions applica- ble to all shareholders. But see “Item 10.B.3(b) Share- 209 Item 10. Additional Information holder rights” regarding conditions for exercising an ADR holder’s right to vote at a shareholder meeting. 10.B.7 Change in control The Articles and the Board Regulations contain no pro- vision that would have an effect of delaying, deferring or preventing a change in control of Novartis AG and that would operate only with respect to a merger, acquisition or corporate restructuring involving us or any of our sub- sidiaries. According to the Swiss Merger Act, shareholders may pass a resolution to merge with another corpora- tion at any time. Such a resolution would require the con- sent of at least two-thirds of all votes present at the nec- essary General Meeting of Shareholders. Under the Swiss Financial Market Infrastructure Act, shareholders and groups of shareholders acting in con- cert who acquire more than 331/3% of our shares would be under an obligation to make an offer to acquire all remaining Novartis AG shares. Novartis AG has neither opted out from the mandatory takeover offer obligation nor opted to increase the threshold for mandatory take- over offers in its Articles. rights relating to our shares are required to notify us and SIX of the level of their holdings whenever such holdings reach, exceed or fall below certain thresholds – 3%, 5%, 10%, 15%, 20%, 25%, 33 1/3%, 50% and 66 2/3% – of the voting rights represented by our share capital (whether exercisable or not). This also applies to anyone who has discretionary power to exercise voting rights associated with our shares. Following receipt of such notification, we are required to inform the public by pub- lishing the information via the electronic publication plat- form operated by SIX. An additional disclosure obligation exists under the Swiss CO that requires us to disclose, once a year in the notes to the financial statements published in our Annual Report, the identity of all of our shareholders (or related groups of shareholders) who have been granted exemp- tion entitling them to vote more than 2% of our registered share capital, as described in “—Item 10.B.3(b) Share- holder rights.” 10.B.9 Differences in the law See the references to Swiss law throughout this “— Item 10.B Memorandum and articles of association.” 10.B.8 Disclosure of shareholdings 10.B.10 Changes in capital Under the Swiss Financial Market Infrastructure Act, per- sons who directly, indirectly or in concert with other par- ties acquire or dispose of our shares or purchase or sale The requirements of the Articles regarding changes in capital are not more stringent than the requirements of Swiss law. 10.C Material contracts Consumer Healthcare Joint Venture with GSK On April 22, 2014 (and as amended from time to time), we entered into a Contribution Agreement with GSK under which GSK contributed its consumer healthcare business (the “GSK Consumer Healthcare Business”) and we contributed our OTC Division, with certain lim- ited exceptions that included the over-the-counter busi- ness of our Sandoz Division, into a newly created joint venture that operated under the GSK Consumer Health- care name (the “Consumer Healthcare Joint Venture”). In consideration for those contributions, GSK owned 63.5% of the issued share capital of the Consumer Healthcare Joint Venture, and we owned 36.5% of the issued share capital of the Consumer Healthcare Joint Venture. We had the right, exercisable from March 2, 2018, to March 2, 2035, to require GSK to purchase our stake in the Consumer Healthcare Joint Venture. On March 27, 2018, we entered into a Put Option Implementation Agreement with GSK and with the Con- sumer Healthcare Joint Venture. Under this agreement, we agreed to the cancellation of our shares in the Con- sumer Healthcare Joint Venture in consideration for a payment to us of USD 13 billion in cash. On May 3, 2018, GSK obtained the necessary shareholder approval, and the transaction was completed on June 1, 2018. Follow- ing cancellation of our shares, GSK acquired 100% con- trol of the Consumer Healthcare Joint Venture. Acquisition of AveXis On April 9, 2018, we entered into an Agreement and Plan of Merger with AveXis, Inc. (“AveXis”) to acquire AveXis for USD 218 per share or a total of approximately USD 8.7 billion in cash. Pursuant to the Merger Agreement, on April 17, 2018, we commenced a tender offer to acquire all outstanding shares of AveXis. We completed the acqui- sition on May 15, 2018. As a result of the merger, AveXis became a wholly-owned subsidiary of Novartis AG. 210 Item 10. Additional Information 10.D Exchange controls There are no Swiss governmental laws, decrees or reg- ulations that restrict – in a manner material to Novartis AG – the export or import of capital, including any for- eign exchange controls, or that generally affect the remit- tance of dividends or other payments to non-residents or non-citizens of Switzerland who hold Novartis AG shares. 10.E Taxation The taxation discussion set forth below is intended only as a descriptive summary and does not purport to be a complete analysis or listing of all potential tax effects rel- evant to the ownership or disposition of our shares or ADRs. The statements of US and Swiss tax laws set forth below are based on the laws and regulations in force as of the date of this 20-F – including the current Conven- tion Between the US and the Swiss Confederation for the Avoidance of Double Taxation with Respect to Taxes on Income, entered into force on December 19, 1997 (the Treaty); the US Internal Revenue Code of 1986, as amended (the Code); Treasury regulations; rulings; judi- cial decisions; and administrative pronouncements – and may be subject to any changes in US and Swiss law, and in any double taxation convention or treaty between the US and Switzerland occurring after that date, which changes may have retroactive effect. Swiss taxation Swiss residents Withholding Tax on dividends and distributions. Divi- dends that we pay and similar cash or in-kind distribu- tions that we may make to a holder of shares or ADRs (including distributions of liquidation proceeds in excess of the nominal value, stock dividends and, under certain circumstances, proceeds from repurchases of shares by us in excess of the nominal value) are generally sub- ject to a Swiss federal withholding tax (the Withholding Tax) at a current rate of 35%. Under certain circum- stances, distributions out of capital contribution reserves made by shareholders after December 31, 1996, are exempt from the Withholding Tax. We are required to withhold this Withholding Tax from the gross distribution and to pay the Withholding Tax to the Swiss Federal Tax Administration. The Withholding Tax is refundable in full to Swiss residents who are the beneficial owners of the taxable distribution at the time it is resolved and duly report the gross distribution received on their personal tax return or in their financial statements for tax pur- poses, as the case may be. Income tax on dividends. A Swiss resident who receives dividends and similar distributions (including stock divi- dends and liquidation surplus) on shares or ADRs is required to include such amounts in the shareholder’s personal income tax return. However, distributions out of qualified capital contribution reserves are not subject to income tax. A corporate shareholder may claim sub- stantial relief from taxation of dividends and similar dis- tributions received if the shares held represent a fair market value of at least CHF 1 million. Capital gains tax upon disposal of shares. Under current Swiss tax law, the gain realized on shares held by a Swiss resident who holds shares or ADRs as part of his private property is generally not subject to any federal, cantonal or municipal income taxation on gains realized on the sale or other disposal of shares or ADRs. However, gains realized upon a repurchase of shares by us may be char- acterized as taxable dividend income if certain condi- tions are met. Book gains realized on shares or ADRs held by a Swiss corporate entity or by a Swiss resident individual as part of the shareholder’s business property are, in general, included in the taxable income of such person. However, the Federal Law on the Direct Federal Tax of December 14, 1990, and several cantonal laws on direct cantonal taxes provide for exceptions for Swiss corporate entities holding more than 10% of our voting stock for more than one year. Residents of other countries Recipients of dividends and similar distributions on our shares who are neither residents of Switzerland for tax purposes nor holding shares as part of a business con- ducted through a permanent establishment situated in Switzerland (Non-Resident Holders) are not subject to Swiss income taxes in respect of such distributions. Moreover, gains realized by such recipients upon the dis- posal of shares are not subject to Swiss income taxes. Non-Resident Holders of shares are, however, sub- ject to the Withholding Tax on dividends and similar dis- tributions mentioned above and, under certain circum- stances, to the Stamp Duty described below. Such Non-Resident Holders may be entitled to a partial refund of the Withholding Tax if the country in which they reside has entered into a bilateral treaty for the avoidance of double taxation with Switzerland. Non-Resident Holders should be aware that the procedures for claiming treaty refunds (and the timeframe required for obtaining a refund) may differ from country to country. Non-Resident Holders should consult their own tax advisors regarding receipt, ownership, purchase, sale or other dispositions of shares or ADRs, and the procedures for claiming a refund of the Withholding Tax. 211 Item 10. Additional Information As of January 1, 2019, Switzerland has entered into bilateral treaties for the avoidance of double taxation with respect to income taxes with the following countries, whereby a part of the above-mentioned Withholding Tax may be refunded (subject to the limitations set forth in such treaties): Albania Algeria Argentina Armenia Australia Austria Azerbaijan Bahrain Bangladesh Belarus Belgium Bulgaria Canada Chile China Colombia Croatia Cyprus Czech Republic Denmark Ecuador Egypt Estonia Finland France Germany Georgia Ghana Greece Hong Kong Hungary Iceland India Indonesia Iran Israel Italy Ivory Coast Republic of Ireland Jamaica Japan Kazakhstan Republic of Korea (South Korea) Kosovo Kuwait Kyrgyzstan Latvia Liechtenstein Lithuania Luxembourg Macedonia Malaysia Malta Mexico Moldova Mongolia Montenegro Morocco Netherlands New Zealand Norway Oman Pakistan Peru Philippines Poland Portugal Qatar Romania Russia Serbia Singapore Slovak Republic Slovenia South Africa Spain Sri Lanka Sweden Taiwan Tajikistan Thailand Trinidad and Tobago Tunisia Turkey Turkmenistan Ukraine United Arab Emirates United Kingdom United States of America Uruguay Uzbekistan Venezuela Vietnam The tax treaty with Bahrain is not applicable to the healthcare industry. Tax treaty negotiations are underway, or have been conducted, with Bosnia and Herzegovina, Brazil, Costa Rica, Ethiopia, Libya, North Korea, Saudi Arabia, Senegal, Syria, Zambia and Zimbabwe. Tax treaty negotiations between Switzerland and some of the countries listed in the immediately preceding sentence have been ongoing for an extended period of time, and we are not certain when or if such negotiations will be completed, and when or if the corresponding treaties will come into effect. A Non-Resident Holder of shares or ADRs will not be lia- ble for any Swiss taxes other than the Withholding Tax described above and, if the transfer occurs through or with a Swiss bank or other Swiss securities dealer, the Stamp Duty described below. If, however, the shares or ADRs of Non-Resident Holders can be attributed to a permanent establishment or a fixed place of business maintained by such person within Switzerland during the relevant tax year, the shares or ADRs may be subject to Swiss income taxes in respect of income and gains real- ized on the shares or ADRs, and such person may qual- ify for a full refund of the Withholding Tax based on Swiss tax law. Residents of the US. A Non-Resident Holder who is a resident of the US for purposes of the Treaty is eligible for a reduced rate of tax on dividends equal to 15% of the dividend, provided that such holder (i) qualifies for benefits under the Treaty, (ii) holds, directly and indi- rectly, less than 10% of our voting stock, and (iii) does not conduct business through a permanent establish- ment or fixed base in Switzerland to which the shares or ADRs are attributable. Such an eligible holder must apply for a refund of the amount of the Withholding Tax in excess of the 15% Treaty rate. A Non-Resident Holder who is a resident of the US for purposes of the Treaty is eligible for a reduced rate of tax on dividends equal to 5% of the dividend, provided that such holder (i) is a com- pany, (ii) qualifies for benefits under the Treaty, (iii) holds directly at least 10% of our voting stock, and (iv) does not conduct business through a permanent establish- ment or fixed place of business in Switzerland to which the shares or ADRs are attributable. Such an eligible holder must apply for a refund of the amount of the With- holding Tax in excess of the 5% Treaty rate. Claims for refunds must be filed on Swiss Tax Form 82 (82C for corporations; 82I for individuals; 82E for other entities), which may be obtained from any Swiss Consulate Gen- eral in the US or from the Federal Tax Administration of Switzerland at the address below, together with an instruction form. Four copies of the form must be duly completed, signed before a notary public of the US, and sent to the Federal Tax Administration of Switzerland, Eigerstrasse 65, CH-3003 Bern, Switzerland. The form must be accompanied by suitable evidence of deduction of Swiss tax withheld at source, such as certificates of deduction, signed bank vouchers or credit slips. The form may be filed on or after July 1 or January 1 following the date the dividend was payable, but no later than Decem- ber 31 of the third year following the calendar year in which the dividend became payable. For US resident holders of ADRs, JPMorgan Chase Bank, N.A., as depos- 212 Item 10. Additional Information itary, will comply with these Swiss procedures on behalf of the holders, and will remit the net amount to the hold- ers. Stamp Duty upon transfer of securities. The sale of shares, whether by Swiss residents or Non-Resident Holders, may be subject to federal securities transfer Stamp Duty of 0.15%, calculated on the sale proceeds, if the sale occurs through or with a Swiss bank or other Swiss securities dealer, as defined in the Swiss Federal Stamp Duty Act. The Stamp Duty has to be paid by the securities dealer and may be charged to the parties in a taxable transaction who are not securities dealers. Stamp Duty may also be due if a sale of shares occurs with or through a non-Swiss bank or securities dealer, provided (i) such bank or dealer is a member of the SIX, and (ii) the sale takes place on the SIX. In addition to this Stamp Duty, the sale of shares by or through a member of the SIX may be subject to a minor stock exchange levy. (i) subject to the primary supervision of a US court and the control of one or more US persons, or (ii) that has a valid election in place to be treated as a US person. If a partnership (or other entity treated as a partnership for US federal income tax purposes) holds shares or ADRs, the tax treatment of a partner generally will depend upon the status of the partner and the activities of the part- nership. Partners in a partnership that holds shares or ADRs are urged to consult their own tax advisor regard- ing the specific tax consequences of the owning and disposing of such shares or ADRs by the partnership. For US federal income tax purposes, a US Holder of ADRs generally will be treated as the beneficial owner of our shares represented by the ADRs. However, see the discussion below under “—Dividends” regarding cer- tain statements made by the US Treasury concerning depositary arrangements. This discussion assumes that each obligation in the Deposit Agreement and any related agreement will be performed in accordance with its terms. US federal income taxation The following is a general discussion of the material US federal income tax consequences of the ownership and disposition of our shares or ADRs that may be relevant to you if you are a US Holder (as defined below). Because this discussion does not consider any specific circum- stances of any particular holder of our shares or ADRs, persons who are subject to US taxation are strongly urged to consult their own tax advisors as to the overall US federal, state and local tax consequences, as well as to the overall Swiss and other foreign tax consequences, of the ownership and disposition of our shares or ADRs. In particular, additional or different rules may apply to US expatriates; banks and other financial institutions; regu- lated investment companies; traders in securities who elect to apply a mark-to-market method of accounting; dealers in securities or currencies; tax-exempt entities; insurance companies; broker-dealers; investors liable for alternative minimum tax; investors that hold shares or ADRs as part of a straddle, hedging or conversion trans- action; holders whose functional currency is not the US dollar; partnerships or other pass-through entities; per- sons who acquired our shares pursuant to the exercise of employee stock options or otherwise as compensa- tion; and persons who hold, directly, indirectly or by attri- bution, 10% or more of our outstanding shares. This dis- cussion generally applies only to US Holders who hold the shares or ADRs as a capital asset (generally, for investment purposes), and whose functional currency is the US dollar. Investors are urged to consult their own tax advisors concerning whether they are eligible for benefits under the Treaty. For purposes of this discussion, a US Holder is a ben- eficial owner of our shares or ADRs who is (i) an individ- ual who is a citizen or resident of the US for US federal income tax purposes; (ii) a corporation (or other entity taxable as a corporation for US federal income tax pur- poses) created or organized in or under the laws of the US or a state thereof or the District of Columbia; (iii) an estate the income of which is subject to US federal income taxation regardless of its source; or (iv) a trust Dividends. US Holders will be required to include in gross income, as an item of ordinary income, the full amount (including the amount of any Withholding Tax) of a divi- dend paid with respect to our shares or ADRs at the time that such dividend is received by the US Holder, in the case of shares, or by the depositary, in the case of ADRs. For this purpose, a “dividend” will include any distribu- tion paid by us with respect to our shares or ADRs (other than certain pro rata distributions of our capital stock) paid out of our current or accumulated earnings and prof- its, as determined under US federal income tax princi- ples. To the extent the amount of a distribution by us exceeds our current and accumulated earnings and prof- its, such excess will first be treated as a tax-free return of capital to the extent of a US Holder’s tax basis in the shares or ADRs (with a corresponding reduction in such tax basis), and thereafter will be treated as capital gain, which will be long-term capital gain if the US Holder held our shares or ADRs for more than one year. Under the Code, dividend payments by us on the shares or ADRs are not eligible for the dividends received deduction gen- erally allowed to corporate shareholders. Dividend income in respect of our shares or ADRs will constitute income from sources outside the US for US foreign tax credit purposes. Subject to the limitations and conditions provided in the Code, US Holders gener- ally may claim as a credit against their US federal income tax liability, any Withholding Tax withheld from a dividend. The rules governing the foreign tax credit are complex. Each US Holder is urged to consult its own tax advisor concerning whether, and to what extent, a foreign tax credit will be available with respect to dividends received from us. Alternatively, a US Holder may claim the With- holding Tax as a deduction for the taxable year within which the Withholding Tax is paid or accrued, provided a deduction is claimed for all of the foreign income taxes the US Holder pays or accrues in the particular year. A deduction does not reduce US tax on a dollar-for-dollar basis like a tax credit. The deduction, however, is not subject to the limitations applicable to foreign tax cred- its, but may be subject to other limitations, and each US Holder is urged to consult its own tax advisor. 213 Item 10. Additional Information The US Treasury has expressed concern that parties to whom ADRs are released may be taking actions incon- sistent with the claiming of foreign tax credits for US Holders of ADRs. Accordingly, the summary above of the creditability of the Withholding Tax could be affected by future actions that may be taken by the US Treasury. In general, a US Holder will be required to determine the amount of any dividend paid in Swiss francs, includ- ing the amount of any Withholding Tax imposed thereon, by translating the Swiss francs into US dollars at the spot rate on the date the dividend is actually or constructively received by a US Holder, in the case of shares, or by the depositary, in the case of ADRs, regardless of whether the Swiss francs are in fact converted into US dollars. If a US Holder converts the Swiss francs so received into US dollars on the date of receipt, the US Holder gener- ally should not recognize foreign currency gain or loss on such conversion. If a US Holder does not convert the Swiss francs so received into US dollars on the date of receipt, the US Holder will have a tax basis in the Swiss francs equal to the US dollar value on such date. Any for- eign currency gain or loss that a US Holder recognizes on a subsequent conversion or other disposition of the Swiss francs generally will be treated as US source ordi- nary income or loss. For a non-corporate US Holder, the US dollar amount of any dividends paid that constitute qualified dividend income generally will be taxable at a maximum rate of 15% (or 20% in the case of taxpayers with annual income that exceeds certain thresholds), provided that the US Holder meets certain holding period and other require- ments. In addition, the dividends could be subject to a 3.8% net investment income tax. This tax is applied against the lesser of the US Holder’s net investment income or the amount by which modified adjusted gross income exceeds a statutory threshold amount based on filing status. We currently believe that dividends paid with respect to our shares and ADRs will constitute qualified dividend income for US federal income tax purposes. US Holders of shares or ADRs are urged to consult their own tax advisors regarding the availability to them of the reduced dividend rate in light of their own particular sit- uation and the computations of their foreign tax credit limitation with respect to any qualified dividends paid to them, as applicable. Sale or other taxable disposition. Upon a sale or other taxable disposition of shares or ADRs, US Holders gen- erally will recognize capital gain or loss in an amount equal to the difference between the US dollar value of the amount realized on the disposition and the US Hold- er’s tax basis (determined in US dollars) in the shares or ADRs. This capital gain or loss generally will be US source gain or loss and will be treated as long-term cap- ital gain or loss if the holding period in the shares or ADRs exceeds one year. In the case of a non-corporate US Holder, any long-term capital gain generally will be sub- ject to US federal income tax at preferential rates, with a maximum rate of 15% (or 20% in the case of taxpayers with annual income that exceeds certain thresholds). In addition, the gains could be subject to a 3.8% investment income tax. This tax is applied against the lesser of the US Holder’s net investment income or the amount by which modified adjusted gross income exceeds a stat- utory threshold amount based on filing status. The deductibility of capital losses is subject to significant lim- itations under the Code. Deposits or withdrawals of our shares by US Holders in exchanges for ADRs will not result in the realization of gain or loss for US federal income tax purposes. US information reporting and backup withholding. Divi- dend payments with respect to shares or ADRs and pro- ceeds from the sale, exchange or other disposition of shares or ADRs received in the United States or through US-related financial intermediaries may be subject to information reporting to the US Internal Revenue Service (IRS) and possible US backup withholding. Certain exempt recipients (such as corporations) are not subject to these information reporting and backup withholding requirements. Backup withholding will not apply to a US Holder who furnishes a correct taxpayer identification number and makes any other required certification or who is otherwise exempt from backup withholding. Any US Holders required to establish their exempt status generally must provide a properly executed IRS Form W-9 (Request for Taxpayer Identification Number and Certi- fication). Backup withholding is not an additional tax. Amounts withheld as backup withholding may be cred- ited against a US Holder’s US federal income tax liabil- ity, and a US Holder may obtain a refund of any excess amounts withheld under the backup withholding rules by timely filing the appropriate claim for refund with the IRS and furnishing any required information. 10.F Dividends and paying agents Not applicable. 10.G Statement by experts Not applicable. 214 Item 10. Additional Information 10.H Documents on display Any statement in this Form 20-F about any of our con- tracts or other documents is not necessarily complete. If the contract or document is filed as an exhibit to the Form 20-F, the contract or document is deemed to mod- ify the description contained in this Form 20-F. You must review the exhibits themselves for a complete descrip- tion of the contract or document. The SEC maintains an internet site at http://www.sec. gov that contains reports and other information regard- ing issuers that file electronically with the SEC. These SEC filings are also available to the public from commer- cial document retrieval services. We are required to file or furnish reports and other information with the SEC under the Securities Exchange Act of 1934 and regulations under that act. As a foreign private issuer, we are exempt from the rules under the Exchange Act prescribing the form and content of proxy statements, and our officers, directors and principal shareholders are exempt from the reporting and short swing profit recovery provisions contained in Section 16 of the Exchange Act. 10.I Subsidiary information Not applicable. 215 Item 11. Quantitative and Qualitative Disclosures About Market Risk Item 11. Quantitative and Qualitative Disclosures About Market Risk The major financial risks facing the Group are managed centrally by Group Treasury. We have a written Treasury Directive and have implemented a strict segregation of front-office and back-office controls. The Group does regular reconciliations of its positions with its counter- parties. In addition, the Treasury function is included in management’s internal control assessment. For information about the effects of currency fluctu- ations and how we manage currency risk, see “Item 5. Operating and Financial Review and Prospects—Item 5.B Liquidity and capital resources.” The information set forth under “Item 18. Financial Statements—Note 28. Financial instruments—additional disclosures” is incorporated by reference. 216 Item 12. Description of Securities Other Than Equity Securities Item 12. Description of Securities Other Than Equity Securities 12.A Debt securities Not applicable. 12.B Warrants and rights Not applicable. 12.C Other securities Not applicable. 12.D American Depositary Shares Fees payable by ADR holders According to our Deposit Agreement with the ADS depositary, JPMorgan Chase Bank, N.A. (JPMorgan), holders of our ADRs may have to pay to JPMorgan, either directly or indirectly, fees or charges up to the amounts set forth below: Category Depositary actions Depositing or substituting Acceptance of shares surrendered, and issuance of ADRs in exchange, underlying shares including surrenders and issuances in respect of: — Share distributions — Stock split — Rights — Merger — Exchange of shares or any other transaction or event or other distribution affecting the ADSs or the deposited shares Acceptance of ADRs surrendered for withdrawal of deposited shares Distribution or sale of shares, the fee being in an amount equal to the fee for the execution and delivery of ADRs that would have been charged as a result of the deposit of such shares Associated fee USD 5.00 for each 100 ADSs (or portion thereof) evidenced by the new ADRs delivered USD 5.00 for each 100 ADSs (or portion thereof) evidenced by the ADRs surrendered USD 5.00 for each 100 ADSs (or portion thereof) Transfers, combining or grouping of depositary receipts USD 1.50 per ADR Expenses incurred on behalf of holders in connection with: — Compliance with foreign exchange control regulations or any law or regulation relating to foreign investment — The depositary’s or its custodian’s compliance with applicable law, rule or regulation — Stock transfer or other taxes and other governmental charges — Cable, telex and facsimile transmission and delivery — Expenses of the depositary in connection with the conversion of foreign currency into US dollars (which are paid out of such foreign currency) — Any other charge payable by any of the depositary or its agents Expenses payable at the sole discretion of the depositary by billing holders or by deducting charges from one or more cash dividends or other cash distributions Advance tax relief Tax relief/reclamation process for qualified holders A depositary service charge of USD 0.008 per ADS 217 Withdrawing underlying shares Selling or exercising rights Transferring, splitting or grouping receipts Expenses of the depositary Item 12. Description of Securities Other Than Equity Securities Fees payable by the depositary to the issuer Pursuant to an agreement effective as of May 11, 2017 (the Agreement), JPMorgan, as our ADS depositary, has agreed to make an annual contribution payment to Novartis at the end of each 12-month period beginning on the effective date of the Agreement and on each sub- sequent anniversary of the effective date of the Agree- ment (each such 12-month period is a “Contract Year”). This annual contribution payment will equal: (a)(1) USD 1.7 million less (a)(2) the custody costs, fees and expenses (including, without limitation, any central securities depository fees, charges and expenses) incurred during the applicable Contract Year (the items in (a)(2) collec- tively are the “Custody Costs”) plus (b) 70% of the gross issuance and cancellation fees collected by JPMorgan under the Deposit Agreement during such Contract Year minus (c) that portion (if any) of JPMorgan’s legal fees, charges and out-of-pocket expenses in excess of USD 50 000 for such Contract Year. To the extent that the Custody Costs for a Contract Year exceed USD 1.7 mil- lion, these costs would be capped at USD 1.7 million. JPMorgan has further agreed to waive the USD 0.05 per ADS issuance fees that would normally be owed by Novartis in connection with our deposits of shares as part of our employee stock ownership and employee par- ticipation plans. Novartis is responsible for reimbursing JPMorgan for all taxes and governmental charges required to have been withheld and/or paid, and not so withheld and/or paid, arising from such waived fees. 218 Item 13. Defaults, Dividend Arrearages and Delinquencies PART II Item 13. Defaults, Dividend Arrearages and Delinquencies None. 219 Item 14. Material Modifications to the Rights of Security Holders and Use of Proceeds Item 14. Material Modifications to the Rights of Security Holders and Use of Proceeds None. 220 Item 15. Controls and Procedures Item 15. Controls and Procedures Report of Novartis Management on Internal Control Over Financial Reporting Novartis AG’s Chief Executive Officer and Chief Finan‑ cial Officer, after evaluating the effectiveness of our dis‑ closure controls and procedures (as defined in Exchange Act Rule 13a‑15(e)) as of the end of the period covered by this Annual Report, have concluded that, as of such date, our disclosure controls and procedures were effec‑ tive. The Board of Directors and management of the Group are responsible for establishing and maintaining adequate internal control over financial reporting. The Group’s internal control system was designed to provide reasonable assurance to the Group’s management and Board of Directors regarding the reliability of financial reporting and the preparation and fair presentation of its published consolidated financial statements. All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective may not pre‑ vent or detect misstatements and can provide only rea‑ sonable assurance with respect to financial statement preparation and presentation. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compli‑ ance with the policies or procedures may deteriorate. Group management assessed the effectiveness of the Group’s internal control over financial reporting as of December 31, 2018. In making this assessment, it used the criteria established in Internal Control—Integrated Framework (2013) issued by the Committee of Sponsor‑ ing Organizations of the Treadway Commission (COSO). Based on our assessment, management concluded that, as of December 31, 2018, the Group’s internal control over financial reporting is effective based on those cri‑ teria. PricewaterhouseCoopers AG, Switzerland, an inde‑ pendent registered public accounting firm, has issued an unqualified opinion on the effectiveness of the Group’s internal control over financial reporting, which is included in this Annual Report under “Item 18. Financial State‑ ments—Report of independent registered public accounting firm.” See the report of PwC, an independent registered public accounting firm, included under “Item 18. Finan‑ cial Statements—Report of independent registered pub‑ lic accounting firm.” There were no changes to our internal control over financial reporting that occurred during the period cov‑ ered by this Annual Report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. Vas Narasimhan Chief Executive Officer Harry Kirsch Chief Financial Officer Basel, January 29, 2019 221 Item 16A. Audit Committee Financial Expert Item 16A. Audit Committee Financial Expert Our Audit and Compliance Committee has determined that Srikant Datar and Elizabeth Doherty each possess specific accounting and financial management expertise and that each is an Audit Committee Financial Expert as defined by the US Securities and Exchange Commission (SEC). The Board of Directors has also determined that Srikant Datar and Elizabeth Doherty are each “indepen‑ dent” in accordance with the applicable requirements of Rule 10A‑3 of the US Securities Exchange Act of 1934, and that other members of the Audit and Compliance Committee have sufficient experience and ability in finance and compliance matters to enable them to ade‑ quately discharge their responsibilities. 222 Item 16B. Code of Ethics Item 16B. Code of Ethics In addition to our Code of Conduct and Professional Practices Policy, which are applicable to all of our asso‑ ciates, we have adopted Ethical Conduct Requirements that impose additional obligations on our principal exec‑ utive officer, principal financial officer, principal account‑ ing officer, and persons performing similar functions. This document is accessible on our internet website at: https://www.novartis.com/investors/company‑over‑ view/corporate‑governance 223 Item 16C. Principal Accountant Fees and Services Item 16C. Principal Accountant Fees and Services The information set forth under “Item 6. Directors, Senior Management and Employees—Item 6.C Board practices— Corporate governance—Our independent external auditors” is incorporated by reference. 224 Item 16D. Exemptions from the Listing Standards for Audit Committees Item 16D. Exemptions from the Listing Standards for Audit Committees Not applicable. 225 Item 16E. Purchases of Equity Securities by the Issuer and Affiliated Purchasers Item 16E. Purchases of Equity Securities by the Issuer and Affiliated Purchasers Total number of shares purchased as part of publicly announced plans or programs (c) 2 Average price Total Number of paid per share in USD (b) Shares Purchased (a) 1 861 113 81 918 62 593 86.92 86.68 82.64 0 0 0 1 035 141 77.12 1 000 000 4 060 146 76.92 4 000 000 4 219 696 74.93 4 200 000 5 535 887 80.44 5 520 000 3 503 739 83.29 3 480 000 3 010 401 84.20 2 980 000 1 391 780 84.63 1 370 000 18 012 86.61 0 716 316 84.81 700 000 24 496 742 80.26 23 250 000 Maximum approximate value of shares that may yet be purchased under the plans or programs (CHF millions) (d) Maximum approximate value of shares that may yet be purchased under the plans or programs (USD millions) (e) 3 4 045 4 045 4 045 3 970 3 663 3 351 2 910 2 623 2 380 2 265 2 265 2 207 4 340 4 300 4 227 4 018 3 705 3 369 2 947 2 711 2 437 2 254 2 274 2 237 2018 Jan. 1‑31 Feb. 1‑28 Mar. 1‑31 Apr. 1‑30 May 1‑31 Jun. 1‑30 Jul. 1‑31 Aug. 1‑31 Sep. 1‑30 Oct. 1‑31 Nov. 1‑30 Dec. 1‑31 Total 1 Column (a) shows shares we purchased as part of our seventh share repurchase program plus the following types of share purchases outside of our publicly announced repurchase program: (1) shares which we purchased on the open market; and (2) shares which we purchased from employees who had obtained the shares through a Novartis Employee Ownership Plan. See “Item 18. Financial Statements – Note 25 Equity‑based participation plans for associates.” 2 Column (c) shows shares purchased as part of our seventh share repurchase program which was approved by the shareholders February 23, 2016 for an amount of up to CHF 10.0 billion. See “Item 6. Directors, Senior Management and Employees – Item 6C. Board Practices – Our capital structure – Changes in capital.” 3 Column (e) shows the Swiss franc amount from column (d) converted into US dollars as of the month‑end, using the Swiss franc/US dollar exchange rate at the applicable month‑end. 226 Item 16F. Change in Registrant’s Certifying Accountant Item 16F. Change in Registrant’s Certifying Accountant Not applicable. 227 Item 16G. Corporate Governance Item 16G. Corporate Governance The information set forth under “Item 6. Directors, Senior Management and Employees—Item 6.C Board practices— Corporate governance—Our corporate governance framework” is incorporated by reference. 228 Item 16H. Mine Safety Disclosure Item 16H. Mine Safety Disclosure Not applicable. 229 Item 17. Financial Statements PART III Item 17. Financial Statements See response to “Item 18. Financial Statements.” 230 Item 18. Financial Statements Item 18. Financial Statements The following financial statements are filed as part of this Annual Report. Consolidated income statements Consolidated statements of comprehensive income Consolidated balance sheets Consolidated statements of changes in equity Consolidated statements of cash flows Notes to the Novartis Group consolidated financial statements 1. Significant accounting policies 2. Significant transactions 3. Segmentation of key figures 2018, 2017 and 2016 4. Associated companies 5. Interest expense and other financial income and expense 6. Taxes 7. Earnings per share 8. Changes in consolidated statements of comprehensive income 9. Property, plant and equipment 10. Goodwill and intangible assets 11. Deferred tax assets and liabilities 12. Financial and other non‑current assets 13. Inventories 14. Trade receivables 15. Marketable securities, commodities, time deposits, derivative financial instruments, and cash and cash equivalents 16. Other current assets 17. Equity 18. Non‑current financial debt 19. Provisions and other non‑current liabilities 20. Current financial debt and derivative financial instruments 21. Provisions and other current liabilities 22. Details to the consolidated statements of cash flows 23. Acquisitions of businesses 24. Post‑employment benefits for associates 25. Equity‑based participation plans for associates 26. Transactions with related parties 27. Commitments and contingencies 28. Financial instruments – additional disclosures 29. Impacts of adoption of new IFRS standards 30. Events subsequent to the December 31, 2018, consolidated balance sheet date 31. Principal Group subsidiaries and associated companies Report of Independent Registered Public Accounting Firm Report of the statutory auditor on the consolidated financial statements of Novartis AG Financial statements of Novartis AG Notes to the financial statements of Novartis AG Appropriation of available earnings and reserves of Novartis AG Report of the statutory auditor on the financial statements of Novartis AG Page F‑1 F‑2 F‑3 F‑4 F‑5 F‑6 F‑6 F‑16 F‑18 F‑29 F‑30 F‑31 F‑32 F‑32 F‑35 F‑37 F‑40 F‑42 F‑42 F‑43 F‑44 F‑44 F‑45 F‑47 F‑48 F‑53 F‑53 F‑55 F‑57 F‑58 F‑62 F‑65 F‑66 F‑68 F‑77 F‑79 F‑80 F‑82 F‑83 A‑1 A‑3 A‑11 A‑13 231 Item 19. Exhibits Item 19. Exhibits The SEC maintains an internet site at http://www.sec.gov that contains reports and other information regarding issuers that file electronically with the SEC. These SEC filings are also available to the public from commercial doc‑ ument retrieval services. 1.1 Articles of Incorporation of Novartis AG, as amended March 2, 2018 (English translation). 1.2 Regulations of the Board of Directors, its Committees and the Executive Committee of Novartis AG, as amended in relevant part January 1, 2014, March 1, 2015, January 1, 2018, and January 21, 2019. 2.1 Amended and Restated Deposit Agreement, dated as of May 11, 2000, among Novartis AG, JPMorgan Chase Bank (fka Morgan Guaranty Trust Company of New York), as depositary, and all holders from time to time of ADRs issued thereunder (incorporated by reference to Exhibit (a)(1) to Post‑Effective Amend‑ ment No. 1 to Novartis AG’s registration statement on Form F‑6 (File No. 333‑11758) as filed with the SEC on September 8, 2000). 2.2 Amendment No. 1 to the Amended and Restated Deposit Agreement (incorporated by reference to Exhibit (a)(2) to Post‑Effective Amendment No. 1 to Novartis AG’s registration statement on Form F‑6 (File No. 333‑11758) as filed with the SEC on September 8, 2000). 2.3 Amendment No. 2 to the Amended and Restated Deposit Agreement (incorporated by reference to Exhibit (a)(3) to Novartis AG’s registration statement on Form F‑6 (File No. 333‑13446) as filed with the SEC on May 3, 2001). 2.4 Restricted Issuance Agreement dated as of January 11, 2002, among Novartis AG, J.P. Morgan Chase Bank, as depositary, and all holders from time to time of ADRs representing ADSs issued thereunder (incorporated by reference to Exhibit 4 to the Registration Statement on Form F‑3, File No. 333‑81862, as filed with the SEC on January 31, 2002). 2.5 Letter Agreement dated December 14, 2007, between Novartis AG and JPMorgan Chase Bank, as depos‑ itary (incorporated by reference to Exhibit 2.4 to the Form 20‑F for the year ended December 31, 2007, as filed with the SEC on January 28, 2008). 2.6 Form of American Depositary Receipt (incorporated by reference to Exhibit (a)(7) to the Registration Statement on Form F‑6, File No. 333‑198623, as filed with the SEC on September 8, 2014). 2.7 The total amount of long‑term debt securities authorized under any instrument does not exceed 10% of the total assets of the Company and its subsidiaries on a consolidated basis. We hereby agree to furnish to the SEC, upon its request, a copy of any instrument defining the rights of holders of long‑term debt of the Company or of its subsidiaries for which consolidated or unconsolidated financial statements are required to be filed. 4.1 Put Option Implementation Agreement relating to the cancellation of our shares in GlaxoSmithKline Con‑ sumer Healthcare Holdings Limited made on March 27, 2018, between GlaxoSmithKline PLC, Setfirst Limited, Novartis AG, Novartis Holding AG, Novartis Finance Corporation and GlaxoSmithKline Consumer Healthcare Holdings Limited. 4.2 Agreement and Plan of Merger dated as of April 6, 2018, among Novartis AG, Novartis AM Merger Cor‑ poration and Avexis, Inc. (incorporated by reference to Exhibit 2.1 to the Current Report on Form 8‑K of AveXis, Inc. as filed with the SEC on April 9, 2018). 8.1 For a list of all of our principal Group subsidiaries and associated companies, see “Item 18. Financial Statements—Note 31. Principal Group subsidiaries and associated companies.” 232 Item 19. Exhibits 12.1 Certification of Vasant Narasimhan, Chief Executive Officer of Novartis AG, pursuant to Section 302 of the Sarbanes‑Oxley Act of 2002. 12.2 Certification of Harry Kirsch, Chief Financial Officer of Novartis AG, pursuant to Section 302 of the Sar‑ banes‑Oxley Act of 2002. 13.1 Certification of Vasant Narasimhan, Chief Executive Officer of Novartis AG, pursuant to Section 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes‑Oxley Act of 2002. 13.2 Certification of Harry Kirsch, Chief Financial Officer of Novartis AG, pursuant to Section 18 U.S.C. Sec‑ tion 1350, as adopted pursuant to Section 906 of the Sarbanes‑Oxley Act of 2002. 15.1 Consent of PricewaterhouseCoopers AG. 101.INS XBRL Instance Document 101.SCH XBRL Taxonomy Extension Schema Document 101.CAL XBRL Taxonomy Extension Calculation Linkbase Document 101.DEF XBRL Taxonomy Extension Definition Linkbase Document 101.LAB XBRL Taxonomy Extension Label Linkbase Document 101.PRE XBRL Taxonomy Extension Presentation Linkbase Document 233 (This page has been left blank intentionally.) 234 Novartis Group consolidated financial statements Novartis Group consolidated financial statements Consolidated income statements (For the years ended December 31, 2018, 2017 and 2016) (USD millions unless indicated otherwise) Net sales to third parties Other revenues Cost of goods sold Gross profit Selling, general and administration Research and development Other income Other expense Operating income Income from associated companies Interest expense Other financial income and expense Income before taxes Taxes Net income Attributable to: Shareholders of Novartis AG Non-controlling interests Basic earnings per share (USD) Diluted earnings per share (USD) The accompanying Notes form an integral part of the consolidated financial statements. Note 2018 2017 2016 3 3 51 900 49 109 48 518 1 266 1 026 918 – 18 407 – 17 175 – 17 520 34 759 32 960 31 916 – 16 471 – 14 997 – 14 192 – 9 074 – 8 972 – 9 039 1 690 1 969 1 927 – 2 735 – 2 331 – 2 344 4 5 5 8 169 6 438 – 957 185 8 629 1 108 – 777 39 13 835 8 999 8 268 703 – 707 – 447 7 817 6 – 1 221 – 1 296 – 1 119 12 614 7 703 6 698 12 611 7 703 6 712 3 0 – 14 7 7 5.44 3.28 2.82 5.38 3.25 2.80 F-1 Novartis Group consolidated financial statements Consolidated statements of comprehensive income (For the years ended December 31, 2018, 2017 and 2016) (USD millions) Net income Note 2018 2017 12 614 7 703 Other comprehensive income to be eventually recycled into the consolidated income statement: 2016 6 698 – 113 15 – 98 671 39 – 1 12 50 – 37 – 237 2 210 – 2 391 1 986 – 1 818 851 – 515 8.1 8.1 8.1 4 8 8.2 8.3 8.1 12 12 – 482 95 315 – 60 – 359 13 – 346 12 208 10 540 851 – 515 4 365 12 210 10 538 4 382 – 2 2 – 17 Fair value adjustments on marketable securities, net of taxes Fair value adjustments on debt securities, net of taxes Fair value adjustments on deferred cash flow hedges, net of taxes Total fair value adjustments on financial instruments, net of taxes Novartis share of other comprehensive income recognized by associated companies, net of taxes Net investment hedge Currency translation effects Total of items to eventually recycle Other comprehensive income never to be recycled into the consolidated income statement: Actuarial (losses)/gains from defined benefit plans, net of taxes Fair value adjustments on equity securities, net of taxes Total of items never to be recycled Total comprehensive income Attributable to: Shareholders of Novartis AG Non-controlling interests The accompanying Notes form an integral part of the consolidated financial statements. F-2 Novartis Group consolidated financial statements Consolidated balance sheets (At December 31, 2018 and 2017) (USD millions) Assets Non-current assets Property, plant and equipment Goodwill Intangible assets other than goodwill Investments in associated companies Deferred tax assets Financial assets Other non-current assets Total non-current assets Current assets Inventories Trade receivables Income tax receivables Marketable securities, commodities, time deposits and derivative financial instruments Cash and cash equivalents Other current assets Total current assets without disposal group Assets of disposal group held for sale Total current assets Total assets Equity and liabilities Equity Share capital Treasury shares Reserves Issued share capital and reserves attributable to Novartis AG shareholders Non-controlling interests Total equity Liabilities Non-current liabilities Financial debts Deferred tax liabilities Provisions and other non-current liabilities Total non-current liabilities Current liabilities Trade payables Financial debts and derivative financial instruments Current income tax liabilities Provisions and other current liabilities Total current liabilities without disposal group Liabilities of disposal group held for sale Total current liabilities Total liabilities Total equity and liabilities The accompanying Notes form an integral part of the consolidated financial statements. F-3 Note 2018 2017 9 10 10 4 11 12 12 13 14 15 15 16 15 696 16 464 35 294 31 750 38 719 29 997 8 352 15 370 8 699 2 345 895 8 229 2 243 818 110 000 104 871 6 956 8 727 248 2 693 13 271 2 861 6 867 8 600 202 625 8 860 3 054 34 756 28 208 2 807 35 563 28 208 145 563 133 079 17 17 944 – 69 969 – 100 77 739 73 299 78 614 74 168 78 59 78 692 74 227 18 11 19 20 22 470 23 224 7 475 7 319 5 168 7 057 37 264 35 449 5 556 9 678 2 038 5 169 5 308 1 723 21 12 284 11 203 29 556 23 403 2 51 29 607 23 403 66 871 58 852 145 563 133 079 Novartis Group consolidated financial statements Consolidated statements of changes in equity (For the years ended December 31, 2018, 2017 and 2016) (USD millions) Note Share capital Treasury shares Issued share capital and reserves attributable Retained Total value to Novartis earnings adjustments shareholders Non- controlling interests Total equity Total equity at January 1, 2016 991 – 101 80 379 – 4 223 77 046 76 77 122 Net income Other comprehensive income Total comprehensive income Dividends Purchase of treasury shares Reduction of share capital Exercise of options and employee transactions Equity-based compensation 8 17.1 17.2 17 – 19 17.2 17.2 Impact of change in ownership of consolidated entities 17.5 Fair value adjustments related to divestments 8 6 712 6 712 – 14 6 698 671 – 3 001 – 2 330 – 3 – 2 333 7 383 – 3 001 4 382 – 17 4 365 – 7 25 2 5 – 6 475 – 985 – 6 212 659 – 7 – 12 – 6 475 – 992 214 664 – 7 12 – 6 475 – 992 214 664 – 7 Total of other equity movements Total equity at December 31, 2016 – 19 972 25 – 6 614 12 – 6 596 – 6 596 – 76 81 148 – 7 212 74 832 59 74 891 Net income Other comprehensive income Total comprehensive income Dividends Purchase of treasury shares Reduction of share capital Exercise of options and employee transactions Equity-based compensation Changes in non-controlling interests Total of other equity movements Total equity at December 31, 2017, as previously reported 8 17.1 17.2 17 17.2 17.2 17.6 7 703 7 703 – 37 2 872 2 835 7 666 2 872 10 538 – 3 – 6 495 – 36 – 5 538 5 2 5 – 2 253 607 – 6 495 – 5 574 255 612 7 703 2 837 10 540 – 6 495 – 5 574 255 612 – 2 2 2 – 2 – 3 – 24 – 11 175 – 11 202 – 2 – 11 204 969 – 100 77 639 – 4 340 74 168 59 74 227 Impact of change in accounting policies 1, 29 237 – 177 60 60 Restated equity at January 1, 2018 969 – 100 77 876 – 4 517 74 228 59 74 287 Net income Other comprehensive income Total comprehensive income Dividends Purchase of treasury shares Reduction of share capital 8 17.1 17.2 12 611 – 482 12 129 – 6 966 – 13 – 1 960 81 81 12 611 3 12 614 – 401 – 5 – 406 12 210 – 6 966 – 1 973 – 2 12 208 – 6 966 – 1 973 17 – 25 34 Exercise of options and employee transactions Other share sales Equity-based compensation Increase of treasury share repurchase obligation under a share buyback trading plan Transaction costs Fair value adjustments on financial assets sold 17.2 17.2 17.2 17.3 17.4 8 Impact of change in ownership of consolidated entities 17.5 Changes in non-controlling interests Other movements Total of other equity movements Total equity at December 31, 2018 17.6 17.7 4 2 4 – 9 430 261 752 – 284 – 79 16 – 13 38 434 263 756 – 284 – 79 – 13 38 434 263 756 – 284 – 79 9 – 1 38 22 – 1 – 16 – 25 944 31 – 7 814 – 16 – 7 824 21 – 7 803 – 69 82 191 – 4 452 78 614 78 78 692 The accompanying Notes form an integral part of the consolidated financial statements. F-4 Novartis Group consolidated financial statements Consolidated statements of cash flows (For the years ended December 31, 2018, 2017 and 2016) (USD millions) Net income Note 2018 2017 12 614 7 703 2016 6 698 Adjustments to reconcile net income to net cash flows from operating activities Reversal of non-cash items and other adjustments 22.1 3 171 7 058 8 437 Dividends received from associated companies and others Interest received Interest paid Other financial receipts Other financial payments Taxes paid 1 719 243 987 97 899 43 – 826 – 708 – 723 218 – 32 – 272 – 155 – 1 670 – 1 611 – 2 111 Net cash flows from operating activities before working capital and provision changes 14 437 13 254 13 088 Payments out of provisions and other net cash movements in non-current liabilities – 664 – 877 – 1 536 Change in net current assets and other operating cash flow items 22.2 499 244 – 77 Net cash flows from operating activities Purchase of property, plant and equipment Proceeds from sales of property, plant and equipment Purchase of intangible assets Proceeds from sales of intangible assets Purchase of financial assets Proceeds from sales of financial assets Purchase of other non-current assets Proceeds from sales of other non-current assets Divestments and acquisitions of interests in associated companies, net 1 Acquisitions and divestments of businesses, net Purchase of marketable securities and commodities Proceeds from sales of marketable securities and commodities 14 272 12 621 11 475 – 1 773 – 1 696 – 1 862 102 92 161 – 1 582 – 1 050 – 1 017 823 640 – 262 – 468 167 – 39 9 22.3 12 854 22.4 – 13 922 – 2 440 472 330 – 42 1 29 – 784 – 580 549 847 – 247 247 – 149 – 765 – 530 622 Net cash flows used in investing activities from continuing operations – 5 591 – 2 979 – 2 693 Net cash flows used in investing activities from discontinued operations 1 22.5 – 140 – 748 Total net cash flows used in investing activities Dividends paid to shareholders of Novartis AG Acquisition of treasury shares Proceeds from exercise options and other treasury share transactions Increase in non-current financial debts Repayment of non-current financial debts Change in current financial debts Impact of change in ownership of consolidated entities Transaction costs payments 2 Dividends paid to non-controlling interests and other financing cash flows Net cash flows used in financing activities Effect of exchange rate changes on cash and cash equivalents Net change in cash and cash equivalents Cash and cash equivalents at January 1 Cash and cash equivalents at December 31 The accompanying Notes form an integral part of the consolidated financial statements. 22.6 22.6 22.6 – 5 591 – 3 119 – 3 441 – 6 966 – 6 495 – 6 475 – 2 036 – 5 490 – 1 109 700 2 856 – 366 1 681 – 19 – 57 – 37 252 214 4 933 1 935 – 188 – 1 696 – 755 1 816 0 – 6 10 7 – 4 244 – 7 733 – 5 314 – 26 4 411 8 860 13 271 84 1 853 7 007 8 860 – 387 2 333 4 674 7 007 1 In 2018, the total net tax payment amounted to USD 1 809 million, of which USD 139 million is included in the line “Divestments and acquisitions of interests in associated companies, net.” In 2016, the total net tax payment amounted to USD 2 299 million, of which USD 188 million was included in the cash flows used in investing activities from discontinued operations. 2 Transaction costs payments directly attributable to the pending transaction of the distribution (spin-off) of the Alcon Division to Novartis AG shareholders (see Note 1) F-5 Notes to the Novartis Group consolidated financial statements Notes to the Novartis Group consolidated financial statements 1. Significant accounting policies The Novartis Group (Novartis or Group) is a multinational group of companies specializing in the research, develop- ment, manufacturing and marketing of a broad range of healthcare products led by innovative pharmaceuticals and also including cost-saving generic pharmaceuticals and eye care products. The Group is head quartered in Basel, Switzerland. The consolidated financial statements of the Group are prepared in accordance with International Financial Reporting Standards (IFRS) as issued by the Interna- tional Accounting Standards Board (IASB). They are pre- pared in accordance with the historical cost convention except for items that are required to be accounted for at fair value. The Group’s financial year-end is December 31, which is also the annual closing date of the individual entities’ financial statements incorporated into the Group’s con- solidated financial statements. The preparation of financial statements requires management to make certain estimates and assump- tions, either at the balance sheet date or during the year, which affect the reported amounts of assets and liabili- ties, including any contingent amounts, as well as of rev- enues and expenses. Actual outcomes and results could differ from those estimates and assumptions. Listed below are accounting policies of significance to Novartis or, in cases where IFRS provides alternatives, the option adopted by Novartis. Scope of consolidation The consolidated financial statements include all enti- ties, including structured entities, over which Novartis AG, Basel, Switzerland, directly or indirectly has control (generally as a result of owning more than 50% of the entity’s voting interest). Consolidated entities are also referred to as “subsidiaries.” In cases where Novartis does not fully own a subsid- iary, it has elected to value any remaining outstanding non-controlling interest at the time of acquiring control of the subsidiary at its proportionate share of the fair value of the net identified assets. The contribution of a business to an associate or joint venture is accounted for by applying the option under IFRS that permits the accounting for the retained inter- est of the business contributed at its net book value at the time of the contribution. Investments in associated companies (generally defined as investments in entities in which Novartis holds between 20% and 50% of voting shares or over which it otherwise has significant influence) and joint ventures are accounted for using the equity method, except for selected venture fund investments for which the Group has elected to apply the method of fair value through the consolidated income statement. Foreign currencies The consolidated financial statements of Novartis are presented in US dollars (USD). The functional currency of subsidiaries is generally the local currency of the respective entity. The functional currency used for the reporting of certain Swiss and foreign finance entities is USD instead of their respective local currencies. This reflects the fact that the cash flows and transactions of these entities are primarily denominated in these curren- cies. For subsidiaries not operating in hyperinflationary economies, the subsidiary’s results, financial position and cash flows that do not have USD as their functional currency are translated into USD using the following exchange rates: • Income, expense and cash flows using for each month the average exchange rate, with the US dollar values for each month being aggregated during the year • Balance sheets using year-end exchange rates • Resulting exchange rate differences are recognized in other comprehensive income The hyperinflationary economies in which Novartis oper- ates are Argentina and Venezuela. Venezuela was hyper- inflationary for all years presented, and Argentina became hyperinflationary effective July 1, 2018, requir- ing retroactive implementation of hyperinflation account- ing as of January 1, 2018. The impact of the restatement of the non-monetary assets and liabilities with the general price index at the beginning of the period is recorded in retained earnings in equity. The subsequent gains or losses resulting from the restatement of non-monetary assets are recorded in “Other financial income and expense” in the consoli- dated income statement. Acquisition of assets Acquired assets are initially recognized on the balance sheet at cost if they meet the criteria for capitalization. If acquired as part of a business combination, the fair value of identified assets represents the cost for these assets. If separately acquired, the cost of the asset includes the purchase price and any directly attributable costs for bringing the asset into the condition to operate as intended. Expected costs for obligations to disman- tle and remove property, plant and equipment when they are no longer used are included in their cost. Property, plant and equipment Property, plant and equipment are depreciated on a straight-line basis in the consolidated income statement F-6 Notes to the Novartis Group consolidated financial statements over their estimated useful lives. Leasehold land is depre- ciated over the period of its lease, whereas freehold land is not depreciated. The related depreciation expense is included in the costs of the functions using the asset. Property, plant and equipment are assessed for impairment whenever there is an indication that the balance sheet carrying amount may not be recoverable using cash flow projections for the useful life. The following table shows the respective useful lives for property, plant and equipment: Buildings Machinery and other equipment Machinery and equipment Furniture and vehicles Computer hardware Useful life 20 to 40 years 7 to 20 years 5 to 10 years 3 to 7 years Government grants obtained for construction activities, including any related equipment, are deducted from the gross acquisition cost to arrive at the balance sheet car- rying value of the related assets. Goodwill and intangible assets Goodwill Goodwill arises in a business combination and is the excess of the consideration transferred to acquire a busi- ness over the underlying fair value of the net identified assets acquired. It is allocated to groups of cash-gener- ating units (CGUs), which are usually represented by the reported segments. Goodwill is tested for impairment annually at the level of these groups of CGUs, and any impairment charges are recorded under “Other expense” in the consolidated income statement. Intangible assets available for use Novartis has the following classes of available-for-use intangible assets: Currently marketed products; Market- ing know-how; Technologies; Other intangible assets (including computer software); and the Alcon brand name. Currently marketed products represent the compos- ite value of acquired intellectual property, patents, and distribution rights and product trade names. Marketing know-how represents the value attribut- able to the expertise acquired for marketing and distrib- uting Alcon surgical products. Technologies represent identified and separable acquired know-how used in the research, development and production processes. Significant investments in internally developed and acquired computer software are capitalized and included in the “Other” category and amortized once available for use. The Alcon brand name is shown separately, as it is the only Novartis intangible asset that is available for use with an indefinite useful life. Novartis considers that it is appropriate that the Alcon brand name has an indefinite life since Alcon-branded products have a history of strong revenue and cash flow performance, and Novartis has the intent and ability to support the brand with spend- ing to maintain its value for the foreseeable future. Except for the Alcon brand name, intangible assets available for use are amortized over their estimated use- ful lives on a straight-line basis and are evaluated for potential impairment whenever facts and circumstances indicate that their carrying value may not be recoverable. The Alcon brand name is not amortized, but evaluated for potential impairment annually. The following table shows the respective useful lives for available-for-use intangible assets and the location in the consolidated income statement in which the respective amortization and any potential impairment charge is recognized: Income statement location for amortization and impairment charges Useful life Currently marketed products 5 to 20 years “Cost of goods sold” Marketing know-how 25 years “Cost of goods sold” Technologies 10 to 20 years Other (including computer software) Alcon brand name 3 to 7 years Not amortized, indefinite useful life “Cost of goods sold” or “Research and development” In the respective functional expense “Other expense” Intangible assets not yet available-for-use Acquired research and development intangible assets, which are still under development and have accordingly not yet obtained marketing approval, are recognized as In-Process Research and Development (IPR&D). IPR&D is not amortized, but evaluated for potential impairment on an annual basis or when facts and circum- stances warrant. Any impairment charge is recorded in the consolidated income statement under “Research and development.” Once a project included in IPR&D has been successfully developed, it is transferred to the “Currently marketed products” category. Impairment of goodwill and intangible assets An asset is considered impaired when its balance sheet carrying amount exceeds its estimated recoverable amount, which is defined as the higher of its fair value less costs of disposal and its value in use. Usually, Novartis applies the fair value less costs of disposal method for its impairment assessment. In most cases, no directly observable market inputs are available to measure the fair value less costs of disposal. Therefore, an estimate is derived indirectly and is based on net pres- ent value techniques utilizing post-tax cash flows and discount rates. In the limited cases where the value in use method would be applied, net present value tech- niques would be applied using pre-tax cash flows and discount rates. Fair value less costs of disposal reflects estimates of assumptions that market participants would be expected to use when pricing the asset or CGUs, and for this pur- pose, management considers the range of economic F-7 Notes to the Novartis Group consolidated financial statements conditions that are expected to exist over the remaining useful life of the asset. The estimates used in calculating the net present val- ues are highly sensitive and depend on assumptions spe- cific to the nature of the Group’s activities with regard to: • Amount and timing of projected future cash flows • Long-term sales forecasts • Actions of competitors (launch of competing products, marketing initiatives, etc.) • Sales erosion rates after the end of patent or other intellectual property rights protection, and timing of the entry of generic competition • Outcome of research and development activities (com- pound efficacy, results of clinical trials, etc.) • Amount and timing of projected costs to develop IPR&D into commercially viable products • Probability of obtaining regulatory approval • Future tax rate • Appropriate royalty rate for the Alcon brand name • Appropriate terminal growth rate • Appropriate discount rate Generally, for intangible assets with a definite useful life, Novartis uses cash flow projections for the whole useful life of these assets. For goodwill and the Alcon brand name, Novartis generally utilizes cash flow projections for a five-year period based on management forecasts, with a terminal value based on cash flow projections usu- ally in line with inflation rates for later periods. Probabil- ity-weighted scenarios are typically used. Discount rates used consider the Group’s estimated weighted average cost of capital, adjusted for specific country and currency risks associated with cash flow projections to approximate the weighted average cost of capital of a comparable market participant. Due to the above factors, actual cash flows and val- ues could vary significantly from forecasted future cash flows and related values derived using discounting tech- niques. Impairment of associated companies accounted for at equity Novartis considers investments in associated compa- nies for impairment evaluation whenever objective evi- dence indicates the net investment may be impaired, including when a quoted share price indicates a fair value less than the per-share balance sheet carrying value for the investment. If the recoverable amount of the investment is esti- mated to be lower than the balance sheet carrying amount, an impairment charge is recognized for the dif- ference in the consolidated income statement under “Income from associated companies.” Cash and cash equivalents financial debts on the consolidated balance sheet, except in cases where a right of offset has been agreed with a bank, which then allows for presentation on a net basis. Marketable securities, commodities and non-current financial assets Commodities, which include gold bullion or coins, are valued at the lower of cost or fair value using current market prices. The changes in fair value below cost are immediately recorded in “Other financial income and expense.” Marketable securities are financial assets consisting principally of equity and debt securities as well as fund investments. Marketable securities held for short-term purposes are principally traded in liquid markets and are classified as marketable securities within current assets on the consolidated balance sheet. The financial impacts related to these financial assets are recorded in “Other financial income and expense” in the consolidated income statement. Marketable securities held for long- term strategic purposes are classified as non-current financial assets on the consolidated balance sheet. The financial impacts related to these financial assets are recorded in “Other income” and “Other expense” in the consolidated income statement. Marketable securities are initially recorded at fair value on their trade date, which is different from the set- tlement date when the transaction is ultimately effected. Quoted securities are remeasured at each reporting date to fair value based on current market prices. If the mar- ket for a financial asset is not active or no market is avail- able, fair values are established using valuation tech- niques. The majority of non-quoted investments are valued initially at fair value through the established pur- chase price between a willing buyer and seller. Non- quoted investments are subsequently adjusted based on values derived from discounted cash flow analysis or other pricing models. These investment values are clas- sified as “Level 3” in the fair value hierarchy. From January 1, 2018, with the adoption of IFRS 9 Financial Instruments, the Group classifies and accounts for its marketable securities and non-current financial assets in the following categories: • Debt securities are valued at fair value through other comprehensive income with subsequent recycling into the consolidated income statement, as they meet the “solely payment of principal and interest and business model” criteria. Unrealized gains and losses, except exchange gains and losses, are recorded as a fair value adjustment in the consolidated statement of compre- hensive income. They are recognized in the consoli- dated income statement when the debt instrument is sold, at which time the gain is transferred to “Other financial income and expense.” Exchange gains and losses related to debt instruments are immediately rec- ognized in the consolidated income statement to “Other financial income and expense.” Cash and cash equivalents include highly liquid invest- ments with original maturities of three months or less, which are readily convertible to known amounts of cash. Bank overdrafts are usually presented within current • Fund investments, equity securities of the Novartis Venture Fund and derivative assets are valued at fair value through profit and loss (FVPL). Unrealized gains and losses, including exchange gains and losses, are F-8 Notes to the Novartis Group consolidated financial statements recognized in the consolidated income statement, for marketable securities held for short-term purposes and derivative assets to “Other financial income and expense,” and for fund investments and equity securi- ties valued at FVPL, held for strategic purposes, to “Other income” for gains and “Other expense” for losses. • Equity securities held as strategic investments, typi- cally held outside of the Novartis Venture Fund, are generally designated at date of acquisition as financial assets valued at fair value through other comprehen- sive income with no subsequent recycling through profit and loss. Unrealized gains and losses, including exchange gains and losses, are recorded as a fair value adjustment in the consolidated statement of compre- hensive income. They are reclassified to retained earn- ings when the equity security is sold. If these equity securities are not designated at date of acquisition as financial assets valued at fair value through other com- prehensive income, they are valued at FVPL, as described above. • Other non-current financial assets, such as loans and long-term receivables from customers, advances and other deposits, are valued at amortized cost, which reflects the time value of money less any allowances for expected credit losses. The Group assesses on a forward-looking basis the expected credit losses associated with its debt securi- ties valued at fair value through other comprehensive income. Impairments on debt securities are recorded in “Other financial income and expense.” For other financial assets valued at amortized costs, impairments, which are based on their expected credit losses, and exchange rate losses are included in “Other expense” in the consolidated income statement, and exchange rate gains and interest income, using the effec- tive interest rate method, are included in “Other income” or “Other financial income” in the consolidated income statement, depending on the nature of the item. Prior to the adoption of IFRS 9, the Group classified and accounted for its marketable securities and non-current financial assets in the following categories: The Group classified all its equity and quoted debt securities as well as fund investments as available for sale, as they were not acquired to generate profit from short-term fluctuations in price. Unrealized gains, except exchange gains related to quoted debt instruments, were recorded as a fair value adjustment in the consolidated statement of comprehensive income. They were recog- nized in the consolidated income statement when the financial asset was sold, at which time the gain was trans- ferred either to “Other financial income and expense,” for the marketable securities held for short-term non-stra- tegic purposes, or to “Other income,” for all other equity securities and fund investments. Exchange gains related to quoted debt instruments were immediately recognized in the consolidated income statement under “Other financial income and expense.” A security was assessed for impairment when its market value at the balance sheet date was less than ini- tial cost reduced by any previously recognized impair- ment. Impairments on equity securities, quoted debt securities and fund investments, and exchange rate losses on quoted debt securities in a foreign currency that were held for short-term non-strategic purposes were recorded in “Other financial income and expense.” Impairments were recorded for all other equity securi- ties and other fund investments in “Other expense” in the consolidated income statement. Other non-current financial assets, including loans held for long-term strategic purposes, were carried at amortized cost, which reflects the time value of money less any allowances for uncollectable amounts. For these financial assets, impairments and exchange rate losses were included in “Other expense” in the consolidated income statement, and exchange rate gains and interest income using the effective interest rate method were included in “Other income” in the consolidated income statement. Section “Impact of adopting significant new IFRS stan- dards in 2018” in this Note 1 and Note 29 provides addi- tional disclosure on the impact of adoption of IFRS 9 Financial Instruments. Derivative financial instruments Derivative financial instruments are initially recognized in the balance sheet at fair value and are remeasured to their current fair value at the end of each subsequent reporting period. The valuation of a forward exchange rate contract is based on the discounted cash flow model, using interest curves and spot rates at the report- ing date as observable inputs. Options are valued based on a modified Black- Scholes model using volatility and exercise prices as major observable inputs. The Group utilizes derivative financial instruments for the purpose of hedging to reduce the volatility in the Group’s performance due to the exposure of various types of business risks. To mitigate these risks, the Group enters into certain derivative financial instruments. The risk reduction is obtained because the derivative’s value or cash flows are expected, wholly or partly, to offset changes in the value or cash flows of the recognized assets or liabilities. The overall strategy is aiming to mit- igate the currency and interest exposure risk of positions that are contractually agreed, and to partially mitigate the exposure risk of selected anticipated transactions. Certain derivative financial instruments meet the criteria for hedge accounting treatment. A prerequisite for obtaining this accounting-hedge relationship is exten- sive documentation on inception and proving on a regu- lar basis that the economic hedge is effective for account- ing purposes. Other derivative financial instruments do not meet the criteria to qualify for hedge accounting. Changes in the fair value of those derivative instruments are recognized immediately in “Other financial income and expense” in the consolidated income statement. In addition, the Group has designated certain long- term debt components as hedges of the translation risk arising on certain net investments in foreign operations. On consolidation, foreign currency differences arising on long-term debt designated as net investment hedges of a foreign operation are recognized in other compre- F-9 Notes to the Novartis Group consolidated financial statements hensive income and accumulated in currency translation effects, to the extent that the hedge is effective. The for- eign currency differences arising from hedge ineffective- ness are recognized in the income statement in “Other financial income and expense.” When a hedged net investment is disposed of, the proportionate portion of the cumulative amount recog- nized in equity in relation to the hedged net investment is transferred to the consolidated income statement as an adjustment to the gain or loss on disposal. Legal and environmental liabilities Novartis and its subsidiaries are subject to contingen- cies arising in the ordinary course of business, such as patent litigation, environmental remediation liabilities and other product-related litigation, commercial litigation, and governmental investigations and proceedings. Provisions are recorded where a reliable estimate can be made of the probable outcome of legal or other dis- putes against the subsidiary. Inventories Contingent consideration Inventory is valued at acquisition or production cost determined on a first-in, first-out basis. This value is used for the “Cost of goods sold” in the consolidated income statement. Unsalable inventory is fully written off in the consolidated income statement under “Cost of goods sold.” Trade receivables Trade receivables are initially recognized at their invoiced amounts, including any related sales taxes less adjust- ments for estimated revenue deductions such as rebates, chargebacks and cash discounts. From January 1, 2018, with the adoption of IFRS 9 Financial Instruments, provisions for expected credit losses are established using an expected credit loss model (ECL). The provisions are based on a forward-look- ing ECL, which includes possible default events on the trade receivables over the entire holding period of the trade receivable. These provisions represent the differ- ence between the trade receivable’s carrying amount in the consolidated balance sheet and the estimated col- lectible amount. Charges for doubtful trade receivables are recorded as marketing and selling costs recognized in the consolidated income statement within “Selling, general and administration” expenses. Prior to the adoption of IFRS 9, the Group’s accounting policy for provisions for doubtful trade receivables was as follows: Provisions for doubtful trade receivables were estab- lished once there was an indication that it was likely that a loss would be incurred. These provisions represent the difference between the trade receivable’s carrying amount in the consolidated balance sheet and the esti- mated collectible amount. Significant financial difficulties of a customer, such as probability of bankruptcy, finan- cial reorganization, default or delinquency in payments, were considered indicators that recovery of the trade receivable was doubtful. Charges for doubtful trade receivables, recorded as marketing and selling costs, were recognized in the consolidated income statement within “Selling, general and administration” expenses. Section “Impact of adopting significant new IFRS stan- dards in 2018” in this Note 1 and Note 29 provides addi- tional disclosure on the impact of adoption of IFRS 9 Financial Instruments. In a business combination or divestment of a business, it is necessary to recognize contingent future payments to previous owners, representing contractually defined potential amounts as a liability or asset. Usually for Novartis, these are linked to milestone or royalty pay- ments related to certain assets and are recognized as a financial liability or financial asset at their fair value, which is then remeasured at each subsequent reporting date. These estimations typically depend on factors such as technical milestones or market performance, and are adjusted for the probability of their likelihood of payment and, if material, are appropriately discounted to reflect the impact of time. Changes in the fair value of contingent consideration liabilities in subsequent periods are recognized in the consolidated income statement in “Cost of goods sold” for currently marketed products and in “Research and development” for IPR&D. Changes in contingent consid- eration assets are recognized in “Other income” or “Other expense,” depending on its nature. The effect of unwinding the discount over time is rec- ognized for contingent liabilities in “Interest expense” and for contingent assets as interest income recognized in the consolidated income statement within “Other financial income and expense.” Defined benefit pension plans and other post-employment benefits The liability in respect of defined benefit pension plans and other post-employment benefits is the defined ben- efit obligation calculated annually by independent actu- aries using the projected unit credit method. The current service cost for such post- employment benefit plans is included in the personnel expenses of the various func- tions where the associates are employed, while the net interest on the net defined benefit liability or asset is recognized as “Other expense” or “Other income.” Treasury shares Treasury shares are initially recorded at fair value on their trade date, which is different from the settlement date, when the transaction is ultimately effected. Treasury shares are deducted from consolidated equity at their nominal value of CHF 0.50 per share. Differences between the nominal amount and the transaction price on purchases or sales of treasury shares with third par- F-10 Notes to the Novartis Group consolidated financial statements ties, or the value of services received for the shares allo- cated to associates as part of share-based compensa- tion arrangements, are recorded in “Retained earnings” in the consolidated statement of changes in equity. Revenue recognition From January 1, 2018, with the implementation of the new standard IFRS 15 Revenue from Contracts with Custom- ers, the Group accounting policy for revenue recognition is as follows: Revenue on the sale of Novartis Group products and services, which is recorded as “Net sales” in the consol- idated income statement, is recognized when a contrac- tual promise to a customer (performance obligation) has been fulfilled by transferring control over the promised goods and services to the customer, substantially all of which is at the point in time of shipment to or receipt of the products by the customer or when the services are performed. If contracts contain customer acceptance provisions, revenue would be recognized upon the sat- isfaction of acceptance criteria. If products are stock- piled at the request of the customer, revenue is only rec- ognized once the products have been inspected and accepted by the customer, and there is no right of return or replenishment on product expiry. The amount of rev- enue to be recognized is based on the consideration Novartis expects to receive in exchange for its goods and services. If a contract contains more than one per- formance obligation, the consideration is allocated based on the standalone selling price of each perfor- mance obligation. Surgical equipment may be sold together with other products and services under a single contract. Revenues are recognized upon satisfaction of each of the perfor- mance obligations in the contract and the consideration is allocated based on the standalone selling price of each performance obligation. For surgical equipment, in addition to cash and install- ment sales, revenue is recognized under finance and operating lease arrangements. Arrangements in which Novartis transfers substantially all the risks and rewards incidental to ownership to the customer are treated as finance lease arrangements. Revenue from finance lease arrangements is recognized at amounts equal to the fair value of the equipment, which approximate the present value of the minimum lease payments under the arrange- ments. As interest rates embedded in lease arrange- ments are approximately market rates, revenue under finance lease arrangements is comparable to revenue for outright sales. Finance income for arrangements lon- ger than twelve months is deferred and subsequently recognized based on a pattern that approximates the use of the effective interest method and recorded in “Other income.” Operating lease revenue for equipment rentals is recognized on a straight-line basis over the lease term. The consideration Novartis receives in exchange for its goods or services may be fixed or variable. Variable consideration is only recognized when it is highly prob- able that a significant reversal will not occur. The most common elements of variable consideration are listed below. • Rebates and discounts granted to government agen- cies, wholesalers, retail pharmacies, managed health- care organizations and other customers are provi- sioned and recorded as a deduction from revenue at the time the related revenues are recorded or when the incentives are offered. They are calculated on the basis of historical experience and the specific terms in the individual agreements. • Refunds granted to healthcare providers under innovative pay-for-performance agreements are pro- visioned and recorded as a revenue deduction at the time the related sales are recorded. They are calcu- lated on the basis of historical experience and clinical data available for the product, as well as the specific terms in the individual agreements. In cases where his- torical experience and clinical data are not sufficient for a reliable estimation of the outcome, revenue rec- ognition is deferred until the uncertainty is resolved or until such history is available. • Cash discounts offered to customers are to encourage prompt payment and are provisioned and recorded as revenue deductions at the time the related sales are recorded. • Shelf stock adjustments are generally granted to cus- tomers, primarily of the Sandoz Division, to cover the inventory held by them at a time the price decline becomes effective. Revenue deduction provisions for shelf stock adjustments are recorded when the price decline is anticipated, based on the impact of the price decline on the customer’s estimated inventory levels. • Sales returns provisions are recognized and recorded as revenue deductions when there is historical expe- rience of Novartis agreeing to customer returns and Novartis can reasonably estimate expected future returns. In doing so, the estimated rate of return is applied, determined on the basis of historical experi- ence of customer returns and considering any other relevant factors. This is applied to the amounts invoiced, also considering the amount of returned products to be destroyed versus products that can be placed back in inventory for resale. Where shipments are made on a resale or return basis, without sufficient historical experience for estimating sales returns, revenue is only recorded when there is evidence of consumption or when the right of return has expired. Provisions for revenue deductions are adjusted to actual amounts as rebates, discounts and returns are pro- cessed. The provision represents estimates of the related obligations, requiring the use of judgment when estimating the effect of these sales deductions. “Other revenue” includes income from profit-sharing arrangements with our collaboration partners, and roy- alty and milestone income from the out-licensing of intel- lectual property (IP) when Novartis retains an interest in the IP through a license. Royalty income earned through a license is recognized when the underlying sales have occurred. Milestone income is recognized at the point in time when it is highly probable that the respective mile- stone event criteria is met, and the risk of reversal of rev- enue recognition is remote. Other revenue also includes revenue from activities such as manufacturing or other services rendered, to the extent such revenue is not F-11 Notes to the Novartis Group consolidated financial statements recorded under net sales, and is recognized when con- trol transfers to the third party and our performance obli- gations are satisfied. Cash discounts are offered to customers to encour- age prompt payment and are recorded as revenue deductions. Prior to the adoption of IFRS 15 on January 1, 2018, the Group accounting policy for revenue recognition was as follows: Revenue was recognized on the sale of Novartis Group products and services, and was recorded as “Net sales” in the consolidated income statement when there was persuasive evidence that a sales arrangement exists; title, risks and rewards for the products are trans- ferred to the customer; the price was determinable; and collectability was reasonably assured. If contracts con- tain customer acceptance provisions, revenue would be recognized upon the satisfaction of acceptance criteria. If products are stockpiled at the request of the customer, revenue was only recognized once the products have been inspected and accepted by the customer, and there was no right of return or replenishment on product expiry. Surgical equipment may be sold together with other products and services under a single contract. The total consideration was allocated to the separate elements based on their relative fair values. Revenue was recog- nized once the recognition criteria have been met for each element of the contract. For surgical equipment, in addition to cash and install- ment sales, revenue was recognized under finance and operating lease arrangements. Arrangements in which Novartis transfers substantially all the risks and rewards incidental to ownership to the customer are treated as finance lease arrangements. Revenue from finance lease arrangements was recognized at amounts equal to the fair values of the equipment, which approximate the pres- ent values of the minimum lease payments under the arrangements. As interest rates embedded in lease arrangements are approximately market rates, revenue under finance lease arrangements was comparable to revenue for outright sales. Finance income for arrange- ments in excess of 12 months was deferred and subse- quently recognized based on a pattern that approximates the use of the effective interest method and recorded in “Other income.” Operating lease revenue for equipment rentals was recognized on a straight-line basis over the lease term. Provisions for rebates and discounts granted to gov- ernment agencies, wholesalers, retail pharmacies, man- aged healthcare organizations and other customers are recorded as a deduction from revenue at the time the related revenues are recorded or when the incentives are offered. They are calculated on the basis of histori- cal experience and the specific terms in the individual agreements. Provisions for refunds granted to healthcare provid- ers under innovative pay-for-performance agreements are recorded as a revenue deduction at the time the related sales are recorded. They are calculated on the basis of historical experience and clinical data available for the product, as well as the specific terms in the indi- vidual agreements. In cases where historical experience and clinical data are not sufficient for a reliable estima- tion of the outcome, revenue recognition was deferred until such history was available. Following a decrease in the price of a product, we generally grant customers a “shelf stock adjustment” for their existing inventory for the involved product. Provi- sions for shelf stock adjustments, which are primarily relevant within the Sandoz Division, are determined at the time of the price decline or at the point of sale, if the impact of a price decline on the products sold can be reasonably estimated based on the customer’s inventory levels of the relevant product. When there was historical experience of Novartis agreeing to customer returns, and Novartis could rea- sonably estimate expected future returns, a provision was recorded for estimated sales returns. In doing so, the estimated rate of return was applied, determined based on historical experience of customer returns and considering any other relevant factors. This was applied to the amounts invoiced, also considering the amount of returned products to be destroyed versus products that could be placed back in inventory for resale. Where ship- ments are made on a resale or return basis, without suf- ficient historical experience for estimating sales returns, revenue was only recorded when there was evidence of consumption or when the right of return had expired. Provisions for revenue deductions were adjusted to actual amounts as rebates, discounts and returns were processed. The provision represents estimates of the related obligations, requiring the use of judgment when estimating the effect of these sales deductions. “Other revenue” includes royalty and profit-sharing income, and revenue from activities such as manufac- turing services or other services rendered, to the extent such revenue was not recorded under net sales. Section “Impact of adopting significant new IFRS stan- dards in 2018” in this Note 1 and Note 29 provides addi- tional disclosure on the impact of adoption. Research and development Internal research and development (R&D) costs are fully charged to “Research and development” in the consol- idated income statement in the period in which they are incurred. The Group considers that regulatory and other uncertainties inherent in the development of new prod- ucts preclude the capitalization of internal development expenses as an intangible asset until marketing approval from a regulatory authority is obtained in a major market such as the United States, the European Union, Switzer- land or Japan. Payments made to third parties, such as contract research and development organizations in compensa- tion for subcontracted R&D, that are deemed to not transfer intellectual property to Novartis are expensed as internal R&D expenses in the period in which they are incurred. Such payments are only capitalized if they meet the criteria for recognition of an internally generated intangible asset, usually when marketing approval has been achieved from a regulatory authority in a major mar- ket. F-12 Notes to the Novartis Group consolidated financial statements Payments made to third parties to in-license or acquire intellectual property rights, compounds and products, including initial upfront and subsequent mile- stone payments, are capitalized, as are payments for other assets, such as technologies to be used in R&D activities. If additional payments are made to the origi- nator company to continue to perform R&D activities, an evaluation is made as to the nature of the payments. Such additional payments will be expensed if they are deemed to be compensation for subcontracted R&D services not resulting in an additional transfer of intellectual property rights to Novartis. Such additional payments will be cap- italized if they are deemed to be compensation for the transfer to Novartis of additional intellectual property developed at the risk of the originator company. Subse- quent internal R&D costs in relation to IPR&D and other assets are expensed, since the technical feasibility of the internal R&D activity can only be demonstrated by the receipt of marketing approval for a related product from a regulatory authority in a major market. Costs for post-approval studies performed to sup- port the continued registration of a marketed product are recognized as marketing expenses. Costs for activ- ities that are required by regulatory authorities as a con- dition for obtaining marketing approval are capitalized and recognized as currently marketed products. Inventory produced ahead of regulatory approval is fully provisioned, and the charge is included in “Other expense” in the consolidated income statement, as its ultimate use cannot be assured. If this inventory can be subsequently sold, the provision is released to “Other income” in the consolidated income statement either on approval by the appropriate regulatory authority or, exceptionally in Europe, on recommendation by the Committee for Medicinal Products for Human Use (CHMP), if approval is virtually certain. Share-based compensation Vested Novartis shares and American Depositary Receipts (ADRs) that are granted as compensation are valued at their market value on the grant date and are immediately expensed in the consolidated income state- ment. The fair values of unvested restricted shares, restricted share units (RSUs) and performance share units (PSUs) in Novartis shares and ADRs granted to associates as compensation are recognized as an expense over the related vesting period. The expense recorded in the consolidated income statement is included in the personnel expenses of the various func- tions where the associates are employed. Unvested restricted shares, restricted ADRs and RSUs are only conditional on the provision of services by the plan participant during the vesting period. They are valued using their fair value on the grant date. As RSUs do not entitle the holder to dividends, the fair value is based on the Novartis share price at the grant date adjusted for the net present value of the dividends expected to be paid during the holding period. The fair value of these grants, after making adjustments for assumptions related to their forfeiture during the vest- ing period, is expensed on a straight-line basis over the respective vesting period. PSUs are subject to certain performance criteria being achieved during the vesting period and require plan participants to provide services during the vesting period. PSUs granted under plans defined as Long-Term Per- formance Plans are subject to performance criteria based on Novartis internal performance metrics. The expense is determined taking into account assumptions concerning performance during the period against tar- gets and expected forfeitures due to plan participants not meeting their service conditions. These assumptions are periodically adjusted. Any change in estimates for past services is recorded immediately as an expense or income in the consolidated income statement, and amounts for future periods are expensed over the remaining vesting period. As a result, at the end of the vesting period, the total charge during the whole vesting period represents the amount that will finally vest. The number of equity instruments that finally vest is deter- mined at the vesting date. PSUs granted under the Long-Term Relative Perfor- mance Plan (LTRPP) are conditional on the provision of services by the plan participant during the vesting period as well as on the total shareholder return (TSR) perfor- mance of Novartis relative to a specific peer group of companies over the vesting period. These performance conditions are based on variables that can be observed in the market. IFRS requires that these observations are taken into account in determining the fair value of these PSUs at the date of grant. Novartis has determined the fair value of these PSUs at the date of grant using a Monte Carlo simulation model. The total fair value of this grant is expensed on a straight-line basis over the vesting period. Adjustments to the number of equity instruments granted are only made if a plan participant does not ful- fill the service conditions. Measuring the fair values of PSUs granted under the LTRPP requires estimates. The Monte Carlo simulation used for determining the fair value of the PSUs related to the LTRPP requires as input parameters the probabil- ity of factors related to uncertain future events; the term of the award; the grant price of underlying shares or ADRs; expected volatilities; the expected correlation matrix of the underlying equity instruments with those of the peer group of companies; and the risk-free inter- est rate. If a plan participant leaves Novartis for reasons other than retirement, disability or death, then unvested restricted shares, restricted ADRs, RSUs and PSUs are forfeited, unless determined otherwise by the provision of the plan rules or by the Compensation Committee of the Novartis Board of Directors, for example, in connec- tion with a reorganization or divestment. F-13 Notes to the Novartis Group consolidated financial statements Government grants Grants from governments or similar organizations are recognized at their fair value when there is a reasonable assurance that the grant will be received and the Group will comply with all attached conditions. Government grants related to income are deferred and recognized in the consolidated income statement over the period necessary to match them with the related costs that they are intended to compensate. The accounting policy for property, plant and equip- ment describes the treatment of any related grants. Restructuring charges Restructuring provisions are recognized for the direct expenditures arising from the restructuring, where the plans are sufficiently detailed and where appropriate communication to those affected has been made. Charges to increase restructuring provisions are included in “Other expense” in the consolidated income statements. Corresponding releases are recorded in “Other income” in the consolidated income statement. Taxes Taxes on income are provided in the same periods as the revenues and expenses to which they relate and include interest and penalties incurred during the period. Deferred taxes are determined using the comprehensive liability method and are calculated on the temporary dif- ferences that arise between the tax base of an asset or liability and its carrying value in the balance sheet pre- pared for consolidation purposes, except for those tem- porary differences related to investments in subsidiaries and associated companies, where the timing of their reversal can be controlled and it is probable that the dif- ference will not reverse in the foreseeable future. Since the retained earnings are reinvested, withholding or other taxes on eventual distribution of a subsidiary’s retained earnings are only taken into account when a dividend has been planned. The estimated amounts for current and deferred tax assets or liabilities, including any amounts related to any uncertain tax positions, are based on currently known facts and circumstances. Tax returns are based on an interpretation of tax laws and regulations, and reflect estimates based on these judgments and interpretations. The tax returns are subject to examination by the com- petent taxing authorities, which may result in an assess- ment being made requiring payments of additional tax, interest or penalties. Inherent uncertainties exist in the estimates of the tax positions. Non-current assets held for sale Non-current assets are classified as assets held for sale when their carrying amount is to be recovered principally through a sale transaction and a sale is considered highly probable. They are stated at the lower of carrying amount and fair value less costs of disposal. Assets held for sale, included within a disposal group or discontinued opera- tions are not depreciated or amortized. Transaction costs recorded in equity Transaction costs that are directly attributable to the potential distribution (spin-off) of Alcon to the Novartis shareholders, and that would otherwise have been avoided, are recorded as a deduction from equity. If the spin-off does not occur, the cost will be recycled into the consolidated income statement. Impact of adopting significant new IFRS standards in 2018 The following new IFRS standards have been adopted by Novartis from January 1, 2018: IFRS 9 Financial Instruments Novartis implemented IFRS 9 Financial Instruments as of January 1, 2018, which substantially changes the classification and measurement of financial instruments. The new standard requires impairments to be based on a forward-looking model, changes the approach to hedg- ing financial exposures and related documentation, changes the recognition of certain fair value changes, and amends disclosure requirements. The impairment of financial assets, including trade and lease receivables, is now assessed using an expected credit loss model; previously, the incurred loss model was used. Given the nature of Novartis financial assets, the Group had no significant impact to its provisions for doubtful accounts or impairments from this change. The new hedge accounting model introduced by the standard requires hedge accounting relationships to be based upon the Group’s own risk management strategy and objectives, and to be discontinued only when the relationships no longer qualify for hedge accounting. There was no impact upon adoption of the new standard, as the Group’s existing hedge relationships continue to be designated as such under the new hedge accounting requirements. The most significant impact to the Group upon adop- tion of IFRS 9 relates to the treatment of the unrealized gains and losses from changes in fair value on certain of the Group’s financial instruments, which were previously classified as available-for-sale marketable securities and financial investments. The unrealized gains and losses (to the extent of previous recognized unrealized gains), which the Group recognized previously in the consoli- dated statement of other comprehensive income, are from January 1, 2018, recognized in the consolidated income statement. This approach is applied to equity securities where the fair value through other compre- hensive income irrevocable option is not applied. F-14 Notes to the Novartis Group consolidated financial statements The Group applied the modified retrospective method upon adoption of IFRS 9 on January 1, 2018. This method requires the recognition of the cumulative effect of ini- tially applying IFRS 9 to retained earnings and not to restate prior years. The cumulative effect recorded at January 1, 2018, was an increase to retained earnings of USD 177 million. IFRS 15 Revenue from Contracts with Customers Novartis implemented the new standard IFRS 15 Reve- nue from Contracts with Customers as of January 1, 2018. The new standard amends revenue recognition requirements and establishes principles for reporting information about the nature, amount, timing and uncer- tainty of revenue and cash flows arising from contracts with customers. The standard replaces IAS 18 Revenue and IAS 11 Construction contracts and related interpre- tations. The impacts of adoption of the new standard are summarized below: • The Group’s “Net sales” are derived from the sale of drug substances, vision care products, surgical equip- ment, and other products and services, where control transfers to our customers and our performance obli- gations are satisfied at the time of shipment to or receipt of the products by the customer or when the services are performed. The adoption of IFRS 15 did not significantly change the timing or amount of reve- nue recognized under these arrangements. • The Group’s “Other revenue” consists of royalty income from the out-licensing of intellectual property (IP), which is recognized as earned, and from manufactur- ing and other services, where revenue is recognized when control transfers to the third party and our per- formance obligations are satisfied. The adoption of IFRS 15 did not significantly change the timing or amount of revenue recognized from these manufactur- ing and other services arrangements, nor did it change accounting for these royalty arrangements, as the standard’s royalty exception is applied for IP licenses. “Other revenue” also includes revenue from profit-shar- ing arrangements with our collaboration partners. Fur- thermore, the Group receives milestone payments related to the out-licensing of IP. The adoption of IFRS 15 did not significantly change the timing or amount of revenue recognized under these arrangements. The Group applied the modified retrospective method upon adoption of IFRS 15 on January 1, 2018. This method requires the recognition of the cumulative effect of ini- tially applying IFRS 15 to retained earnings and not to restate prior years. The cumulative effect recorded at January 1, 2018, was an increase to retained earnings of USD 60 million. For further information on the impact of adoption of IFRS 9 Financial Instruments and IFRS 15 Revenue from Con- tracts with Customers, see Note 29. New IFRS standards effective as of January 1, 2019 IFRS 16 Leases IFRS 16 Leases substantially changes the financial state- ments as the majority of leases for which the company is the lessee will become on-balance sheet liabilities with corresponding right-of-use assets on the balance sheet. The lease liability reflects the net present value of the remaining lease payments, and the right-of-use asset corresponds to the lease liability, adjusted for payments made before the commencement date, lease incentives and other items related to the lease agreement. The stan- dard replaces IAS 17 Leases. Upon adoption of the new standard, a portion of the annual operating lease costs, which is currently fully rec- ognized as a functional expense, will be recorded as interest expense. In addition, the portion of the annual lease payments recognized in the cash flow statement as a reduction of the lease liability will be recognized as an outflow from financing activities, which currently is fully recognized as an outflow from operating activities. Given the leases involved and the current low interest rate environment, the Group does not expect these effects to be significant. The Group will implement the new standard on Jan- uary 1, 2019, and will apply the modified retrospective method, with right-of-use assets measured at an amount equal to the lease liability, adjusted by the amount of the prepaid or accrued lease payments relating to those leases recognized in the balance sheet immediately before the date of initial application and will not restate prior years. Results of our impact assessment: The undiscounted operating lease commitments as of December 31, 2018 disclosed in Note 27, amounted to USD 3.6 billion. This includes approximately USD 0.3 bil- lion of leases with a commencement date in 2019 and short-term leases as well as low-value leases that will be recognized on a straight-line basis as expense in profit and loss. For the remaining lease commitments of USD 3.3 billion, the Group expects to recognize on January 1, 2019, lease liabilities in the range of USD 1.9 billion and right-of-use assets in the range of USD 1.7 billion (after adjustments for the approximately USD 0.2 billion pre- payments and accrued lease payments recognized as at December 31, 2018). This does not include the right to use assets and lease liability on finance lease agree- ments of USD 79 million and USD 92 million, respectively. We expect an insignificant impact to retained earnings upon adoption of IFRS 16 to arise from subleases that were accounted for as operating lease agreements under IAS 17 and are accounted for as finance leases under IFRS 16. As a lessor, the Group does not expect any signifi- cant impact upon adoption. There are no other IFRS standards or interpretations not yet effective that would be expected to have a material impact on the Group. F-15 Notes to the Novartis Group consolidated financial statements 2. Significant transactions Significant transactions in 2018 Innovative Medicines – acquisition of Advanced Accelerator Applications S.A. On October 30, 2017, Novartis entered into a binding memorandum of understanding with Advanced Acceler- ator Applications S.A. (AAA), a company headquartered in Saint-Genis-Pouilly, France, under which Novartis agreed to commence a tender offer for 100% of the share capital of AAA subject to certain conditions. Novartis commenced the tender offer on December 7, 2017, to purchase all of the outstanding ordinary shares for a price of USD 41 per share and USD 82 per American Depositary Share (ADS), each representing two ordinary shares of AAA, which expired on January 19, 2018. The offer valued AAA’s equity at USD 3.9 billion, on a fully diluted basis. As of January 19, 2018, the expiration date of the ten- der offer, approximately 97% of the then-outstanding fully diluted ordinary shares, including ordinary shares represented by ADSs (hereinafter collectively referred to as “the outstanding shares”), were validly tendered. On January 22, 2018, Novartis accepted and paid USD 3.9 billion for the outstanding shares tendered in the offer. On January 22, 2018, Novartis commenced a sub- sequent offering period that expired on January 31, 2018. As of the expiration of the subsequent offering period, an additional 1.8% of the outstanding shares were validly tendered. Novartis accepted and paid approximately USD 60 million, resulting in an increase in Novartis own- ership in AAA to 98.7%. The fair value of the total purchase consideration was USD 3.9 billion. The purchase price allocation resulted in net identifiable assets of approximately USD 1.9 bil- lion, consisting of USD 2.5 billion intangible assets, USD 0.6 billion net deferred tax liabilities, and goodwill of approximately USD 2.0 billion. In 2018, from the date of the acquisition the business generated net sales of USD 0.4 billion. Management estimates net sales for the entire year 2018 would have amounted to USD 0.4 billion had AAA been acquired at the beginning of 2018. The 2018 results from operations since the acquisition were not material. As of December 31, 2018, Novartis held 99.1% of the then-outstanding fully diluted ordinary shares, including ordinary shares represented by ADSs. AAA is a radiopharmaceutical company that devel- ops, produces and commercializes molecular nuclear medicines – including Lutathera (USAN: lutetium Lu 177 dotatate/INN: lutetium (177Lu) oxodotreotide), a first-in- class radioligand therapy product for neuroendocrine tumors – and a portfolio of diagnostic products. Radio- pharmaceuticals, such as Lutathera, are unique medici- nal formulations containing radioisotopes, which are used clinically for both diagnosis and therapy. Innovative Medicines – acquisition of AveXis, Inc. On April 6, 2018, Novartis entered into an agreement and plan of merger with AveXis, Inc., a US-based clinical stage gene therapy company, under which Novartis com- menced on April 17, 2018, a tender offer to purchase all outstanding common stock of AveXis, Inc. for USD 218 per share in cash. On May 15, 2018, Novartis completed the acquisition of the common stock of AveXis, Inc. and paid a total of USD 8.7 billion. The fair value of the total purchase consideration was USD 8.7 billion. The purchase price allocation resulted in net identifiable assets of approximately USD 7.2 bil- lion, consisting of USD 8.5 billion intangible assets, USD 1.6 billion net deferred tax liabilities and other net assets of USD 0.3 billion, and goodwill of approximately USD 1.5 billion. Results of operations since the date of acqui- sition were not material. AveXis, Inc. is focused on developing and commer- cializing novel treatments for patients suffering from rare and life-threatening neurological genetic diseases. AveXis, Inc.’s initial product candidate, AVXS-101, is a pro- prietary gene therapy currently in development for the treatment of spinal muscular atrophy (SMA) type 1 – the leading genetic cause of infant mortality – and SMA types 2 and 3. In addition, AveXis, Inc. has a pipeline of other novel treatments for rare neurological diseases, including Rett syndrome (RTT) and a genetic form of amyotrophic lateral sclerosis (ALS) caused by mutations in the superoxide dismutase 1 (SOD1) gene. Innovative Medicines – acquisition of Endocyte, Inc. On October 18, 2018, Novartis entered into an agree- ment and plan of merger with Endocyte, a US-based bio- pharmaceutical company focused on developing tar- geted therapeutics for cancer treatment. The transaction was completed on December 21, 2018. Under the terms of the agreement, Novartis acquired all outstanding shares of Endocyte common stock for USD 24 per share. The total consideration amounted to USD 2.1 billion. The fair value of the total purchase consideration was USD 2.1 billion. The preliminary purchase price allocation resulted in net identifiable assets of approximately USD 1.5 billion, consisting of USD 1.5 billion intangible assets, USD 0.3 billion net deferred tax liabilities and other net assets of USD 0.3 billion, and goodwill of approximately USD 0.6 billion. The purchase price allocation is prelim- inary as the transaction closed on December 21, 2018, which is close to the Group’s year-end and therefore not providing sufficient time to complete the valuation of the intangible assets, deferred taxes, assumed liabilities and goodwill. If new information obtained within 12 months from December 21, 2018, about facts and circumstances that existed at the date of the acquisition identifies adjustments to the above amounts, or any additional pro- visions that existed at the date of acquisition, then the accounting for the acquisition will be revised. The Group currently does not expect such potential revisions to be material. Endocyte uses drug conjugation technology to develop targeted therapies with companion imaging agents, including 177Lu-PSMA-617, a potential first-in- class investigational radioligand therapy for the treat- F-16 Notes to the Novartis Group consolidated financial statements ment of metastatic castration-resistant prostate cancer (mCRPC). (USD millions) Corporate – divestment of 36.5% stake in GlaxoSmithKline Consumer Healthcare Holdings Ltd. On March 27, 2018, Novartis entered into an agreement with GlaxoSmithKline plc (GSK) to divest its 36.5% stake in GlaxoSmithKline Consumer Healthcare Holdings Ltd. to GSK for USD 13.0 billion in cash. As a result, Novartis discontinued the use of equity method accounting start- ing from April 1, 2018. On June 1, 2018, the transaction closed and Novartis realized a pre-tax gain of USD 5.8 billion, recorded in income from associated companies. Significant pending transaction Sandoz – divestment of US dermatology business and generic US oral solids portfolio On September 6, 2018, Novartis announced it has agreed to sell selected portions of its Sandoz US portfolio, spe- cifically the Sandoz US dermatology business and generic US oral solids portfolio, to Aurobindo Pharma USA Inc. (Aurobindo), for USD 0.8 billion in cash and potential earn-outs. The Sandoz US portfolios to be sold to Aurobindo include approximately 300 products as well as additional development projects. The sale includes the Sandoz US generic and branded dermatology businesses as well as its dermatology development center. As part of the trans- action, Aurobindo will acquire the manufacturing facili- ties in Wilson, North Carolina, and in Hicksville and Mel- ville, New York. The transaction is expected to close in the course of 2019, following the completion of customary closing con- ditions. As the fair value of the consideration (USD 0.8 billion) less costs to sell is below the carrying value of the divested business (USD 1.0 billion, which includes an allocation of Sandoz goodwill of USD 0.2 billion), an impairment of the net assets to be divested in the amount of USD 0.2 billion was recognized as a reduction to good- will. In the Group’s consolidated balance sheet at Decem- ber 31, 2018, the business assets and liabilities are sep- arately shown as assets and liabilities of disposal group held for sale. The disposal group, assets and liabilities classified as held for sale consist of the following: (USD millions) Assets of disposal group classified as held for sale Property, plant and equipment Intangible assets other than goodwill Deferred tax assets Other non-current assets Inventories Other current assets Total December 31, 2018 148 478 8 1 165 7 807 Liabilities of disposal group classified as held for sale Deferred tax liabilities Provisions and other non-current liabilities Provisions and other current liabilities Total December 31, 2018 2 4 45 51 There are no cumulative income or expenses included in other comprehensive income relating to the disposal group. Significant transactions in 2017 Innovative Medicines – acquisition of Ziarco Group Limited On January 20, 2017, Novartis acquired Ziarco Group Limited (Ziarco), a privately held company in the United Kingdom that focuses on the development of novel treat- ments in dermatology. This acquisition adds a once-daily oral H4 receptor antagonist in development for atopic dermatitis, commonly known as eczema, to complement the Novartis dermatology portfolio and pipeline. The fair value of the total purchase consideration was USD 420 million. The amount consisted of an initial cash payment of USD 325 million and the net present value of the con- tingent consideration of USD 95 million, due to Ziarco shareholders, which they are eligible to receive upon the achievement of specified development milestones. The purchase price allocation resulted in net identifiable assets of USD 395 million and goodwill of USD 25 mil- lion. The 2017 results of operations since the date of acquisition were not material. Innovative Medicines – acquisition of Encore Vision, Inc. On January 20, 2017, Novartis acquired Encore Vision, Inc. (Encore), a privately-held company in Fort Worth, Texas, in the United States, that focuses on the devel- opment of a novel treatment in presbyopia. The fair value of the total purchase consideration was USD 456 million. The amount consisted of an initial cash payment of USD 366 million and the net present value of the contingent consideration of USD 90 million, due to Encore share- holders, which they are eligible to receive upon the achievement of specified development and commercial- ization milestones. The purchase price allocation resulted in net identifiable assets of USD 389 million and good- will of USD 67 million. The 2017 results of operations since the date of acquisition were not material. Significant transactions in 2016 Alcon – acquisition of Transcend Medical, Inc. On February 17, 2016, Alcon entered into an agreement to acquire Transcend Medical, Inc. (Transcend), a pri- vately held, US-based company focused on developing minimally invasive surgical devices to treat glaucoma. The transaction closed on March 23, 2016, and the fair value of the total purchase consideration was USD 332 F-17 Notes to the Novartis Group consolidated financial statements million. The amount consisted of an initial cash payment of USD 240 million and the net present value of contin- gent consideration of USD 92 million due to the Tran- scend shareholders, which they are eligible to receive upon the achievement of specified development and commercialization milestones. The purchase price allo- cation resulted in net identifiable assets of USD 294 mil- lion and goodwill of USD 38 million. The 2016 results of operations since the date of acquisition were not mate- rial. Innovative Medicines – acquisition of Reprixys Pharmaceuticals Corporation On November 18, 2016, Novartis acquired Reprixys Pharmaceuticals Corporation (Reprixys), a privately held, US-based company specializing in the development of therapeutics in certain hematologic and inflammatory disorders, following receipt of results of the SUSTAIN study. The previously held interest of 19% is adjusted to its fair value of USD 64 million through the consolidated income statement at acquisition date. This remeasure- ment resulted in a gain of USD 53 million. The fair value of the total purchase consideration for acquiring the 81% stake Novartis did not already own amounted to USD 268 million. The amount consisted of an initial cash payment of USD 194 million and the net present value of the contingent consideration of USD 74 million due to Reprixys shareholders, which they are eli- gible to receive upon the achievement of specified devel- opment and commercialization milestones. The pur- chase price allocation resulted in net identifiable assets of USD 332 million. No goodwill was recognized. The 2016 results of operations since the date of acquisition were not material. 3. Segmentation of key figures 2018, 2017 and 2016 The businesses of Novartis are divided operationally on a worldwide basis into three identified reporting seg- ments: Innovative Medicines, Sandoz and Alcon. In addi- tion, we separately report Corporate activities. Reporting segments are presented in a manner con- sistent with the internal reporting to the chief operating decision-maker, which is the Executive Committee of Novartis. The reporting segments are managed sepa- rately because they each research, develop, manufac- ture, distribute and sell distinct products that require dif- fering marketing strategies. The Executive Committee of Novartis is responsible for allocating resources and assessing the performance of the reporting segments. Effective January 1, 2018, following an internal reor- ganization, the reporting of the financial results of the reporting segments Innovative Medicines and Alcon have been adapted. The restatements reflect, in all years presented, the transfer of the Innovative Medicine Divi- sion ophthalmic over-the-counter products together with a small portfolio of surgical diagnostics products to the Alcon Division. In the prior year, the Alcon brand name intangible asset was reported in Corporate, as it was used to market products of the Alcon Division and prod- ucts within the Ophthalmology business franchise of the Innovative Medicines Division. In connection with the planned spin-off of the Alcon Division (see Note 30), it is the intention of the Group to transfer the full rights of the Alcon brand name to the Alcon Division. As a result, the Innovative Medicines Division started the process to rebrand the products within its Ophthalmology business franchise and will no longer use the Alcon brand name. As a result, the Alcon brand name intangible asset is reported in the Alcon Division. To comply with IFRS, Novartis has restated its consolidated income statement and balance sheet disclosures by segment to reflect the internal reorganization and the reclassification of the Alcon brand name. This restatement had no impact on the reported financial results of the Sandoz Division or the total Group. Innovative Medicines researches, develops, manu- factures, distributes and sells patented prescription medicines. The Innovative Medicines Division is orga- nized into two global business units: Novartis Oncology and Novartis Pharmaceuticals. Novartis Oncology con- sists of the global business franchise Oncology, and Novartis Pharmaceuticals consists of the global business franchises Ophthalmology; Neuroscience; Immunology, Hepatology and Dermatology; Respiratory; Cardio-Met- abolic; and Established Medicines. Sandoz develops, manufactures and markets finished dosage form medicines as well as intermediary products including active pharmaceutical ingredients. Sandoz is organized globally into three franchises: Retail Generics, Anti-Infectives and Biopharmaceuticals. In Retail Gener- ics, Sandoz develops, manufactures and markets active ingredients and finished dosage forms of pharmaceuticals to third parties. Retail Generics includes the areas of car- diovascular, central nervous system, dermatology, gas- trointestinal and hormonal therapies, metabolism, oncology, ophthalmics, pain and respiratory, as well as finished dosage form anti-infectives sold to third parties. In Anti-Infectives, Sandoz manufactures and supplies active pharmaceutical ingredients and intermediates, mainly antibiotics, for internal use by Retail Generics and for sale to third-party customers. In Biopharmaceuticals, Sandoz develops, manufactures and markets protein- or other biotechnology-based products, including biosimi- lars, and provides biotechnology manufacturing services to other companies. Alcon researches, discovers, develops, manufac- tures, distributes and sells a broad range of eye care products. Alcon is the leading eye care devices company globally. Alcon is organized into two global business fran- chises: Surgical and Vision Care. Surgical researches, develops, manufactures, distributes and sells ophthal- F-18 Notes to the Novartis Group consolidated financial statements mic products for cataract surgery, vitreoretinal surgery, refractive laser surgery and glaucoma surgery. The Sur- gical portfolio also includes implantables, consumables and surgical equipment required for these procedures and supports the end-to-end procedure needs of the ophthalmic surgeon. Vision Care researches, develops, manufactures, distributes and sells daily disposable, reusable, and color-enhancing contact lenses and a comprehensive portfolio of ocular health products, including products for dry eye, contact lens care and ocular allergies, as well as ocular vitamins and redness relievers. Alcon also provides services, training, educa- tion and technical support for both the Surgical and Vision Care businesses. Income and expenses relating to Corporate include the costs of the Group headquarters and those of cor- porate coordination functions in major countries. In addi- tion, Corporate includes other items of income and expense that are not attributable to specific segments, such as certain revenues from intellectual property rights, certain expenses related to post-employment benefits, environmental remediation liabilities, charitable activities, donations and sponsorships. Usually, no allo- cation of Corporate items is made to the segments. As a result, Corporate assets and liabilities principally con- sist of net liquidity (cash and cash equivalents, market- able securities less financial debts), investments in asso- ciated companies and current and deferred taxes and non-segment-specific environmental remediation and post-employment benefit liabilities. Our divisions are supported by the Novartis Institutes for BioMedical Research, Global Drug Development, Novartis Technical Operations and Novartis Business Services organizations. • The Novartis Institutes for BioMedical Research (NIBR) conducts research activities for the Innovative Medicines Division and also collaborates with Sandoz. • The Global Drug Development organization was estab- lished in July 2016 and oversees all drug development activities for our Innovative Medicines Division and the biosimilars portfolio of our Sandoz Division. • The Novartis Technical Operations organization was established in July 2016, to centralize management of our manufacturing operations across our Innovative Medicines and Sandoz Divisions. • Novartis Business Services (NBS) was established in January 2015 as a shared services organization and delivers business support services across the Group, such as information technology, real estate and facil- ity services, procurement, product lifecycle services, human resources, and financial reporting and account- ing operations. The accounting policies mentioned in Note 1 are used in the reporting of segment results. Inter-segmental sales are made at amounts that are considered to approximate arm’s length transactions. The Executive Committee of Novartis evaluates segmental performance and allo- cates resources among the segments based on a num- ber of measures including net sales, operating income and net operating assets. Segment net operating assets consist primarily of property, plant and equipment; intan- gible assets; goodwill; inventories; and trade and other operating receivables less operating liabilities. F-19 Notes to the Novartis Group consolidated financial statements Segmentation – consolidated income statements Innovative Medicines Sandoz Alcon Corporate (including eliminations) Group (USD millions) 2018 2017 restated 1 2018 2017 2018 2017 restated 1 2018 2017 2018 2017 Net sales to third parties 34 892 32 278 9 859 10 060 7 149 6 771 51 900 49 109 Sales to other segments 741 668 177 118 4 3 – 922 – 789 Net sales Other revenues Cost of goods sold Gross profit 35 633 32 946 10 036 10 178 7 153 6 774 – 922 – 789 51 900 49 109 1 188 898 62 37 3 16 88 1 266 1 026 – 9 870 – 8 650 – 5 530 – 5 800 – 3 983 – 3 588 976 863 – 18 407 – 17 175 26 951 25 194 4 568 4 415 3 170 3 189 70 162 34 759 32 960 Selling, general and administration – 10 907 – 9 887 – 2 305 – 2 126 – 2 754 – 2 532 – 505 – 452 – 16 471 – 14 997 Research and development – 7 675 – 7 615 – 814 – 774 – 585 – 583 – 9 074 – 8 972 Other income Other expense Operating income 977 1 027 505 204 58 47 150 691 1 690 1 969 – 1 475 – 1 124 – 622 – 351 – 83 – 124 – 555 – 732 – 2 735 – 2 331 7 871 7 595 1 332 1 368 – 194 – 3 – 840 – 331 8 169 8 629 Income from associated companies 1 – 1 5 23 6 432 1 086 6 438 1 108 Interest expense Other financial income and expense Income before taxes Taxes Net income Attributable to: Shareholders of Novartis AG Non-controlling interests Included in net income are: Interest income Depreciation of property, plant and equipment – 957 – 777 185 39 13 835 8 999 – 1 221 – 1 296 12 614 7 703 12 611 7 703 3 0 294 110 – 1 075 – 916 – 285 – 270 – 235 – 217 – 122 – 117 – 1 717 – 1 520 Amortization of intangible assets – 2 214 – 2 167 – 366 – 447 – 1 052 – 1 066 – 7 – 10 – 3 639 – 3 690 Impairment charges on property, plant and equipment, net Impairment charges on intangible assets, net Impairment charges and fair value gains on financial assets, net – 239 – 84 – 60 – 73 – 3 – 2 – 304 – 157 – 592 – 591 – 249 – 61 – 391 – 57 – 1 232 – 709 107 – 42 17 – 29 – 113 – 185 11 – 256 Additions to restructuring provisions – 395 – 122 – 32 – 61 – 13 – 8 – 94 – 3 – 534 – 194 Equity-based compensation of Novartis equity plans – 645 – 593 – 53 – 52 – 93 – 71 – 220 – 208 – 1 011 – 924 1 Restated to reflect the product transfers between the Innovative Medicines and Alcon Divisions that was effective as of January 1, 2018 F-20 Notes to the Novartis Group consolidated financial statements Innovative Medicines Sandoz Alcon Corporate (including eliminations) Group (USD millions) 2017 restated 1 2016 restated 1 2017 2016 2017 restated 1 2016 restated 1 2017 2016 2017 2016 Net sales to third parties 32 278 31 831 10 060 10 144 6 771 6 543 49 109 48 518 Sales to other segments 668 624 118 104 3 – 789 – 728 Net sales Other revenues Cost of goods sold Gross profit 32 946 32 455 10 178 10 248 6 774 6 543 – 789 – 728 49 109 48 518 898 815 37 37 3 4 – 8 650 – 8 976 – 5 800 – 5 971 – 3 588 – 3 447 25 194 24 294 4 415 4 314 3 189 3 100 88 863 162 62 1 026 918 874 – 17 175 – 17 520 208 32 960 31 916 Selling, general and administration – 9 887 – 9 225 – 2 126 – 1 981 – 2 532 – 2 480 – 452 – 506 – 14 997 – 14 192 Research and development – 7 615 – 7 696 – 774 – 814 – 583 – 529 – 8 972 – 9 039 Other income Other expense Operating income 1 027 1 091 204 185 47 48 691 603 1 969 1 927 – 1 124 – 1 209 – 351 – 259 – 124 – 100 – 732 – 776 – 2 331 – 2 344 7 595 7 255 1 368 1 445 – 3 39 – 331 – 471 8 629 8 268 Income from associated companies – 1 23 6 1 086 697 1 108 703 Interest expense Other financial income and expense Income before taxes Taxes Net income Attributable to: Shareholders of Novartis AG Non-controlling interests Included in net income are: Interest income Depreciation of property, plant and equipment – 777 – 707 39 – 447 8 999 7 817 – 1 296 – 1 119 7 703 6 698 7 703 6 712 0 – 14 110 43 – 916 – 883 – 270 – 260 – 217 – 229 – 117 – 117 – 1 520 – 1 489 Amortization of intangible assets – 2 167 – 2 346 – 447 – 450 – 1 066 – 1 053 – 10 – 12 – 3 690 – 3 861 Impairment charges on property, plant and equipment, net Impairment charges on intangible assets, net Impairment charges and fair value gains on financial assets, net – 84 – 93 – 73 – 2 – 5 – 2 – 157 – 102 – 591 – 524 – 61 – 65 – 57 – 2 – 709 – 591 – 42 – 55 – 29 – 185 – 77 – 256 – 132 Additions to restructuring provisions – 122 – 236 – 61 – 46 – 8 – 36 – 3 – 25 – 194 – 343 Equity-based compensation of Novartis equity plans – 593 – 582 – 52 – 47 – 71 – 53 – 208 – 164 – 924 – 846 1 Restated to reflect the product transfers between the Innovative Medicines and Alcon Divisions that was effective as of January 1, 2018 F-21 Notes to the Novartis Group consolidated financial statements Segmentation – consolidated balance sheets (USD millions) Total assets 1 Total liabilities Total equity Net debt Innovative Medicines Sandoz Alcon Corporate (including eliminations) Group 2018 2017 2018 2017 2018 2017 2018 2017 2018 2017 67 055 52 657 17 328 18 231 25 971 26 412 35 209 35 779 145 563 133 079 – 13 056 – 11 457 – 3 377 – 3 459 – 1 964 – 1 893 – 48 474 – 42 043 – 66 871 – 58 852 78 692 74 227 16 184 19 047 94 876 93 274 Net operating assets 53 999 41 200 13 951 14 772 24 007 24 519 Included in assets and liabilities are: Total property, plant and equipment 10 098 10 857 2 159 2 525 2 878 2 403 561 679 15 696 16 464 Additions to property, plant and equipment 2 822 877 294 326 519 431 Total goodwill and intangible assets 1 44 593 30 154 9 712 10 993 19 578 20 573 139 130 94 1 774 1 728 27 74 013 61 747 Additions to goodwill and intangible assets 2 Total investment in associated companies 1 265 984 107 64 196 82 24 16 1 592 1 146 81 41 7 7 8 264 15 322 8 352 15 370 Additions to investment in associated companies 18 6 11 40 29 46 Cash and cash equivalents, marketable securities, commodities, time deposits and derivative financial instruments Financial debts and derivative financial instruments Current income tax and deferred tax liabilities 15 964 9 485 15 964 9 485 32 148 28 532 32 148 28 532 9 513 6 891 9 513 6 891 1 2017 restated to reflect the product transfers between the Innovative Medicines and Alcon Divisions that was effective as of January 1, 2018, and the Alcon brand name reclassification from Corporate to the Alcon Division. These restatements had no impact on Sandoz or the total Group. 2 Excluding the impact of business combinations The following table shows countries that accounted for more than 5% of at least one of the respective Group totals, as well as regional information for net sales for the years ended December 31, 2018, 2017 and 2016, and for selected non-current assets for the years ended December 31, 2018 and 2017: 2018 % 2017 % 2016 % 2018 % 2017 Net sales1 Total of selected non-current assets2 United States 17 560 34 16 935 34 17 117 35 39 082 852 2 836 2 830 2 41 972 (USD millions) Country Switzerland France Germany United Kingdom Japan Other Group Region Europe Americas 2 705 4 184 1 261 3 169 22 169 51 900 19 064 21 595 Asia/Africa/Australasia 11 241 43 40 43 920 28 476 4 3 1 284 3 128 7 957 148 5 8 2 6 2 490 3 690 1 160 3 177 5 8 2 6 2 390 3 634 1 182 3 267 5 7 2 7 3 976 3 124 758 144 43 20 821 43 20 098 42 9 005 9 9 668 100 49 109 100 48 518 100 98 061 100 93 581 37 41 22 17 492 20 899 10 718 36 42 22 17 079 20 998 10 441 35 43 22 55 913 39 082 3 066 57 40 3 61 699 29 113 2 769 % 47 30 3 9 11 100 66 31 3 Group 51 900 100 49 109 100 48 518 100 98 061 100 93 581 100 1 Net sales from operations by location of third-party customer 2 Total of property, plant and equipment; goodwill; intangible assets; and investment in associated companies The Group’s largest, second-largest and third-largest customers account for approximately 16%, 13% and 7% of net sales, respectively (2017: 17%, 12% and 7%, respec- tively; 2016: 16%, 12% and 6%, respectively). All seg- ments had sales to these customers in 2018, 2017 and F-22 Notes to the Novartis Group consolidated financial statements 2016. No other customer accounted for 5% or more of net sales in any year. The highest amounts of trade receivables outstand- ing were for these same three customers and amounted to 12%, 10% and 6%, respectively, of the trade receiv- ables at December 31, 2018 (2017: 14%, 9% and 5%, respectively). Segmentation – net sales by region1 Innovative Medicines Europe US Asia/Africa/Australasia Canada and Latin America Total Of which in Established Markets Of which in Emerging Growth Markets Sandoz Europe US Asia/Africa/Australasia Canada and Latin America Total Of which in Established Markets Of which in Emerging Growth Markets Alcon Europe US Asia/Africa/Australasia Canada and Latin America Total Of which in Established Markets Of which in Emerging Growth Markets Group Europe US Asia/Africa/Australasia Canada and Latin America Total Of which in Established Markets Of which in Emerging Growth Markets 2018 USD m 2017 restated USD m 2 Change (2017 to 2018) USD % 2016 restated USD m 2 Change (2016 to 2017) USD % 12 296 11 127 11 11 041 11 864 10 857 8 097 2 635 7 702 2 592 34 892 32 278 26 258 24 174 8 634 8 104 4 963 2 754 1 363 779 4 633 3 278 1 391 758 9 859 10 060 7 233 2 626 7 383 2 677 1 805 2 942 1 781 621 7 149 5 395 1 754 1 732 2 800 1 625 614 6 771 5 153 1 618 19 064 17 492 17 560 16 935 11 241 10 718 4 035 3 964 51 900 49 109 38 886 36 710 13 014 12 399 9 5 2 8 9 7 7 – 16 – 2 3 – 2 – 2 – 2 4 5 10 1 6 5 8 9 4 5 2 6 6 5 10 644 7 540 2 606 31 831 23 954 7 877 4 354 3 708 1 418 664 10 144 7 580 2 564 1 684 2 765 1 483 611 6 543 5 092 1 451 17 079 17 117 10 441 3 881 48 518 36 626 11 892 1 2 2 – 1 1 1 3 6 – 12 – 2 14 – 1 – 3 4 3 1 10 0 3 1 12 2 – 1 3 2 1 0 4 1 Net sales from operations by location of third-party customer. Emerging Growth Markets comprise all markets other than the Established Markets of the US, Canada, Western Europe, Japan, Australia and New Zealand. 2 Restated to reflect the product transfers between the Innovative Medicines and Alcon Divisions that was effective as of January 1, 2018. This restatement had no impact on Sandoz or the total Group. F-23 Notes to the Novartis Group consolidated financial statements Innovative Medicines net sales by business franchise 2018 USD restated USD millions millions 1 2017 Change (2017 restated 2016 Change (2016 USD to 2017) USD % millions 1 USD % to 2018) 2018 USD restated USD millions millions 1 2017 Change (2017 restated 2016 Change (2016 USD to 2017) USD % millions 1 USD % to 2018) Oncology Tasigna 1 874 1 841 2 1 739 Sandostatin 1 587 1 612 – 2 1 646 6 – 2 Respiratory Ultibro Breezhaler Gleevec/Glivec 1 561 1 943 – 20 3 323 – 42 Seebri Breezhaler Afinitor/Votubia 1 556 1 525 2 1 516 Promacta/Revolade Tafinlar + Mekinist 1 174 1 155 867 873 35 32 635 672 Exjade/Jadenu 1 099 1 059 4 956 Onbrez Breezhaler Subtotal COPD2 portfolio 703 Xolair 3 Other 1 039 25 454 148 101 411 151 112 674 920 23 10 363 – 2 149 13 1 – 10 143 – 22 4 655 13 835 3 10 9 31 – 26 Jakavi Votrient Kisqali Lutathera Kymriah Other Total Oncology business unit Ophthalmology 977 828 235 167 76 777 808 26 581 2 729 76 209 0 6 nm nm 0 0 0 Total Respiratory 1 767 1 617 9 1 521 6 Cardio-Metabolic Entresto Other 1 028 507 103 170 198 22 17 29 14 21 1 139 887 28 993 – 11 Total Cardio-Metabolic 1 050 524 100 184 185 13 428 12 274 9 12 790 – 4 Lucentis 2 046 1 888 8 1 835 Travoprost Group 517 Topical Olopatadine Group 247 589 284 – 12 619 – 13 335 – 15 Other 1 748 1 860 – 6 1 944 Total Ophthalmology 4 558 4 621 – 1 4 733 – 4 – 2 Neuroscience Gilenya Other 3 341 3 185 5 3 109 2 88 102 – 14 124 – 18 Total Neuroscience 3 429 3 287 4 3 233 2 Immunology, Hepatology and Dermatology Cosentyx 2 837 2 071 37 1 128 554 402 38 283 1 1 0 1 Ilaris Other Total Immunology, Hepatology and Dermatology Established Medicines Galvus Group Diovan Group Exforge Group Zortress/Certican Neoral/Sandimmun(e) Voltaren/Cataflam 1 284 1 233 4 1 193 3 1 023 1 002 464 463 445 957 960 414 488 465 7 1 073 – 11 4 926 12 398 4 4 – 5 515 – 5 – 4 525 – 11 Other 2 587 2 964 – 13 3 328 – 11 Total Established Medicines 7 268 7 481 – 3 7 958 – 6 Total Pharmaceutical business unit 21 464 20 004 7 19 041 Total division net sales 34 892 32 278 8 31 831 5 1 84 42 0 1 Restated to reflect the product transfers between the Innovative Medicines and Alcon Divisions that was effective as of January 1, 2018 2 Chronic obstructive pulmonary disease 3 Net sales reflect Xolair sales for all indications (e.g., including Xolair SAA and Xolair CSU, which is managed by the Immunology, Hepatology and Dermatology franchise). 1 37 30 11 34 11 nm nm nm 3 – 5 3 392 2 474 37 1 412 75 nm = not meaningful F-24 Business franchise Neuroscience Indication US USD m Rest of world USD m Total USD m Relapsing multiple sclerosis 1 765 1 576 3 341 Notes to the Novartis Group consolidated financial statements Top 20 Innovative Medicines Division product net sales – 2018 Brands Gilenya Cosentyx Lucentis Tasigna Sandostatin Gleevec/Glivec Afinitor/Votubia Galvus Group Promacta/Revolade Tafinlar + Mekinist Exjade/Jadenu Xolair 1 Entresto Diovan Group Exforge Group Jakavi Votrient Ilaris Immunology, Hepatology and Dermatology Psoriasis, ankylosing spondylitis and psoriatic arthritis Ophthalmology Age-related macular degeneration Oncology Oncology Oncology Oncology Chronic myeloid leukemia Carcinoid tumors and acromegaly Chronic myeloid leukemia and GIST Breast cancer/TSC Established Medicines Diabetes Oncology Oncology Oncology Respiratory Immune thrombocytopenic purpura Melanoma Chronic iron overload Asthma Cardio-Metabolic Chronic heart failure Established Medicines Established Medicines Oncology Oncology Immunology, Hepatology and Dermatology Hypertension Hypertension Myelofibrosis Renal cell carcinoma Auto-inflammatory (CAPS, TRAPS, HIDS/MKD, FMF, SJIA, AOSD and gout) Reduction of elevated intraocular pressure 1 674 1 163 2 046 1 068 770 1 121 627 1 284 593 698 578 1 039 472 939 983 977 424 806 817 440 929 581 457 521 556 84 19 404 2 837 2 046 1 874 1 587 1 561 1 556 1 284 1 174 1 155 1 099 1 039 1 028 1 023 1 002 977 828 262 292 554 194 145 323 319 517 464 9 654 17 292 26 946 2 210 5 736 7 946 11 864 23 028 34 892 Travoprost Group Ophthalmology Zortress/Certican Established Medicines Transplantation Top 20 products total Rest of portfolio Total division sales 1 Net sales reflect Xolair sales for all indications (e.g., including Xolair SAA and Xolair CSU, which are managed by the Immunology, Hepatology and Dermatology franchise). F-25 Notes to the Novartis Group consolidated financial statements Top 20 Innovative Medicines Division product net sales – 2017 Business franchise Neuroscience Indication US USD m Rest of world USD m Total USD m Relapsing multiple sclerosis 1 709 1 476 3 185 Gleevec/Glivec Oncology Chronic myeloid leukemia and GIST Immunology, Hepatology and Dermatology Psoriasis, ankylosing spondylitis and psoriatic arthritis Brands Gilenya Cosentyx Lucentis Tasigna Sandostatin Afinitor/Votubia Galvus Group Exjade/Jadenu Exforge Group Diovan Group Xolair 1 Tafinlar + Mekinist Promacta/Revolade Votrient Jakavi Ophthalmology Age-related macular degeneration Oncology Oncology Oncology Chronic myeloid leukemia Carcinoid tumors and acromegaly Breast cancer/TSC Cardio-Metabolic Diabetes Oncology Chronic iron overload Established Medicines Established Medicines Respiratory Oncology Oncology Oncology Oncology Hypertension Hypertension Asthma Melanoma Immune thrombocytopenic purpura Renal cell carcinoma Myelofibrosis Reduction of elevated intraocular pressure Travoprost Group Ophthalmology Entresto Cardio-Metabolic Chronic heart failure Neoral/Sandimmun(e) Immunology, Hepatology and Dermatology Transplantation Voltaren/Cataflam Established Medicines Inflammation/pain Top 20 products total Rest of portfolio2 Total division sales2 1 275 796 627 1 316 810 832 819 515 28 87 339 446 407 216 297 38 1 888 1 031 780 706 1 233 544 932 870 920 534 421 401 777 373 210 450 465 2 071 1 943 1 888 1 841 1 612 1 525 1 233 1 059 960 957 920 873 867 808 777 589 507 488 465 8 445 16 123 24 568 2 412 5 298 7 710 10 857 21 421 32 278 1 Net sales reflect Xolair sales for all indications (e.g., including Xolair SAA and Xolair CSU, which are managed by the Immunology, Hepatology and Dermatology franchise). 2 Restated to reflect the product transfers between the Innovative Medicines and Alcon Divisions that was effective as of January 1, 2018 F-26 Notes to the Novartis Group consolidated financial statements Top 20 Innovative Medicines Division product net sales – 2016 Brands Business franchise Indication Gleevec/Glivec Oncology Chronic myeloid leukemia and GIST Gilenya Lucentis Tasigna Sandostatin Afinitor/Votubia Galvus Group Cosentyx Diovan Group Exjade/Jadenu Exforge Group Xolair 1 Votrient Tafinlar + Mekinist Promacta/Revolade Neuroscience Ophthalmology Oncology Oncology Oncology Relapsing multiple sclerosis Age-related macular degeneration Chronic myeloid leukemia Carcinoid tumors and acromegaly Breast cancer/TSC Cardio-Metabolic Diabetes Immunology, Hepatology and Dermatology Psoriasis, ankylosing spondylitis and psoriatic arthritis Established Medicines Hypertension Oncology Chronic iron overload Established Medicines Hypertension Respiratory Oncology Oncology Oncology Asthma Renal cell carcinoma Melanoma Immune thrombocytopenic purpura Reduction of elevated intraocular pressure Travoprost Group Ophthalmology Jakavi Oncology Myelofibrosis Voltaren/Cataflam Established Medicines Inflammation/pain Neoral/Sandimmun(e) Immunology, Hepatology and Dermatology Transplantation Exelon/Exelon Patch Established Medicines Alzheimer’s disease Top 20 products total Rest of portfolio2 Total division sales2 US USD m Rest of world USD m 1 214 2 109 1 683 1 426 1 835 1 017 793 741 1 193 363 926 509 916 835 372 374 325 408 581 525 474 354 722 853 775 765 147 447 10 357 298 310 211 41 90 Total USD m 3 323 3 109 1 835 1 739 1 646 1 516 1 193 1 128 1 073 956 926 835 729 672 635 619 581 525 515 444 7 923 16 076 23 999 2 721 5 111 7 832 10 644 21 187 31 831 1 Net sales reflect Xolair sales for all indications (e.g., including Xolair SAA and Xolair CSU, which is managed by the Immunology, Hepatology and Dermatology franchise). 2 Restated to reflect the product transfers between the Innovative Medicines and Alcon Divisions that was effective as of January 1, 2018 F-27 Notes to the Novartis Group consolidated financial statements Sandoz net sales by business franchise Alcon net sales by business franchise Change (2017 to 2018) Change (2016 2016 to 2017) USD % USD m USD % 2017 USD m 2018 USD m 2018 USD m Change (2017 Change (2016 to 2018) restated to 2017) USD % USD m 1 USD % 2016 2017 restated USD m 1 Retail Generics 1 7 880 8 409 – 6 8 623 Biopharmaceuticals 1 436 1 135 27 1 002 Anti-Infectives 543 516 5 519 Total division net sales 9 859 10 060 – 2 10 144 – 2 13 – 1 – 1 1 Of which USD 826 million (2017: USD 880 million) represents anti-infectives sold under the Sandoz name Surgical Consumables Implantables 2 227 2 097 6 2 007 1 136 1 034 10 1 007 Equipment/other 636 594 7 565 Total Surgical 3 999 3 725 7 3 579 Vision Care Contact lenses 1 928 1 833 5 1 762 Ocular health 1 222 1 213 1 1 202 Total Vision Care 3 150 3 046 3 2 964 Total division net sales 7 149 6 771 6 6 543 4 3 5 4 4 1 3 3 1 Restated to reflect the product transfers between the Innovative Medicines and Alcon Divisions that was effective as of January 1, 2018 The product portfolio of Sandoz and Alcon is widely spread in 2018, 2017 and 2016. Segmentation – other revenue Innovative Medicines Sandoz Alcon Corporate (including eliminations) Group 2018 2017 2018 2017 2018 2017 2018 2017 2018 2017 874 162 128 24 648 186 28 36 3 10 45 4 62 4 24 9 37 3 16 88 877 188 173 28 652 301 28 45 3 16 88 1 266 1 026 Total other revenues 1 188 898 1 Other includes revenue from activities such as manufacturing or other services rendered, to the extent such revenue is not recorded under net sales. Innovative Medicines Sandoz Alcon Corporate (including eliminations) Group 2017 2016 2017 2016 2017 2016 2017 2016 2017 2016 648 186 28 36 558 167 65 25 4 24 9 37 6 24 7 37 3 4 88 62 652 301 28 45 564 257 65 32 3 4 88 62 1 026 918 (USD millions) Profit-sharing income Royalty income Milestone income Other 1 (USD millions) Profit-sharing income Royalty income Milestone income Other 1 Total other revenues 898 815 1 Other includes revenue from activities such as manufacturing or other services rendered, to the extent such revenue is not recorded under net sales. F-28 Notes to the Novartis Group consolidated financial statements 4. Associated companies (USD millions) Roche Holding AG, Switzerland GlaxoSmithKline Consumer Healthcare Holdings Ltd., UK Others Associated companies related to continuing operations Net income statement effect Other comprehensive income effect 1 Total comprehensive income effect 2018 526 5 910 2 2017 456 629 23 2016 464 2018 75 2017 108 2016 – 39 2018 601 234 – 557 – 145 710 5 353 5 2 2017 564 484 23 2016 425 944 5 6 438 1 108 703 – 482 – 37 671 5 956 1 071 1 374 1 In 2018, Novartis share of other comprehensive income recognized by associated companies, net of taxes of USD 511 million was recycled into the consolidated income statement as a result of the divestment of the investment in GSK Consumer Healthcare Holdings Ltd. No Novartis share of other comprehensive income recognized by associated companies, net of taxes was recycled into the consolidated income statement in 2017 and 2016. Novartis has significant investments in Roche Holding AG, Basel (Roche) as well as certain other smaller invest- ments that are accounted for as associated companies. The investment in GlaxoSmithKline Consumer Health- care Holdings Ltd, Brentford, Middlesex, UK, was divested on June 1, 2018, to GlaxoSmithKline plc, Great Britain. (USD millions) Balance sheet value December 31, December 31, 2017 2018 Roche Holding AG, Switzerland 8 195 8 121 (CHF billions) Total comprehen- comprehen- Revenue Net income sive income sive income Other December 31, 2017 June 30, 2018 53.3 28.1 6.6 6.4 0.7 0.8 7.3 7.2 A purchase price allocation was performed on the basis of publicly available information at the time of acquisition of the investment. The December 31, 2018, balance sheet value allocation is as follows: GlaxoSmithKline Consumer Healthcare Holdings Ltd., UK Others Total Roche Holding AG (USD millions) 157 7 020 229 Novartis share of Roche’s estimated net assets Novartis share of re-appraised intangible assets 8 352 15 370 Implicit Novartis goodwill Current value of share in net identifiable assets and goodwill Accumulated equity accounting adjustments and translation effects less dividends received Balance sheet value December 31, 2018 2 466 521 2 887 5 874 2 321 8 195 The Group’s holding in Roche voting shares was 33.3% at December 31, 2018, 2017 and 2016. This investment represents approximately 6.2% of Roche’s total out- standing voting and non-voting equity instruments at December 31, 2018, 2017 and 2016. Since full-year 2018 financial data for Roche is not available when Novartis produces its consolidated finan- cial results, a survey of analyst estimates is used to esti- mate the Group’s share of Roche’s net income. Any dif- ferences between these estimates and actual results will be adjusted in the Group’s 2019 consolidated financial statements when available. The following tables show summarized financial infor- mation for Roche, including current values of fair value adjustments made at the time of the acquisition of the shares, for the year ended December 31, 2017, and for the six months ended June 30, 2018 (since full-year 2018 data is not yet available): (CHF billions) Current assets Non-current assets Current Non-current liabilities liabilities December 31, 2017 June 30, 2018 31.6 29.6 55.4 57.8 22.2 23.0 25.5 25.0 The identified intangible assets principally relate to the value of currently marketed products and are amortized on a straight-line basis over their estimated average use- ful life of 20 years. In 2018, dividends received from Roche in relation to the distribution of its 2017 net income amounted to USD 464 million (2017: USD 438 million in relation to the distribution of its 2016 net income). The consolidated income statement effects from applying Novartis accounting principles for this invest- ment in 2018, 2017 and 2016 are as follows: (USD millions) 2018 2017 2016 Novartis share of Roche’s estimated current-year consolidated net income Prior-year adjustment Amortization of fair value adjustments relating to intangible assets, net of taxes of USD 40 million (2017: USD 42 million; 2016: USD 42 million) Net income effect 799 – 125 669 – 67 678 – 68 – 148 – 146 526 456 – 146 464 F-29 Notes to the Novartis Group consolidated financial statements The publicly quoted market value of the Novartis inter- est in Roche (SIX symbol: RO) at December 31, 2018, was USD 13.2 billion (2017: USD 13.4 billion). tors. Furthermore, Novartis had customary minority rights and also exit rights at a pre-defined, market-based pricing mechanism. GlaxoSmithKline Consumer Healthcare Holdings Ltd. On March 27, 2018, Novartis entered into an agreement with GlaxoSmithKline plc, Great Britain (GSK) to divest its 36.5% stake in GSK Consumer Healthcare Holdings Ltd. (GSK Consumer Healthcare) to GSK for USD 13.0 billion in cash. As a result, Novartis discontinued the use of equity method accounting starting from April 1, 2018. The divestment transaction closed on June 1, 2018, and Novartis realized a pre-tax gain of USD 5.8 billion, recorded in income from associated companies. See Note 2. GSK Consumer Healthcare was formed in March, 2015, via contribution of businesses from both Novartis and GSK. At December 31, 2017 and 2016, Novartis had a 36.5% interest in GSK Consumer Healthcare and had four of 11 seats on the GSK Consumer Healthcare board of direc- In 2018, dividends received from GSK Consumer Healthcare amounted to USD 252 million (2017: USD 544 million). The consolidated income statement effects from applying Novartis accounting principles for this invest- ment in 2018, 2017 and 2016 are as follows: (USD millions) 2018 2017 2016 Novartis share of GSK Consumer Healthcare’s estimated current-year consolidated net income Prior-year adjustment Amortization of fair value adjustments relating to intangible assets and inventory, net of taxes of USD 1 million (2017: USD 1 million; 2016: USD 2 million) Pre-tax gain on divestment of GSK Consumer Healthcare Net income effect 119 4 589 47 268 – 22 – 3 – 7 – 12 5 790 5 910 629 234 5. Interest expense and other financial income and expense Interest expense Other financial income and expense (USD millions) Interest expense 2018 – 892 2017 – 758 2016 (USD millions) – 709 Interest income (Expense)/ income arising from discounting long-term liabilities – 65 – 19 2 Total interest expense – 957 – 777 – 707 Dividend income Net capital losses on available-for-sale securities Impairment of commodities and available-for-sale securities, net Other financial expense Monetary loss from hyperinflation accounting Currency result, net Total other financial income and expense 2018 294 1 – 2 – 33 – 10 – 65 2017 110 1 – 1 12 – 25 2016 43 1 – 1 7 – 20 – 58 – 477 185 39 – 447 F-30 Notes to the Novartis Group consolidated financial statements 6. Taxes Income before taxes (USD millions) Switzerland Foreign Total income before taxes 2018 11 686 2 149 13 835 2017 5 289 3 710 8 999 2016 3 110 4 707 7 817 (As a percentage) Applicable tax rate 2018 2017 2016 14.0 14.5 13.2 Effect of disallowed expenditures 2.0 3.4 3.5 Effect of utilization of tax losses brought forward from prior periods – 0.1 – 0.1 – 0.2 Effect of income taxed at reduced rates – 0.4 – 0.2 – 0.2 Effect of income not subject to tax 1 – 3.7 0.0 0.0 Effect of tax credits and allowances – 2.4 – 2.2 – 2.8 Current and deferred income tax expense Effect of release of contingent consideration liability – 0.2 – 1.2 0.0 (USD millions) Switzerland Foreign 2018 – 671 2017 – 462 2016 – 709 – 1 132 – 1 594 – 1 418 Current income tax expense – 1 803 – 2 056 – 2 127 Switzerland Foreign Deferred tax income 23 559 582 – 298 1 058 765 243 760 1 008 Total income tax expense – 1 221 – 1 296 – 1 119 Analysis of tax rate The main elements contributing to the difference between the Group’s overall applicable tax rate (which can change each year since it is calculated as the weighted average tax rate based on the pre-tax income of each subsidiary) and the effective tax rate are: Effect of tax rate change on current and deferred tax assets and liabilities 2 Effect of write-off of deferred tax assets Effect of write down and reversal of write-down of investments in subsidiaries – 0.5 0.2 0.7 0.0 0.2 0.5 – 0.1 – 1.1 – 1.0 Effect of tax benefits expiring in 2017 0.0 – 0.8 – 0.5 Effect of non-deductible losses in Venezuela 0.0 Effect of prior year items Effect of other items 3 Effective tax rate 0.0 1.2 0.2 1.3 0.2 0.1 – 0.6 0.6 8.8 14.4 14.3 1 Included in 2018 is the effect of income not subject to tax (-3.7%) arising from the portion of the non-taxable gain on the divestment of the Group’s investment in GSK Consumer Healthcare Holdings Ltd. attributable to Switzerland. 2 Included in 2017 is a 0.7% impact related to the revaluation of the deferred tax assets and liabities and a portion of current tax payables. This revaluation resulted from the US tax reform legislation enacted on December 22, 2017, refer to Note 11 for additional disclosures. 3 In 2018, other items (+0.6%) include changes in uncertain tax positions (+1.0%) and other items (-0.4%). In 2016, other items (+0.1%) include one-time impacts for the deferred tax effects on the net assets of certain subsidiaries resulting from the change in their tax status (-6.2%), the changes in uncertain tax positions (+5.1%) and other items (+1.2%). Novartis has a substantial business presence in many countries and is therefore subject to different income and expense items that are non-taxable (permanent dif- ferences) or taxed at different rates in those tax jurisdic- tions. This results in a difference between our applicable tax rate and effective tax rate, as shown in the table above. The utilization of tax-loss carry-forwards lowered the tax charge by USD 19 million in 2018, by USD 7 million in 2017 and by USD 18 million in 2016. F-31 Notes to the Novartis Group consolidated financial statements 7. Earnings per share Net income attributable to shareholders of Novartis AG (USD millions) Number of shares (in millions) 2018 2017 12 611 7 703 2016 6 712 Weighted average number of shares outstanding used in basic earnings per share 2 319 2 346 2 378 Adjustment for vesting of restricted shares, restricted share units and dilutive shares from options 25 25 22 Weighted average number of shares in diluted earnings per share 2 344 2 371 2 400 Basic earnings per share (USD) Diluted earnings per share (USD) 5.44 3.28 2.82 5.38 3.25 2.80 Basic earnings per share (EPS) is calculated by dividing net income attributable to shareholders of Novartis AG by the weighted average number of shares outstanding in a reporting period. This calculation excludes the aver- age number of issued shares purchased by the Group and held as treasury shares. For diluted EPS, the weighted average number of shares outstanding is adjusted to assume the vesting of all restricted shares, restricted share units, and the conversion of all potentially dilutive shares arising from options on Novartis shares that have been issued. No options were excluded from the calculation of diluted EPS in 2018, 2017 or 2016, as all options were dilutive in all years. 8. Changes in consolidated statements of comprehensive income The consolidated statements of comprehensive income include the Group’s net income for the year as well as all other valuation adjustments recorded in the Group’s con- solidated balance sheet but that under IFRS are not recorded in the consolidated income statement. These include fair value adjustments to financial instruments, actuarial gains or losses on defined benefit pension and other post-employment plans, and currency translation effects, net of tax. F-32 Notes to the Novartis Group consolidated financial statements The following table summarizes these value adjustments and currency translation effects attributable to Novartis shareholders: (USD millions) Value adjustments at January 1, 2016 Fair value adjustments on financial instruments Net actuarial losses from defined benefit plans Currency translation effects Total value adjustments in 2016 Fair value adjustments related to divestments Value adjustments at December 31, 2016 Fair value adjustments on financial instruments Net investment hedge Net actuarial losses from defined benefit plans Currency translation effects Total value adjustments in 2017 Value adjustments at December 31, 2017, as previously reported Impact of adoption of IFRS 9 on retained earnings and OCI 1 Reclassification to presentation required under IFRS 9 Fair value adjustments on marketable securities 462 – 113 – 113 349 39 39 388 – 177 – 211 Fair value Fair value adjustments adjustments on on debt deferred cash flow hedges securities – 1 – 18 15 Fair value Actuarial adjustments gains/(losses) on equity from defined securities benefit plans Cumulative currency translation effects Total value adjustments – 5 413 747 – 4 223 – 1 – 1 – 1 – 2 15 – 3 12 12 9 9 12 211 211 13 – 16 – 514 – 98 – 514 – 2 389 – 2 389 – 514 – 2 389 – 3 001 12 12 – 5 915 – 1 642 – 7 212 851 851 – 237 2 208 1 971 50 – 237 851 2 208 2 872 – 5 064 329 – 4 340 – 177 – 5 064 329 – 4 517 25 – 16 95 – 359 320 65 – 4 452 95 320 415 744 Restated value adjustments at January 1, 2018 – 2 Fair value adjustments on financial instruments Fair value adjustments on financial assets sold Net investment hedge Net actuarial gains from defined benefit plans Currency translation effects Total value adjustments in 2018 Value adjustments at December 31, 2018 – 2 – 359 12 21 – 3 – 359 208 – 5 423 1 Notes 1 and 29 provide additional disclosures related to the impact of adoption of IFRS 9 Financial Instruments. OCI: other comprehensive income 8.1) The 2018, 2017 and 2016 changes in the fair value of financial instruments were as follows: (USD millions) Fair value adjustments at January 1, 2018, as previously reported Impact of adoption of IFRS 9 on retained earnings and other comprehensive income 2 Reclassification to presentation required under IFRS 9 Restated fair value adjustments at January 1, 2018 Changes in fair value: – Equity securities Amortized net losses on cash flow hedges transferred to the consolidated income statement Deferred tax on above items Realized net gains reclassified to the retained earnings: – Other financial assets sold Fair value adjustments during the year Fair value adjustments at December 31, 2018 Fair value adjustments on marketable securities Fair value adjustments on equity securities 1 Fair value Fair value adjustments adjustments on on debt deferred cash flow hedges securities – 2 9 388 – 177 – 211 Total 395 – 177 211 211 18 – 5 – 16 – 3 208 – 2 9 218 18 13 – 6 – 16 9 227 13 – 1 12 21 – 2 1 Includes fair value adjustments on equity securities designated as financial assets valued at fair value through other comprehensive income with no subsequent recycling into the consolidated income statement. 2 Notes 1 and 29 provide aditional disclosures on impact of adoption of IFRS 9 Financial Instruments. F-33 Notes to the Novartis Group consolidated financial statements (USD millions) Fair value adjustments at January 1, 2017 Changes in fair value: – Available-for-sale marketable securities – Available-for-sale financial investments Realized net gains transferred to the consolidated income statement: – Other financial assets sold Amortized net losses on cash flow hedges transferred to the consolidated income statement Impaired financial assets transferred to the consolidated income statement Deferred tax on above items 1 Fair value adjustments during the year Fair value adjustments at December 31, 2017 Fair value adjustments on marketable securities Fair value Fair value adjustments adjustments on on debt deferred cash flow hedges securities 349 – 1 – 3 12 47 – 109 102 – 13 39 388 – 1 – 1 – 2 13 – 1 12 9 Total 345 11 47 – 109 13 102 – 14 50 395 1 Included in 2017 is a USD 18 million impact related to the revaluation of deferred tax liabilities on available-for-sale financial investments held in the US that were previously recognized through other comprehensive income. This revaluation resulted from the US tax reform legislation enacted on December 22, 2017, refer to Note 11 for additional disclosures. (USD millions) Fair value adjustments at January 1, 2016 Changes in fair value: – Available-for-sale marketable securities – Available-for-sale financial investments Realized net gains transferred to the consolidated income statement: – Marketable securities sold – Other financial assets sold Amortized net losses on cash flow hedges transferred to the consolidated income statement Impaired financial assets transferred to the consolidated income statement Deferred tax on above items Fair value adjustments during the year Fair value adjustments at December 31, 2016 8.2) In 2018, cumulative currency translation losses of USD 946 million were recycled through the income state- ment as a result of the divestment of the investment in GSK Consumer Healthcare Holdings Ltd. See Notes 2 and 4. No currency translation losses or gains were recy- cled through the income statement in 2017 and 2016. 8.3) Remeasurements from defined benefit plans arise as follows: (USD millions) Defined benefit pension plans before tax Other post-employment benefit plans before tax Taxation on above items 1 Total after tax Attributable to: Shareholders of Novartis AG Non-controlling interests Fair value adjustments on marketable securities Fair value Fair value adjustments adjustments on on debt deferred cash flow hedges securities 462 – 1 – 18 1 – 87 – 1 – 154 131 – 3 – 113 349 16 – 1 15 – 3 – 1 Total 443 1 – 87 – 1 – 154 16 131 – 4 – 98 345 2018 2017 – 482 1 367 54 69 76 – 592 2016 – 667 12 140 – 359 851 – 515 – 359 851 – 514 – 1 1 Included in 2017 is a USD -272 million impact related to the revaluation of deferred tax assets on US post-employment benefits that were previously recognized through other comprehensive income. This revaluation resulted from the US tax reform legislation enacted on December 22, 2017, refer to Note 11 for additional disclosures. F-34 Notes to the Novartis Group consolidated financial statements 9. Property, plant and equipment The following table summarizes the movements of property, plant and equipment during 2018: (USD millions) Cost January 1, 2018 Cost of assets related to disposal group held for sale 1 Impact of business combinations Reclassifications 2 Additions 3 Disposals and derecognitions 4 Currency translation effects December 31, 2018 Accumulated depreciation January 1, 2018 Buildings Construction in progress Machinery and other equipment Total 14 064 2 368 16 858 34 010 – 114 40 538 110 – 212 – 291 – 24 15 – 1 470 1 250 – 21 – 76 – 160 80 931 407 – 457 – 504 – 309 137 1 774 – 697 – 887 14 135 2 042 17 155 34 028 Land 720 – 11 2 1 7 – 7 – 16 696 – 40 – 5 983 – 38 – 11 485 – 17 546 Accumulated depreciation on assets related to disposal group held for sale 1 56 Depreciation charge 5 Accumulated depreciation on disposals and derecognitions 4 – 3 – 574 180 4 3 101 161 – 1 140 – 1 717 412 Impairment charge Reversal of impairment charge Currency translation effects December 31, 2018 Net book value at December 31, 2018 – 1 – 122 – 16 – 185 1 115 8 2 12 361 – 43 – 6 328 – 37 – 11 924 – 18 332 653 7 807 2 005 5 231 15 696 595 – 324 20 479 Net book value of property, plant and equipment under finance lease contracts 79 Commitments for purchases of property, plant and equipment Capitalized borrowing costs 79 289 6 1 Note 2 provides additional disclosures related to disposal group held for sale. 2 Reclassifications between various asset categories due to completion of plant and other equipment under construction. 3 Additions in the disposal group held for sale for the period from January 1, 2018, to the date of reclassification to assets held for sale were USD 21 million 4 Derecognition of assets that are no longer used and are not considered to have a significant disposal value or other alternative use. 5 Depreciation charge in the disposal group held for sale for the period from January 1, 2018, to the date of reclassification to assets held for sale was USD 15 million F-35 Notes to the Novartis Group consolidated financial statements The following table summarizes the movements of property, plant and equipment during 2017: (USD millions) Cost January 1, 2017 Reclassifications 1 Additions Disposals and derecognitions 2 Currency translation effects December 31, 2017 Accumulated depreciation January 1, 2017 Depreciation charge Accumulated depreciation on disposals and derecognitions 2 Impairment charge Reversal of impairment charge Currency translation effects December 31, 2017 Net book value at December 31, 2017 Land Buildings Construction in progress Machinery and other equipment Total 687 13 113 2 680 14 816 31 296 5 13 – 23 38 508 104 – 324 663 – 1 617 1 104 1 186 425 1 728 – 71 190 – 593 – 1 011 1 106 1 997 720 14 064 2 368 16 858 34 010 – 40 – 5 436 – 15 – 10 164 – 15 655 – 3 6 – 510 275 – 25 – 3 – 287 – 1 007 – 1 520 534 – 106 30 849 – 189 32 – 772 – 1 063 34 – 58 2 – 1 – 40 – 5 983 – 38 – 11 485 – 17 546 680 8 081 2 330 5 373 16 464 Net book value of property, plant and equipment under finance lease contracts 78 Commitments for purchases of property, plant and equipment Capitalized borrowing costs 1 Reclassifications between various asset categories due to completion of plant and other equipment under construction 2 Derecognition of assets that are no longer used and are not considered to have a significant disposal value or other alternative use 78 318 9 F-36 Notes to the Novartis Group consolidated financial statements 10. Goodwill and intangible assets The following table summarizes the movements of goodwill and intangible assets in 2018: Goodwill Intangible assets other than goodwill (USD millions) Cost January 1, 2018 In-process research and Alcon Total development brand name Technologies Currently marketed Marketing know-how products Other intangible assets Total 32 179 6 462 2 980 6 638 34 105 5 960 1 852 57 997 Cost of assets related to disposal group held for sale 1 – 9 – 276 – 1 116 Impact of business combinations 4 084 10 224 2 531 479 728 2 – 2 – 1 403 1 12 756 218 385 1 592 – 697 477 – 214 – 70 – 928 – 183 – 1 395 – 183 – 380 – 76 – 41 – 387 – 18 – 522 35 700 16 167 2 980 6 253 35 412 5 960 2 253 69 025 – 429 – 1 170 – 4 268 – 19 631 – 1 668 – 1 263 – 28 000 Reclassifications 2 Additions 3 Disposals and derecognitions 4 Impairment charge 5 Currency translation effects December 31, 2018 Accumulated amortization January 1, 2018 Accumulated amortization / impairments on assets related to disposal group held for sale 1 Amortization charge 5 Accumulated impairments on disposals and derecognitions4 Impairment charge 5 Currency translation effects 23 2 107 816 925 – 570 – 2 521 – 238 – 310 – 3 639 209 – 167 6 791 – 53 – 825 26 152 257 1 257 – 4 – 1 049 16 200 December 31, 2018 – 406 – 1 120 – 4 758 – 21 218 – 1 906 – 1 304 – 30 306 Net book value at December 31, 2018 35 294 15 047 2 980 1 495 14 194 4 054 949 38 719 1 Note 2 provides additional disclosures related to assets of disposal group held for sale. 2 Reclassifications between various asset categories as a result of product launches of acquired In-Process Research & Development and completion of software development 3 No addition in the disposal group held for sale for the period from January 1, 2018, to the date of reclassification to assets held for sale. 4 Derecognitions of assets that are no longer used or being developed and are not considered to have a significant disposal value or other alternative use 5 Amortization related to the disposal group held for sale for the period from January 1, 2018, to the date of reclassification to assets held for sale was USD 45 million Impairment charges related to the disposal group held for sale for the write-down of the allocated goodwill were USD 183 million and for the currently marketed products were USD 37 million (thereof USD 9 million recognized for the period from January 1, 2018, to the date of reclassification to assets held for sale) F-37 Notes to the Novartis Group consolidated financial statements The following table summarizes the movements of goodwill and intangible assets in 2017: Goodwill Intangible assets other than goodwill (USD millions) Cost January 1, 2017 In-process research and Alcon Total development brand name Technologies Currently marketed Marketing know-how products Other intangible assets Total 31 381 5 150 2 980 6 548 33 007 5 960 1 492 55 137 Impact of business combinations 94 Reclassifications 1 Additions Disposals and derecognitions 2 Currency translation effects 704 1 223 – 389 697 – 353 134 175 282 – 328 969 5 – 1 86 1 223 1 146 214 162 – 64 – 746 48 1 237 December 31, 2017 32 179 6 462 2 980 6 638 34 105 5 960 1 852 57 997 Accumulated amortization January 1, 2017 Reclassifications 1 Amortization charge Accumulated impairments on disposals and derecognitions2 Impairment charge – 401 – 886 – 3 637 – 16 863 – 1 430 – 981 – 23 797 6 352 – 615 – 27 – 6 – 577 – 2 571 – 238 – 304 – 3 690 317 – 92 – 54 – 416 61 – 2 – 37 730 – 709 – 534 Currency translation effects – 28 December 31, 2017 – 429 – 1 170 – 4 268 – 19 631 – 1 668 – 1 263 – 28 000 Net book value at December 31, 2017 31 750 5 292 2 980 2 370 14 474 4 292 589 29 997 1 Reclassifications between various asset categories as a result of product launches of acquired In-Process Research & Development and completion of software development 2 Derecognitions of assets that are no longer used or being developed and are not considered to have a significant disposal value or other alternative use The following table summarizes the allocation of the net book values of goodwill and intangible assets by report- ing segment at December 31, 2018: Goodwill Intangible assets other than goodwill (USD millions) Innovative Medicines Sandoz (excluding assets of disposal group held for sale) Alcon Corporate In-process research and Alcon Total development brand name Technologies Currently marketed Marketing know-how products Other intangible assets Total 18 551 14 377 6 11 228 431 26 042 7 837 8 899 7 419 246 5 304 1 115 37 1 875 2 980 1 185 1 851 4 054 363 10 679 118 123 Net book value at December 31, 2018 35 294 15 047 2 980 1 495 14 194 4 054 949 38 719 The following table summarizes the allocation of the net book values of goodwill and intangible assets by report- ing segment at December 31, 2017: 1 Goodwill Intangible assets other than goodwill (USD millions) Innovative Medicines Sandoz Alcon Corporate In-process research and Alcon Total development brand name Technologies Currently marketed Marketing know-how products 9 10 786 539 1 589 Other intangible assets Total 354 15 517 30 2 783 2 980 1 822 2 099 4 292 194 11 678 11 19 14 637 4 368 8 210 8 895 8 625 291 8 Net book value at December 31, 2017 31 750 5 292 2 980 2 370 14 474 4 292 589 29 997 1 Restated to reflect the product transfers between the Innovative Medicines and the Alcon Division that was effective January 1, 2018, and the Alcon brand name reclassification from Corporate to the Alcon Division. These restatements had no impact on Sandoz or the total Group. See Note 3. The Innovative Medicines, Sandoz and Alcon Divisions’ cash generating units, to which goodwill is allocated, each comprise a group of smaller cash-generating units. The valuation method of the recoverable amount of the cash generating units, to which goodwill is allocated, is based on the fair value less costs of disposal. F-38 Notes to the Novartis Group consolidated financial statements In the prior year, the Alcon brand name indefinite life intangible asset was reported in Corporate, as it was used to market products of the Alcon Division and prod- ucts within the Ophthalmology business franchise of the Innovative Medicines Division. In connection with the planned spin-off of the Alcon Division (see Note 30), it is the intention of the Novartis Group to transfer the full rights of the Alcon brand name to the Alcon Division. As a result, the Innovative Medicines Division started the process to rebrand the products within its Ophthalmol- ogy business franchise and will no longer use the Alcon brand name. As a result, the Alcon brand name indefinite life intangible asset is reported in the Alcon Division in all years presented. In 2018, net sales of the Alcon Divi- sion products together are the grouping of cash-gener- ating units, which are used to determine the recoverable amount. In the prior year, net sales of products within Innovative Medicines, Ophthalmology business fran- chise and Alcon Division products, which used the Alcon brand name, together were the grouping of cash-gener- ating units, which were used to determine the recover- able amounts. The valuation method is based on the fair value less costs of disposal. tions: (As a percentage) Terminal growth rate Discount rate (post-tax) Innovative Medicines Sandoz Alcon 1.5 7.5 2.0 7.5 3.0 7.5 The Alcon terminal growth rate assumption of 3% is higher than the expected inflation rate of the medical device industry, and more specifically the ophthalmic sub-segment of the industry. The growth rates are expected to exceed this long-term inflation rate, as the aging population to which Alcon’s products are pre- scribed is growing faster than the general population. The discount rates for all divisions consider the Group’s weighted average cost of capital, adjusted to approximate the weighted average cost of capital of a comparable market participant. The fair value less costs of disposal, for all groupings of cash-generating units containing goodwill or indefi- nite life intangible assets, is reviewed for the impact of reasonably possible changes in key assumptions. In par- ticular, we considered an increase in the discount rate, a decrease in the terminal growth rate, and certain neg- ative impacts on the forecasted cash flows. These rea- sonably possible changes in key assumptions did not indicate an impairment. “Note 1. Significant accounting policies—Impairment of goodwill and intangible assets” provides additional disclosures on how the Group performs goodwill and intangible asset impairment testing. The following table shows the intangible asset and goodwill impairment charges for 2018 and 2017: (USD millions) Sandoz 2 Alcon 3 Total 2018 – 592 – 249 – 391 2017 – 591 – 61 – 57 – 1 232 – 709 1 2018 includes an impairment of USD 400 million related to a partial write-down of the Votrient currently marketed product; 2017 includes an impairment of USD 465 million related to the write-down of the Serelaxin IPR&D 2 2018 includes impairments of USD 220 million related to the write-down of the allocated goodwill (USD 183 million) and the currently marketed products (USD 37 million) related to the pending divestment of the Sandoz US dermatology business and generic US oral solids portfolio. (see Note 2) 3 2018 includes an impairment of USD 337 million related to the write-down of the CyPass currently marketed product, which was acquired with the Alcon Division 2016 acquisition of Transcend Medical, Inc. (see Note 2) The following assumptions are used in the calcula- Innovative Medicines 1 F-39 Notes to the Novartis Group consolidated financial statements 11. Deferred tax assets and liabilities (USD millions) Property, plant & equipment Pensions and other benefit Intangible obligations assets of associates Tax loss Other assets, provisions forwards and accruals carry- Total Inventories Gross deferred tax assets at January 1, 2018 137 1 287 1 090 3 786 97 1 983 8 380 Gross deferred tax liabilities at January 1, 2018 – 613 – 2 985 – 254 – 455 – 9 – 1 003 – 5 319 Net deferred tax balance at January 1, 2018 – 476 – 1 698 836 3 331 88 980 3 061 At January 1, 2018 – 476 – 1 698 836 3 331 Net deferred tax balance related to disposal group held for sale Credited/(charged) to income Charged to equity Charged to other comprehensive income Impact of business combinations 1 31 1 378 – 6 88 – 1 4 – 86 – 113 69 980 3 061 – 1 368 – 17 8 – 6 582 – 17 77 – 2 874 298 83 – 2 493 Other movements 13 42 6 9 1 – 51 20 Net deferred tax balance at December 31, 2018 – 431 – 4 151 915 3 248 273 1 370 1 224 Gross deferred tax assets at December 31, 2018 without disposal group Gross deferred tax liabilities at December 31, 2018 without disposal group Net deferred tax balance at December 31, 2018 without disposal group 191 1 233 1 188 3 722 273 2 175 8 782 – 622 – 5 384 – 273 – 474 – 805 – 7 558 – 431 – 4 151 915 3 248 273 1 370 1 224 After offsetting the following amount of deferred tax assets and liabilities within the same tax jurisdiction the balance amounts to: Deferred tax assets at December 31, 2018 Deferred tax liabilities at December 31, 2018 Net deferred tax balance at December 31, 2018 83 8 699 – 7 475 1 224 Gross deferred tax assets at January 1, 2017 224 1 331 1 839 4 160 146 2 597 10 297 Gross deferred tax liabilities at January 1, 2017 – 629 – 4 019 – 358 – 511 – 1 403 – 6 920 Net deferred tax balance at January 1, 2017 – 405 – 2 688 1 481 3 649 146 1 194 3 377 At January 1, 2017 Credited/(charged) to income Charged to equity Charged to other comprehensive income Impact of business combinations – 405 – 2 688 1 481 3 649 – 30 1 279 – 90 – 304 – 592 – 322 Other movements – 41 33 37 – 14 Net deferred tax balance at December 31, 2017 – 476 – 1 698 836 3 331 146 – 49 5 – 14 88 1 194 3 377 – 46 – 101 – 69 2 760 – 101 – 661 – 317 3 980 3 061 Gross deferred tax assets at December 31, 2017 137 1 287 1 090 3 786 97 1 983 8 380 Gross deferred tax liabilities at December 31, 2017 – 613 – 2 985 – 254 – 455 – 9 – 1 003 – 5 319 Net deferred tax balance at December 31, 2017 – 476 – 1 698 836 3 331 88 980 3 061 After offsetting the following amount of deferred tax assets and liabilities within the same tax jurisdiction the balance amounts to: Deferred tax assets at December 31, 2017 Deferred tax liabilities at December 31, 2017 Net deferred tax balance at December 31, 2017 151 8 229 – 5 168 3 061 The following table presents deferred tax assets and deferred tax liabilities, which are expected to have an impact on current taxes payable after more than 12 months: (USD billions) 2018 2017 Expected to have an impact on current tax payable after more than 12 months – Deferred tax assets – Deferred tax liabilities 3.9 6.7 3.5 4.4 F-40 Notes to the Novartis Group consolidated financial statements For unremitted earnings retained by consolidated enti- ties for reinvestment, no provision is made for income taxes that would be payable upon the distribution of these earnings. If these earnings were remitted, an income tax charge could result based on the tax stat- utes currently in effect. (USD billions) 2018 2017 Unremitted earnings that have been retained by consolidated entities for reinvestment 73 66 Temporary differences on which no deferred tax has been provided as they are permanent in nature related to: (USD billions) Investments in subsidiaries Goodwill from acquisitions 2018 3 – 33 2017 3 – 29 The gross value of tax-loss carry-forwards that have, or have not, been capitalized as deferred tax assets, with their expiry dates is as follows: (USD millions) One year Two years Three years Four years Five years More than five years Total (USD millions) One year Two years Three years Four years Five years More than five years Total Not capitalized Capitalized 2018 total 23 14 27 65 345 522 996 4 0 12 5 36 2 288 2 345 27 14 39 70 381 2 810 3 341 Not capitalized Capitalized 2017 total 37 64 87 26 67 654 935 3 4 5 25 16 40 68 92 51 83 1 671 1 724 2 325 2 659 (USD millions) 2018 2017 2016 Tax losses carried forward that expired 8 1 19 Deferred tax assets related to taxable losses of relevant Group entities are recognized to the extent it is consid- ered probable that future taxable profits will be available against which such losses can be utilized in the foresee- able future. On December 22, 2017, the US enacted tax reform leg- islation (Tax Cuts and Jobs Act), which – among other provisions – reduced the US corporate tax rate from 35% to 21%, effective January 1, 2018. This required a reval- uation of the deferred tax assets and liabilities and a por- tion of current tax payables to the newly enacted tax rates at the date of enactment. The following table shows the impact on the revalu- ation of deferred assets and liabilities and current income tax liabilities at December 31, 2017: (USD millions) Deferred tax asset and liability revaluation Items previously recognized in consolidated income statement Items previously recognized in other comprehensive income 1 Items previously recognized in retained earnings 2 Total revaluation of deferred tax assets and liabilities Total revaluation of current tax payables Total revaluation of deferred tax assets and liabilities and current income tax liabilities Income statement Equity Total – 24 – 24 – 254 – 254 – 71 – 71 – 24 – 325 – 349 – 37 – 37 – 61 – 325 – 386 1 Related to post-employment benefits and available for sale financial investments 2 Related to equity based compensation plans The enacted US tax reform legislation includes a provi- sion that requires the US parent company’s foreign sub- sidiaries’ unremitted earnings to be subject to an imme- diate toll tax on the qualifying amount of unremitted earnings (the deemed repatriated earnings). Previously, these earnings were taxable upon distribution to the US parent company. The toll tax amount owed is payable, without interest, in installments over an eight-year period through 2024. Certain of the Group’s US subsidiaries are the parent company of non-US domiciled companies, and as a result, USD 70 million of deferred tax liabilities related to these entities’ unremitted earnings, the major- ity of which were recognized in 2016, were reclassified to current income tax liabilities at December 31, 2017. F-41 Notes to the Novartis Group consolidated financial statements 12. Financial and other non-current assets Financial assets Other non-current assets (USD millions) Equity securities Debt securities Fund investments 2018 2017 (USD millions) 2018 2017 1 155 1 073 Deferred compensation plans 31 251 36 166 Prepaid post-employment benefit plans Other non-current assets 468 137 290 895 484 133 201 818 Total financial investments 1 437 1 275 Total other non-current assets Long-term receivables from customers Minimum lease payments from finance lease agreements Contingent consideration receivables 1 164 91 396 Long-term loans, advances and security deposits 257 197 122 394 255 Total financial assets 2 345 2 243 1 Note 28 provides additional disclosures related to contingent considerations. Minimum finance lease payments The following table shows the receivables of the gross investments in finance leases and the net present value of the minimum lease payments, as well as unearned finance income, related to surgical equipment lease arrange- ments. The finance income is recorded in “Other income.” 2018 2017 (USD millions) Total future payments Unearned finance income Present value Provision Net book value Total future payments Unearned finance income Present value Provision Not later than one year 1 64 Between one and five years 117 Later than five years Total 48 229 – 5 – 9 – 2 – 16 59 108 46 213 – 2 – 28 – 35 – 65 57 80 11 148 83 180 31 294 – 7 – 14 – 2 – 23 76 166 29 271 – 3 – 59 – 14 – 76 Net book value 73 107 15 195 1 The current portion of the minimum lease payments is recorded in trade receivables or other current assets (to the extent not yet invoiced). 13. Inventories (USD millions) Raw material, consumables Work in progress Finished products Total inventories 2018 931 3 087 2 938 6 956 2017 841 2 957 3 069 6 867 The following table shows the recognized amount of inventory provision and reversals of inventory provision: (USD millions) Inventory provisions 2018 – 751 Reversals of inventory provisions 272 2017 – 470 189 2016 – 283 67 The following table shows the amount of inventory rec- ognized as an expense in “Cost of goods sold” in the consolidated income statements: (USD billions) 2018 2017 2016 Cost of goods sold – 10.4 – 10.3 – 10.3 The reversals mainly result from the release of products initially requiring additional quality control inspections and from the reassessment of inventory values manu- factured prior to regulatory approval but for which approval was subsequently received. F-42 Notes to the Novartis Group consolidated financial statements 14. Trade receivables (USD millions) Total gross trade receivables Provisions for doubtful trade receivables Total trade receivables, net 2018 8 853 – 126 8 727 2017 8 790 – 190 8 600 The following table summarizes the movement in the provision for expected credit losses: (USD millions) January 1 Impact of divestments Impact of business combination Provisions for doubtful trade receivables charged to the consolidated income statement Utilization provisions for doubtful trade receivables Reversal of provisions for doubtful trade receivables Currency translation effects December 31 2018 – 190 – 1 – 47 39 61 12 2017 – 162 12 2016 – 142 – 119 – 76 12 76 – 9 17 37 2 – 126 – 190 – 162 The following sets forth the trade receivables that are not overdue as specified in the payment terms and con- ditions established with Novartis customers, as well as an analysis of overdue amounts and related provisions for doubtful trade receivable: (USD millions) Not overdue Past due for not more than one month Past due for more than one month but less than three months Past due for more than three months but less than six months Past due for more than six months but less than one year Past due for more than one year 2018 7 916 296 2017 7 758 279 194 136 98 213 230 137 137 249 Provisions for doubtful trade receivables Total trade receivables, net – 126 8 727 – 190 8 600 Trade receivable balances include sales to drug whole- salers, retailers, private health systems, government agencies, managed care providers, pharmacy benefit managers and government-supported healthcare sys- tems. Novartis continues to monitor sovereign debt issues and economic conditions, particularly in Greece, Italy, Portugal, Spain, Brazil, Russia, Saudi Arabia, Tur- key, and Argentina, which has been included in 2018, and evaluates trade receivables in these countries for poten- tial collection risks. The majority of the outstanding trade receivables from Greece, Portugal, Saudi Arabia and Spain are due directly from local governments or from government-funded entities. Deteriorating credit and economic conditions as well as other factors in these closely monitored countries have resulted in, and may continue to result in, an increase in the average length of time that it takes to collect these trade receivables and may require the Group to re-evaluate the estimated collectible amount of these trade receivables in future periods. The following table shows the gross trade receiv- ables balance from these closely monitored countries at December 31, 2018 and 2017, the amounts that are past due for more than one year, and the related provisions that have been recorded: (USD millions) Total balance of gross trade receivables from closely monitored countries Past due for more than one year Provisions 2018 2017 1 729 1 733 97 44 124 95 At December 31, 2018, amounts past due for more than one year are not significant in any of these countries on a standalone basis. Total trade receivables include amounts denomi- nated in the following major currencies: (USD millions) US dollar (USD) Euro (EUR) Japanese yen (JPY) Chinese yuan (CNY) Russian ruble (RUB) Brazilian real (BRL) British pound (GBP) Australian dollar (AUD) Swiss franc (CHF) Canadian dollar (CAD) Other currencies Total trade receivables, net 2018 3 510 1 551 2017 3 451 1 533 658 282 247 206 183 161 100 136 600 312 268 237 208 165 127 73 1 693 8 727 1 626 8 600 F-43 Notes to the Novartis Group consolidated financial statements 15. Marketable securities, commodities, time deposits, derivative financial instruments, and cash and cash equivalents Marketable securities, commodities, time deposits and derivative financial instruments 2018 325 35 360 104 2 087 130 12 2 693 2018 302 12 11 325 2017 328 34 362 106 125 31 1 625 2017 303 14 11 328 2018 3 121 10 150 13 271 2017 2 970 5 890 8 860 2018 588 99 2017 717 93 811 753 1 2 1 360 2 861 3 8 450 1 030 3 054 (USD millions) Debt securities Fund investments Total marketable securities Commodities Time deposits and short-term investments with original maturity more than 90 days Derivative financial instruments Accrued interest on debt securities, time deposits and short-term investments Total marketable securities, commodities, time deposits and derivative financial instruments The following table provides a breakdown of debt securities by currency: (USD millions) US dollar (USD) Euro (EUR) Japanese yen (JPY) Total debt securities Cash and cash equivalents (USD millions) Current accounts Time deposits and short-term investments with original maturity less than 90 days Total cash and cash equivalents 16. Other current assets (USD millions) VAT receivable Withholding tax recoverable Prepaid expenses – Third parties – Associated companies Receivables from associated companies Contingent consideration receivable 1 Other receivables and current assets Total other current assets 1 Note 28 provides additional disclosures related to contingent consideration. F-44 Notes to the Novartis Group consolidated financial statements 17. Equity The following table shows the movement in the share capital: (USD millions) Share capital Treasury shares Outstanding share capital Jan 1, 2016 Movement in year Dec 31, 2016 Movement in year Dec 31, 2017 Movement in year Dec 31, 2018 991 – 101 890 – 19 25 6 972 – 76 896 – 3 – 24 – 27 969 – 100 869 – 25 31 6 944 – 69 875 The following table shows the movement in the shares: 2018 2017 2016 Number of outstanding shares (in millions) Note Total Novartis shares Total Total treasury outstanding shares shares 1 Total Novartis shares Total Total treasury outstanding shares shares 1 Total Novartis shares Total Total treasury outstanding shares shares 1 Balance at beginning of year 2 616.8 – 299.3 2 317.5 2 627.1 – 253.0 2 374.1 2 677.0 – 303.1 2 373.9 – 66.2 66.2 – 10.3 10.3 – 49.9 49.9 Shares canceled for capital reduction 2 Shares acquired to be canceled 3 Other share purchases 4 Other share sales Exercise of options and employee transactions 5 17.8 Equity-based compensation 5 – 23.3 – 23.3 – 1.2 – 1.2 3.0 3.0 7.8 7.4 7.8 7.4 – 66.2 – 66.2 – 3.8 – 3.8 – 10.3 – 10.3 – 2.6 – 2.6 4.6 8.8 4.6 8.8 4.1 9.0 4.1 9.0 0.2 Total movements – 66.2 59.9 – 6.3 – 10.3 – 46.3 – 56.6 – 49.9 50.1 Balance at end of year 2 550.6 – 239.4 2 311.2 2 616.8 – 299.3 2 317.5 2 627.1 – 253.0 2 374.1 1 Approximately 121.6 million treasury shares (2017: 131.3 million; 2016: 134.6 million) are held in Novartis entities that restrict their availability for use. 2 Novartis reduced its share capital by canceling shares that were repurchased on the SIX Swiss Exchange second trading line during previous years. 3 Shares repurchased on the SIX Swiss Exchange second trading line under the CHF 10 billion share buyback authority approved at the 2016 Annual General Meeting (AGM) 4 Shares acquired from employees, which were previously granted to them under the respective programs 5 Shares delivered as a result of options being exercised and physical share deliveries related to equity-based participation plans 17.1) The amount available for distribution as a dividend to shareholders is based on the available distributable retained earnings of Novartis AG determined in accor- dance with the legal provisions of the Swiss Code of Obligations. Dividend per share (in CHF) Total dividend payment (in USD billion) 2018 2.80 2017 2.75 2016 2.70 7.0 6.5 6.5 F-45 Notes to the Novartis Group consolidated financial statements 17.2) The following table summarizes the treasury shares movements: 2018 2017 2016 Number of outstanding Number of outstanding Number of outstanding Note shares Equity impact USD m (in millions) shares Equity impact USD m (in millions) shares Equity impact USD m (in millions) Shares acquired to be canceled 1 – 23.3 – 1 859 – 66.2 – 5 270 – 10.3 Other share purchases 2 Purchase of treasury shares Other share sales Exercise of options and employee transactions 3 17.8 Equity-based compensation 4,5 Total – 1.2 – 114 – 3.8 – 304 – 2.6 – 24.5 – 1 973 – 70.0 – 5 574 – 12.9 3.0 7.8 7.4 263 434 756 4.6 8.8 255 612 – 6.3 – 520 – 56.6 – 4 707 4.1 9.0 0.2 – 784 – 208 – 992 214 664 – 114 1 Shares repurchased on the SIX Swiss Exchange second trading line under the CHF 10 billion share buyback authority approved at the 2016 Annual General Meeting (AGM) 2 Shares acquired from employees, which were previously granted to them under the respective programs 3 Shares delivered as a result of options being exercised related to equity-based participation plans and the delivery of treasury shares. The average share price of the shares delivered was significantly below market price, reflecting the strike price of the options exercised. 4 Equity-settled share-based compensation is expensed in the consolidated income statement in accordance with the vesting period of the share-based compensation plans. The value for the shares and options granted is credited to consolidated equity over the respective vesting period. In addition, tax benefits arising from tax-deductible amounts exceeding the expense recognized in the income statement are credited to equity. 5 Included in 2017 is a USD 71 million impact related to the revaluation of deferred tax assets on equity-based compensation that were previously recognized through retained earnings. This revaluation resulted from the US tax reform legislation enacted on December 22, 2017; refer to Note 11 for additional disclosures. 17.3) In 2018, Novartis entered into an irrevocable, non-discretionary arrangement with a bank to repur- chase Novartis shares on the second trading line under its up-to USD 5 billion share buyback. Novartis can can- cel this arrangement at any time but may be subject to a 90-day waiting period. The commitment under this arrangement therefore reflects the obligated purchases by the bank under such trading plan over a rolling 90-day period, or if shorter, until the maturity date of such trad- ing plan. The commitment under this arrangement amounted to USD 284 million as of December 31, 2018. In 2017, Novartis entered into a similar irrevocable, non-discretionary arrangement with a bank to repur- chase Novartis shares. The commitment under this arrangement reflected the expected purchases by the bank under such trading plan over a rolling 90-day period. As of December 31, 2017, this trading plan com- mitment was fully executed and expired, and as a con- sequence, there is no contingent liability related to this plan recognized. 17.4) Transaction costs of USD 79 million, net of tax, that are directly attributable to the potential distribution (spin- off) of Alcon to Novartis shareholders and that would otherwise have been avoided, are recorded as a deduc- tion from equity. See Note 1. 17.5) The impact of change in ownership of consolidated entities represents the excess of the amount paid to non-controlling interest over their carrying value and equity allocation to non-controlling interest due to change in ownership percentage. 17.6) Changes in non-controlling interests represent the impact on the non-controlling interest of transactions with minority shareholders such as change in ownership percentage, dividend payments and other equity trans- actions. 17.7) Other movements includes, for subsidiaries in hyperinflationary economies, the impact of the restate- ment of the non-monetary assets and liabilities with the general price index at the beginning of the period as well as the restatement of the equity balances of the current year. In 2018, the amount recorded in equity related to hyperinflation accounting was USD 38 million (2017: USD nil, 2016: USD nil). See Note 1. 17.8) At December 31, 2018, the market maker held 11 mil- lion written call options, originally issued as part of the share-based compensation for associates that have not yet been exercised. The weighted average exercise price of these options is USD 62.70 and they have contractual lives of 10 years, with remaining lives up to five years. In December 2018, Novartis entered into an agreement with the market maker for its employee options to repurchase a portion of the outstanding written call options that are not exercised in exchange for treasury shares. F-46 Notes to the Novartis Group consolidated financial statements 18. Non-current financial debt (USD millions) Straight bonds Liabilities to banks and other financial institutions 1 Finance lease obligations Total, including current portion of non-current financial debt Less current portion of non-current financial debt Total non-current financial debts 1 Average interest rate 0.3% (2017: 0.3%) 2018 2017 25 283 22 957 285 92 539 87 25 660 23 583 – 3 190 – 359 22 470 23 224 All bonds are initially recorded at the amount of proceeds received, net of transaction costs. They are subsequently carried at amortized cost, with the difference between the proceeds, net of transaction costs, and the amount due on redemption being recognized as a charge to the consolidated income statement over the period of the relevant bond. Financial debts, including current finan- cial debts, contain only general default covenants. The Group is in compliance with these covenants. The percentage of fixed-rate financial debt to total financial debt was 80% at December 31, 2018, and 82% at December 31, 2017. The average interest rate on total financial debt in 2018 was 2.7% (2017: 2.6%). The following table provides a breakdown of straight bonds: Nominal Currency amount Issuance year Maturity year Issuer 2017 (USD Issue price millions) millions) 2018 (USD Coupon 5.125% 4.400% 2.400% 3.700% 3.400% 4.400% 0.750% 1.625% 0.250% 0.625% 1.050% 3.000% 4.000% 0.125% 0.625% 1.800% 2.400% 3.100% 0.000% 1.125% 0.500% 1.375% 1.700% USD USD USD USD USD USD EUR EUR CHF CHF CHF USD USD EUR EUR USD USD USD EUR EUR EUR EUR EUR 3 000 1 000 1 500 500 2 150 1 850 600 600 500 550 325 1 750 1 250 1 250 500 1 000 1 000 1 000 1 250 600 750 750 750 2009 2010 2012 2012 2014 2014 2014 2014 2015 2015 2015 2015 2015 2016 2016 2017 2017 2017 2017 2017 2018 2018 2018 Total straight bonds 2019 Novartis Securities Investment Ltd., Hamilton, Bermuda 99.822% 3 000 2 997 2020 Novartis Capital Corporation, New York, United States 99.237% 998 997 2022 Novartis Capital Corporation, New York, United States 99.225% 1 493 1 491 2042 Novartis Capital Corporation, New York, United States 98.325% 489 489 2024 Novartis Capital Corporation, New York, United States 99.287% 2 137 2 134 2044 Novartis Capital Corporation, New York, United States 99.196% 1 825 1 824 2021 Novartis Finance S.A., Luxembourg, Luxembourg 2026 Novartis Finance S.A., Luxembourg, Luxembourg 2025 Novartis AG, Basel, Switzerland 2029 Novartis AG, Basel, Switzerland 2035 Novartis AG, Basel, Switzerland 99.134% 99.697% 100.640% 100.502% 100.479% 683 684 508 558 330 713 714 513 564 333 2025 Novartis Capital Corporation, New York, United States 99.010% 1 732 1 730 2045 Novartis Capital Corporation, New York, United States 98.029% 1 219 1 218 2023 Novartis Finance S.A., Luxembourg, Luxembourg 99.127% 1 419 1 480 2028 Novartis Finance S.A., Luxembourg, Luxembourg 98.480% 2020 Novartis Capital Corporation, New York, United States 99.609% 2022 Novartis Capital Corporation, New York, United States 99.449% 2027 Novartis Capital Corporation, New York, United States 99.109% 563 998 995 989 588 996 993 988 2021 Novartis Finance S.A., Luxembourg, Luxembourg 99.133% 1 421 1 480 2027 Novartis Finance S.A., Luxembourg, Luxembourg 2023 Novartis Finance S.A., Luxembourg, Luxembourg 2030 Novartis Finance S.A., Luxembourg, Luxembourg 2038 Novartis Finance S.A., Luxembourg, Luxembourg 715 99.874% 99.655% 99.957% 99.217% 684 853 856 849 25 283 22 957 F-47 Notes to the Novartis Group consolidated financial statements The following tables provide a breakdown of total non-current financial debt, including current portion by maturity and currency: Breakdown by maturity: (USD millions) 2018 2019 2020 2021 2022 2023 After 2023 Total Breakdown by currency: (USD millions) US dollar (USD) Euro (EUR) Japanese yen (JPY) Swiss franc (CHF) Total The following table shows the comparison of balance sheet and fair value of total non-current financial debt, including current portion: (USD millions) 2018 Balance sheet 2018 Fair values 2017 Balance sheet 2017 Fair values Straight bonds 25 283 25 438 22 957 23 835 Others Total 377 377 626 626 25 660 25 815 23 583 24 461 The fair values of straight bonds are determined by quoted market prices. Other financial debts are recorded at notional amounts, which are a reasonable approxima- tion of the fair values. The following table shows the pledged assets: 2018 3 190 2 006 2 111 2 585 2 278 2017 359 3 173 1 997 2 194 2 485 1 480 13 490 11 895 25 660 23 583 2018 2017 15 964 15 945 8 028 5 695 (USD millions) 272 533 1 396 1 410 25 660 23 583 Total net book value of property, plant & equipment pledged as collateral for non-current financial debts 2018 2017 96 84 19. Provisions and other non-current liabilities (USD millions) Accrued liability for employee benefits: Defined benefit pension plans 1 Other long-term employee benefits and deferred compensation Other post-employment benefits 1 Environmental remediation provisions Provisions for product liabilities, governmental investigations and other legal matters Contingent consideration 2 Other non-current liabilities 2018 2017 3 546 3 157 600 954 634 214 874 497 625 953 706 230 809 577 Total provisions and other non-current liabilities 7 319 7 057 1 Note 24 provides additional disclosures related to post-employment benefits. 2 Note 28 provides additional disclosures related to contingent consideration. Novartis believes that its total provisions are adequate based upon currently available information. However, given the inherent difficulties in estimating liabilities in this area, Novartis may incur additional costs beyond the amounts provided. Management believes that such addi- tional amounts, if any, would not be material to the Group’s financial condition but could be material to the results of operations or cash flows in a given period. F-48 Notes to the Novartis Group consolidated financial statements Environmental remediation provisions The following table shows the movements in the envi- ronmental liability provisions: (USD millions) January 1 Cash payments Releases Additions Currency translation effects December 31 Less current provision Non-current environmental remediation provisions at December 31 2018 761 – 48 – 21 7 – 7 692 – 58 2017 773 – 46 – 153 154 33 761 – 55 2016 871 – 75 1 – 24 773 – 65 634 706 708 The material components of the environmental remedi- ation provisions consist of costs to sufficiently clean and refurbish contaminated sites to the extent necessary and to continue surveillance at sites where the environmen- tal remediation exposure is less significant. A substantial portion of the environmental remedia- tion provisions relate to the remediation of Basel regional landfills in the adjacent border areas in Switzerland, Ger- many and France. The provisions are re-assessed on a yearly basis and adjusted as necessary. In the United States, Novartis has been named under federal legislation (the Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended) as a potentially responsible party (PRP) in respect of certain sites. Novartis actively participates in, or monitors, the cleanup activities at the sites in which it is a PRP. The provision takes into consideration the num- ber of other PRPs at each site as well as the identity and financial position of such parties in light of the joint and several nature of the liability. The expected timing of the related cash outflows as of December 31, 2018, is currently projected as follows: might be fully or partially off-set by insurance in certain circumstances. Novartis has not established provisions for potential damage awards for certain additional legal claims against its subsidiaries if Novartis currently believes that a pay- ment is either not probable or cannot be reliably esti- mated. In total, these not-provisioned-for matters include more than 2 000 individual product liability cases and certain other legal matters. Plaintiffs’ alleged claims in these matters, which Novartis does not believe to be entirely remote but which do not fulfill the conditions for the establishment of provisions, currently aggregate to, according to Novartis’ current best belief, approximately USD 1.5 billion. In addition, in some of these matters there are claims for punitive or multiple (treble) damages, civil penalties and disgorgement of profits that in Novartis’ view are either wholly or partially unspecified or wholly or partially unquantifiable at present; the Group believes that information about these amounts claimed by plain- tiffs generally is not meaningful for purposes of deter- mining a reliable estimate of a loss that is probable or more than remote. A number of other legal matters are in such early stages or the issues presented are such that the Group has not made any provisions since it cannot currently estimate either a potential outcome or the amount of any potential losses. For these reasons, among others, the Group generally is unable to make a reliable estimate of possible loss with respect to such cases. It is therefore not practicable to provide information about the poten- tial financial impact of those cases. There might also be cases for which the Group was able to make a reliable estimate of the possible loss or the range of possible loss, but the Group believes that publication of such information on a case-by-case basis would seriously prejudice the Group’s position in ongo- ing legal proceedings or in any related settlement dis- cussions. Accordingly, in such cases, information has been disclosed with respect to the nature of the contin- gency, but no disclosure is provided as to an estimate of the possible loss or range of possible loss. Note 27 contains additional information on contin- Expected cash outflows gencies. (USD millions) Due within two years Due later than two years, but within five years Due later than five years, but within ten years Due after ten years Total environmental remediation liability provisions 150 185 297 60 692 Provisions for product liabilities, governmental investigations and other legal matters Novartis has established provisions for certain product liabilities, governmental investigations and other legal matters where a potential cash outflow is probable and Novartis can make a reliable estimate of the amount of the outflow. These provisions represent the Group’s cur- rent best estimate of the total financial effect for the mat- ters described below and for other less significant mat- ters. Potential cash outflows reflected in a provision F-49 Summary of significant legal proceedings The following is a summary of significant legal proceed- ings to which Novartis or its subsidiaries are a party or were a party and that concluded in 2018. Alcon pending spin-off (see Note 30): In case of approval of the Alcon spin-off, under the Separation and Distribution Agreement Novartis will enter into with Alcon in connection with the separation and the spin-off, Novartis and Alcon will each agree, subject to certain conditions and except to the extent otherwise described below with respect to any matter, to indemnify the other party and its directors, officers, employees and other representatives against any pending or future liabilities or claims that constitute either a Novartis Group liability, in the case of Novartis, or an Alcon liability, in the case of Alcon, under the terms of the Separation and Distri- bution Agreement, based on whether such claim or lia- Notes to the Novartis Group consolidated financial statements bility relates to the Novartis or the Alcon business and products. Investigations and related litigations Southern District of New York (S.D.N.Y.) marketing practices investigation and litigation In 2013, the US government filed a civil complaint in inter- vention to an individual qui tam action against Novartis Pharmaceuticals Corporation (NPC) in the United States District Court (USDC) for the S.D.N.Y. The complaint, as subsequently amended, asserts federal False Claims Act (FCA) and common law claims with respect to speaker programs and other promotional activities for certain NPC cardiovascular medications (Lotrel, Starlix and Val- turna) allegedly serving as mechanisms to provide kick- backs to healthcare professionals (HCPs). It seeks dam- ages, which according to the complaint are “substantial”, including treble damages and maximum civil penalties per claim, as well as disgorgement of Novartis profits from the alleged unlawful conduct. Also in 2013, New York State filed a civil complaint in intervention assert- ing similar claims. Neither government complaint in inter- vention adopted the individual relator’s claims with respect to off-label promotion of Valturna, which were subsequently dismissed with prejudice by the court. The individual relator continues to litigate the kickback claims on behalf of other states and municipalities. A trial in the S.D.N.Y. matter is currently scheduled in 2019. The claims are being vigorously contested. S.D.N.Y./Western District of New York healthcare fraud investigation In 2011, Alcon Laboratories, Inc. (ALI) received a sub- poena from the United States Department of Health & Human Services relating to an investigation into allega- tions of healthcare fraud, including potential off-label promotion of certain products. The subpoena requests the production of documents relating to marketing prac- tices, including the remuneration of healthcare provid- ers, in connection with surgical equipment and certain Novartis products (Vigamox, Nevanac, Omnipred, Econo- pred). ALI is cooperating with this investigation. S.D.N.Y. Gilenya marketing practices investigation and litigation In 2013, NPC received a civil investigative demand from the United States Attorney’s Office (USAO) for the S.D.N.Y. requesting the production of documents and information relating to marketing practices for Gilenya, including the remuneration of healthcare providers in connection therewith. In 2017, S.D.N.Y. and New York State declined to intervene in claims raised by an indi- vidual relator in a qui tam complaint, which continue to be vigorously contested. Government generic pricing antitrust investigations, antitrust class actions Since 2016, Sandoz Inc. received grand jury subpoenas and a civil investigative demand and interrogatories from the Antitrust and Civil Divisions of the US Department of Justice (DoJ), and a subpoena and interrogatories from the Attorney General of the State of Connecticut in con- nection with alleged price fixing and market allocation of generic drugs in the US market as well as alleged FCA violations. The requests are for documents related to the marketing and pricing of generic pharmaceutical prod- ucts sold by Sandoz Inc. and its subsidiaries, including Fougera Pharmaceuticals Inc. (Fougera), and related communications with competitors. Sandoz Inc. is coop- erating with these investigations, which it believes to be part of a broader inquiry into industry practice. Since the third quarter of 2016, Sandoz Inc. and Foug- era have been sued alongside other generic pharmaceu- tical companies in more than 20 individual and putative class action complaints by direct and indirect purchas- ers and Attorneys General for 45 states, the District of Columbia and Puerto Rico. Plaintiffs claim that defen- dants, including Sandoz, engaged in price fixing and mar- ket allocation of generic drugs in the US market and seek damages and injunctive relief. The actions contain prod- uct-specific complaints as well as complaints alleging the existence of an over-arching industry conspiracy, and assert violations of federal and state antitrust laws as well as consumer protection laws. The cases have been consolidated for pretrial purposes in the USDC for the Eastern District of Pennsylvania (E.D. Pa.) and the claims are being vigorously contested. Asia/Russia investigation In 2017 and 2018, Alcon and Novartis Group companies, as well as certain present and former executives and associates of Alcon and Novartis, received document requests and subpoenas from the DoJ and the US Secu- rities and Exchange Commission (SEC) requesting infor- mation concerning Alcon accounting, internal controls and business practices in Asia and Russia, including rev- enue recognition for surgical equipment and related products and services, as well as relationships with third- party distributors, both before and after Alcon became part of the Novartis Group. Alcon and Novartis are coop- erating with this investigation. In case of approval of the Alcon spin-off, Novartis will indemnify Alcon in respect of defined direct monetary liabilities relating to the cur- rent scope of the ongoing investigation by the DoJ and the SEC relating to certain business practices in Asia and Russia and related accounting treatment. Lucentis/Avastin® matters In connection with an investigation into whether Novartis Farma S.p.A., Novartis AG, F. Hoffmann-La Roche AG, Genentech Inc. and Roche S.p.A. colluded to artificially preserve the market positions of Avastin® and Lucentis, in 2014 the Italian Competition Authority imposed a fine equivalent to USD 125 million on Novartis AG and Novartis Farma S.p.A. Novartis paid the fine, subject to the right to later claim recoupment, and is appealing before the Consiglio di Stato. In 2014 and 2015, the Italian Ministry of Health and the Lombardia region sent letters with pay- ment requests for a total equivalent of approximately USD 1.3 billion in damages from Novartis and Roche enti- ties based on the above allegations. In 2019, the French Competition Authority issued a Statement of Objections against Novartis entities alleging anti-competitive prac- tices on the French market for anti-vascular endothelial growth factor treatments for wet age-related macular degeneration from 2008 to 2013. Novartis continues to vigorously contest all claims in Italy and France. Also, Novartis is challenging policies and regulations allowing F-50 Notes to the Novartis Group consolidated financial statements off-label/unlicensed use and reimbursement for eco- nomic reasons in various countries, including in Italy, the UK, and Brazil. Japan investigation In 2015, a trial started against a former Novartis Pharma K.K. (NPKK) employee, and also NPKK under the dual liability concept in Japanese law, over allegations brought by the Tokyo District Public Prosecutor Office for alleged manipulation of data in sub-analysis publications of the Kyoto Heart Study regarding valsartan. The charges against NPKK are subject to a maximum total fine of JPY 4 million. In 2018, the Tokyo High Court upheld a not- guilty ruling of the Tokyo District Court for both the for- mer NPKK employee and NPKK. A further appeal by the Tokyo District Public Prosecutor Office remains pend- ing. South Korea investigation In 2016, the Seoul Western District Prosecutor initiated a criminal investigation into, among other things, allega- tions that Novartis Korea utilized medical journals to pro- vide inappropriate economic benefits to HCPs. A crimi- nal trial is ongoing. Greece investigation Novartis is investigating allegations of potentially inap- propriate economic benefits to HCPs, government offi- cials and others in Greece. Novartis is providing informa- tion to the Greek authorities investigating these allegations, including the Greek Coordinating Body for Inspection and Control and the Greek Body of Prosecu- tion of Financial Crime, from which it received a sum- mons in 2018. Novartis is also responding to a subpoena and document requests from the SEC and DoJ that it received in 2016 and 2017 in connection with such alle- gations and is cooperating with their investigation. Antitrust class actions Contact lenses Since the first quarter of 2015, more than 50 class action complaints have been filed in several courts across the US naming as defendants contact-lens manufacturers, including ALI, and alleging violations of federal antitrust law as well as the antitrust, consumer protection and unfair competition laws of various states, in connection with the implementation of unilateral price policies by the defendants in the sale of contact lenses. The cases have been consolidated in the Middle District of Florida by the Judicial Panel on Multidistrict Litigation and the claims are being vigorously contested. Enoxaparin In 2015, Sandoz and Momenta Pharmaceuticals were sued in a putative antitrust class action in federal court in Tennessee alleging that Momenta and Sandoz engaged in anticompetitive and unfair business conduct with regard to sales of enoxaparin, and the same allega- tions were made by Amphastar in a lawsuit filed in fed- eral court in California and subsequently moved to fed- eral court in Massachusetts (Sandoz, Momenta Pharmaceuticals and Amphastar are currently engaged in patent litigation concerning enoxaparin). The claims are being vigorously contested. Exforge Since 2018, Novartis Group companies as well as other pharmaceutical companies were sued by various direct and indirect purchasers of Exforge in multiple US indi- vidual and putative class action complaints. They claim that Novartis made a reverse payment in the form of an agreement not to launch an authorized generic, alleging violations of federal antitrust law and state antitrust, con- sumer protection and common laws and seeking dam- ages as well as injunctive relief. The cases have been consolidated in the S.D.N.Y. and the claims are being vig- orously contested. Product liability litigation Reclast NPC is a defendant in more than 20 US product liability actions involving Reclast and alleging atypical femur fracture injuries, all of which are in New Jersey state or federal court and in California state court coordinated with claims against other bisphosphonate manufactur- ers. The claims are being vigorously contested. Taxotere® (docetaxel) Sandoz is a defendant in more than 2 000 US product liability actions involving Taxotere® (docetaxel), an oncology product, many of which have been transferred to Multidistrict Litigation in the Eastern District of Loui- siana. The complaints allege misleading marketing and that Sanofi, as innovator, and several 505(b)(2) NDA hold- ers (including Sandoz) failed to warn of the risk of per- manent alopecia/hair loss. The claims are being vigor- ously contested. Amiodarone Sandoz entities are named in more than 10 individual and multi-plaintiff US product liability cases involving amiodarone, a cardiac drug indicated to treat life-threat- ening arrhythmias that have not responded to other treat- ment. The complaints allege failure to warn, off-label pro- motion and failure to include medication guides to pharmacies. The claims are being vigorously contested. Valsartan Since 2018, claims have been brought against Sandoz and other pharmaceutical companies alleging injury from carcinogenic impurities found in valsartan and valsartan / HCT film-coated tablets marketed or manufactured by Sandoz, including several putative class actions in Can- ada. The claims are being vigorously contested. Other matters Average Wholesale Price (AWP) litigation Lawsuits have been brought, the latest in February 2016, by various US state governmental entities and private parties against various pharmaceutical companies, including certain Sandoz entities and NPC, alleging that they fraudulently overstated the AWP that is or has been used by payors, including state Medicaid agencies, to calculate reimbursements to healthcare providers. NPC remains a defendant in an action brought by the state of Illinois and in a putative class action brought by private payors in New Jersey, and Sandoz remains a defendant in an individual action for declaratory judgment in Penn- F-51 Notes to the Novartis Group consolidated financial statements sylvania, which is considered concluded for reporting purposes. The claims are being vigorously contested. IP matters MIVS platform patent infringement litigation In 2015, Johns Hopkins University filed a patent infringe- ment lawsuit against certain Alcon entities alleging that the use of certain Alcon surgical products, principally by third parties, infringes a patent directed to certain meth- ods of ocular surgery. The claims are being vigorously contested. Concluded legal matters District of Massachusetts (D. Mass.) charitable foundation investigation In 2016 and 2017, NPC received subpoenas from the USAO for the D. Mass. requesting documents related to NPC’s support of 501(c)(3) organizations that provide co-payment assistance to Medicare patients who are prescribed Novartis medicines, including the respective accounting and tax treatment, as well as related to pric- ing strategies for Gleevec, Tasigna, Zometa, and Gilenya. In 2018, NPC agreed to a settlement in principle to pay USD 23 million to resolve the investigation into potential violations of federal health care laws, including the Anti-Kickback Statute and FCA. This settlement is sub- ject to mutually agreeable terms and finalization of the documentation. Novartis considers this matter con- cluded for the purpose of reporting legal proceedings. Gleevec In 2015 and 2016, Novartis Group companies were sued in putative antitrust class actions in the D. Mass. alleg- ing delayed generic entry of Gleevec and seeking dam- ages on behalf of direct and indirect purchasers of Gleevec. The motion to dismiss those actions was granted and was finally affirmed on appeal by the US Court of Appeals for the First Circuit in 2018. A similar class action that was filed in 2018 in E.D. Pa. on behalf of direct purchasers of Gleevec was voluntarily dis- missed in the same year. The matters are therefore con- cluded. Oriel litigation In 2013, Shareholder Representative Services LLC filed a complaint in New York State Court against Sandoz Inc., two affiliates and two former officers of Sandoz AG asserting various common law and statutory contract, fraud and negligent misrepresentation claims arising out of Sandoz Inc.’s purchase of Oriel Therapeutics, Inc. In March 2015, the court dismissed all parties and claims but for a breach of contract claim against Sandoz Inc. In 2018, the remaining case was resolved through settle- ment, the payment of which was not material to Novartis. Eye drop products consumer class actions Plaintiffs alleged that Alcon’s and Sandoz’s eye drop products for glaucoma were unfairly designed so that the drop dosage is more than necessary and exceeds the capacity of the eye, leading to wastage and higher costs to patient consumers. In 2018, the remaining cases against Alcon and Sandoz in New Jersey and Missouri were voluntarily dismissed with prejudice by plaintiffs, in exchange for defendants’ agreement not to pursue stat- utory costs, and the Massachusetts case was finally dis- missed upon appeal by the Court of Appeals for the First Circuit. Summary of product liability, governmental investigations and other legal matters provision movements (USD millions) January 1 Cash payments Releases of provisions Additions to provisions Currency translation effects December 31 2018 351 – 118 – 107 220 – 6 340 2017 395 – 69 – 70 93 2 351 2016 1 194 – 811 – 239 243 8 395 Less current portion – 126 – 121 – 131 Non-current product liabilities, governmental investigations and other legal matters provisions at December 31 214 230 264 Novartis believes that its total provisions for investiga- tions, product liability, arbitration and other legal matters are adequate based upon currently available information. However, given the inherent difficulties in estimating lia- bilities, there can be no assurance that additional liabil- ities and costs will not be incurred beyond the amounts provided. F-52 Notes to the Novartis Group consolidated financial statements 20. Current financial debt and derivative financial instruments (USD millions) Interest-bearing accounts of associates payable on demand 1 Bank and other financial debt 2 Commercial paper Current portion of non-current financial debt Fair value of derivative financial instruments 2018 2017 1 778 1 822 701 3 951 3 190 58 692 2 328 359 107 Total current financial debt and derivative financial instruments 9 678 5 308 1 Weighted average interest rate 0.5% (2017: 0.5%) 2 Weighted average interest rate 9.6% (2017: 7.0%) The consolidated balance sheet amounts of current financial debt, other than the current portion of non- current financial debt, approximate the estimated fair value due to the short-term nature of these instruments. Details on commercial papers are provided under “Liquidity risk” in Note 28. 21. Provisions and other current liabilities (USD millions) Taxes other than income taxes Restructuring provisions Accrued expenses for goods and services received but not invoiced Accruals for royalties Accrued interests on financial debt Provisions for deductions from revenue Accruals for compensation and benefits including social security Environmental remediation liabilities Deferred income Provisions for product liabilities, governmental investigations and other legal matters 1 Accrued share-based payments Contingent considerations 2 Commitment for repurchase of own shares 3 Other payables Total provisions and other current liabilities 1 Note 19 provides additional disclosures related to legal provisions. 2 Note 28 provides additional disclosures related to contingent considerations. 3 Note 17 provides additional disclosures related to commitment for repurchase of own shares. Provisions are based upon management’s best estimate and adjusted for actual experience. Such adjustments to the historic estimates have not been material. 2018 2017 528 507 970 651 156 660 153 977 586 145 5 262 2 527 4 672 2 327 58 236 126 273 33 284 673 55 305 121 261 44 897 12 284 11 203 F-53 Notes to the Novartis Group consolidated financial statements Provisions for deductions from revenue The following table shows the movement of the provisions for deductions from revenue: Income statement charge (USD millions) 2018 Revenue deductions Effect of currency translation provisions at and business January 1 combinations Payments/ Adjustments utilizations of prior years Current year Change in provisions offset against Revenue deductions gross trade provisions at receivables December 31 US-specific healthcare plans and program rebates 1 590 – 4 158 Non-US-specific healthcare plans and program rebates 1 356 – 78 – 2 182 Non-healthcare plans and program-related rebates, returns and other deductions Total 2018 2017 1 726 4 672 – 51 – 12 227 – 129 – 18 567 – 90 83 – 91 – 98 4 541 2 555 11 956 19 052 US-specific healthcare plans and program rebates 1 461 – 3 684 Non-US-specific healthcare plans and program rebates 1 020 131 – 1 954 – 62 80 3 875 2 186 Non-healthcare plans and program-related rebates, returns and other deductions Total 2017 2016 1 702 4 183 65 – 11 814 – 127 12 045 196 – 17 452 – 109 18 106 US-specific healthcare plans and program rebates 1 165 – 3 203 Non-US-specific healthcare plans and program rebates 1 024 – 31 – 1 844 7 – 26 3 492 1 883 Non-healthcare plans and program-related rebates, returns and other deductions Total 2016 1 601 3 790 – 19 – 11 142 – 117 11 383 – 50 – 16 189 – 136 16 758 – 109 441 332 – 107 – 145 – 252 14 – 4 10 1 883 1 625 1 754 5 262 1 590 1 356 1 726 4 672 1 461 1 020 1 702 4 183 Restructuring provisions movements (USD millions) January 1 Additions Cash payments Releases Transfers Currency translation effects December 31 2018 153 534 – 145 – 33 – 2 507 2017 222 194 – 200 – 64 – 7 8 153 2016 260 343 – 260 – 66 – 76 21 222 In 2018, additions to provisions of USD 534 million were mainly related to the following reorganizations: • The Innovative Medicines Division’s Oncology business unit initiative to streamline its organizational structure. The objective was to enhance agility and efficiency, resulting in an acceleration of operational execution. In addition, a program to reorganize the Japanese busi- ness model was launched. Region Europe transformed its approach to market in light of the changing product portfolio. The objective is to speed up patient access. • Novartis Business Services launched an initiative to reorganize its organizational structure to achieve cost efficiencies by shifting activities to global service cen- ters. • Group-wide initiatives to streamline Novartis Technical Operations and implement new technologies, mainly in the Innovative Medicines Division but also in the Sandoz Division, continued. In 2017, additions to provisions of USD 194 million were mainly related to the following reorganizations: • The Innovative Medicines Division’s Pharmaceuticals business unit adjusted a regional promotional model, which led to a restructuring of the sales force. It also streamlined the above country operating model to facil- itate an even higher external competition-oriented focus. Furthermore, the development organization streamlined its activities to create efficiencies. • The Alcon Division continued initiatives to realign its operations to focus on the Surgical and Vision Care businesses after the Ophthalmic Pharmaceuticals business transfer to the Innovative Medicines Division. • The Sandoz Division launched initiatives to focus resources to gain efficiencies. • Group-wide initiatives to streamline Novartis Technical Operations in the Innovative Medicines and Sandoz Divisions were launched. In 2016, additions to provisions of USD 343 million were mainly related to the following reorganizations: • The Innovative Medicines Division’s Pharmaceuticals business unit realigned its operations to improve its operating agility, to focus resources on key growth driv- ers. Furthermore, research realigned and focused its F-54 Notes to the Novartis Group consolidated financial statements operations, resulting in redundancies from the consol- idation of certain research teams and the outsourcing of certain activities to qualified third-party vendors. • The Alcon Division launched several initiatives to improve its efficiencies, resulting in redundancies, as it realigned its operations to focus on its Surgical and Vision Care business franchises after the transfer of its Ophthalmic Pharmaceuticals business to the Innovative Medicines Division. • The Sandoz Division launched an initiative to reallocate resources to priority, high-growth and higher profitabil- ity countries. • Various Group-wide initiatives to simplify organiza- tional structure, including the consolidation of manu- facturing sites and support services. 22. Details to the consolidated statements of cash flows 22.1) Reversal of non-cash items and other adjustments (USD millions) Depreciation, amortization and impairments on: Property, plant and equipment Intangible assets Financial assets 1 Non-cash change in provisions and other non-current liabilities Gains on disposal and other adjustments on property, plant and equipment; intangible assets; financial assets; and other non-current assets, net Equity-settled compensation expense Income from associated companies 2 Taxes Net financial expense Total 2018 2017 2016 2 021 4 871 – 11 876 1 677 4 399 256 160 – 900 – 1 043 759 683 – 6 438 – 1 108 1 221 1 296 772 738 3 171 7 058 1 591 4 452 132 956 – 935 671 – 703 1 119 1 154 8 437 1 Includes fair value adjustments 2 2018 includes a reversal of a pre-tax gain (USD 5.8 billion) recognized from the divestment of the investment in GSK Consumer Healthcare Holdings Ltd. (see Note 2). The net cash proceed of USD 13.0 billion from the divestment is included in the consolidated statements of cash flows in line “Divestments and acquisitions of interests in associated companies, net.” 22.2) Cash flows from changes in working capital and other operating items included in the net cash flows from operating activities (USD millions) (Increase) in inventories (Increase) in trade receivables Increase/(decrease) in trade payables Change in other current assets Change in other current liabilities Other adjustments, net Total 2018 – 533 – 569 309 403 891 – 2 499 2017 – 247 – 204 58 – 180 816 1 244 2016 – 235 – 229 – 587 460 505 9 – 77 22.3) Cash flows arising from divestments and acquisitions of interests in associated companies In 2018, divestments and acquisitions of interests in associated companies included USD 12 855 million net of taxes (USD 12 994 million before taxes) from the divestment of the investment in GSK Consumer Healthcare Holdings Ltd. (see Note 2). F-55 Notes to the Novartis Group consolidated financial statements 22.4) Cash flows arising from acquisitions and divestments of businesses The following is a summary of the cash flow impact of acquisitions and divestments. The most significant trans- actions are described in Note 2. (USD millions) Net assets recognized as a result of business combinations Fair value of previously held equity interests Receivables and payables contingent consideration, net 1 Other payments and deferred consideration, net Cash flows used for acquisitions of businesses Cash flows from divestments of businesses 2 Note 2018 23 – 13 946 2017 – 999 41 – 35 206 – 36 – 13 940 – 829 18 45 2016 – 869 64 84 – 44 – 765 Cash flows used for acquisitions and divestments of businesses, net – 13 922 – 784 – 765 1 The contingent consideration of the 2016 Transcend Medical, Inc. acquisition amounted to USD 92 million. Of this amount, USD 60 million was paid in 2016. 2 In 2018, USD 18 million represents the net cash inflows from previous years divestments. In 2017, the USD 45 million primarily relates to the net identifiable assets of a divested business of USD 48 million, comprised of non-current assets of USD 29 million, current assets of USD 34 million partly offset by current liabilities of USD 15 million. Notes 2 and 23 provide further information regarding acquisitions and divestments of businesses. All acquisi- tions were for cash. 22.5) Cash flows used in investing activities from discontinued operations In 2015, Novartis completed a series of portfolio trans- formation transactions, including the divestments of its Animal Health and Vaccines businesses. In addition, a combined consumer healthcare business was created through the combination of the Novartis OTC and GlaxoSmithKline (GSK) Consumer Healthcare busi- nesses. On March 2, 2015, a new entity, GlaxoSmithKline Consumer Healthcare Holdings Ltd. (GSK Consumer Healthcare), was formed via the contribution of busi- nesses from both Novartis and GSK. Novartis had a 36.5% interest in the newly created entity. To reflect these transactions, Novartis reported the Group’s finan- cial results in 2015 as “continuing operations” and “dis- continued operations.” The net cash outflows used in discontinued operations in the years 2017 (USD 140 mil- lion) and 2016 (USD 748 million) includes portfolio trans- formation transactional payments related to the divested businesses. The Group’s interest in GSK Consumer Healthcare was sold to GSK on June 1, 2018 (see Notes 2 and 4). 22.6) Reconciliation of liabilities arising from financing activities (USD millions) January 1, 2018 Increase in non-current financial debts Repayment of non-current financial debts Change in current financial debts Impact of business combinations Changes in fair values, and other changes Amortization of bonds discount Currency translation effects Current portion of non-current financial debt December 31, 2018 Current financial debts and derivative financial instruments Non-current financial debts Total 23 224 5 308 28 532 2 856 10 5 27 – 366 1 681 4 – 48 2 2 856 – 366 1 681 14 – 43 29 – 462 – 93 – 555 – 3 190 3 190 22 470 9 678 32 148 F-56 Notes to the Novartis Group consolidated financial statements (USD millions) January 1, 2017 Increase in non-current financial debts Repayment of non-current financial debts Change in current financial debts Changes in fair values, and other changes Amortization of bonds discount Currency translation effects Current portion of non-current financial debt December 31, 2017 Current financial debts and derivative financial instruments Non-current financial debts Total 17 897 5 905 23 802 4 933 – 1 – 6 16 744 – 359 – 187 – 755 – 140 126 359 4 933 – 188 – 755 – 146 16 870 23 224 5 308 28 532 23. Acquisitions of businesses Fair value of assets and liabilities arising from acquisitions (USD millions) Property, plant and equipment Currently marketed products Acquired research and development Other intangible assets Deferred tax assets Financial and other assets Inventories Trade receivables and other current assets Cash and cash equivalents Deferred tax liabilities Current and non-current financial debts Trade payables and other liabilities Net identifiable assets acquired Acquired liquidity Non-controlling interests Goodwill Net assets recognized as a result of business combinations 2017 2016 10 224 1 223 8 39 2018 137 2 531 1 381 19 20 90 451 690 4 1 1 1 112 20 – 2 874 – 325 – 372 – 14 – 627 11 000 – 1 112 – 26 4 084 13 946 – 1 925 – 20 94 999 814 – 1 56 869 Note 2 details significant acquisitions of businesses, spe- cifically, AAA, AveXis and Endocyte in 2018, Ziarco and Encore in 2017, and Transcend and Reprixys in 2016. The goodwill arising out of these acquisitions is attributable to the growth platform, the assembled workforce, and the accounting for deferred tax liabilities on the acquired assets. No goodwill from 2018 and 2017 is tax-deduct- ible. Goodwill of USD 18 million from 2016 is tax deduct- ible. F-57 Notes to the Novartis Group consolidated financial statements 24. Post-employment benefits for associates Defined benefit plans In addition to the legally required social security schemes, the Group has numerous independent pension and other post-employment benefit plans. In most cases, these plans are externally funded in entities that are legally separate from the Group. For certain Group companies, however, no independent plan assets exist for the pen- sion and other post-employment benefit obligations of associates. In these cases the related unfunded liability is included in the balance sheet. The defined benefit obli- gations (DBOs) of all major pension and other post-em- ployment benefit plans are reappraised annually by inde- pendent actuaries. Plan assets are recognized at fair value. The major plans are based in Switzerland, the United States, the United Kingdom, Germany and Japan, which represent 94%of the Group’s total DBO for pen- sion plans. Details of the plans in the two most signifi- cant countries of Switzerland and the United States, which represent 80%of the Group’s total DBO for post-employment benefit plans, are provided below. Swiss-based pension plans represent the most sig- nificant portion of the Group’s total DBO and plan assets. For the active insured members born on or after Janu- ary 1, 1956, or having joined the plans after December 31, 2010, the benefits are partially linked to the contribu- tions paid into the plan. Certain features of Swiss pen- sion plans required by law preclude the plans being cat- egorized as defined contribution plans. These factors include a minimum interest guarantee on retirement sav- ings accounts, a pre-determined factor for converting the accumulated savings account balance into a pen- sion, and embedded death and disability benefits. All benefits granted under Swiss-based pension plans are vested, and Swiss legislation prescribes that the employer has to contribute a fixed percentage of an associate’s pay to an external pension fund. Additional employer contributions may be required whenever the plan’s statutory funding ratio falls below a certain level. The associate also contributes to the plan. The pension plans are run by separate legal entities, each governed by a board of trustees that – for the principal plans – con- sists of representatives nominated by Novartis and the active insured associates. The boards of trustees are responsible for the plan design and asset investment strategy. In September 2017, the pension regulations in Swit- zerland were amended, which resulted in a change in accounting from defined benefit to defined contribution for a component of the Swiss pension plans. This change resulted in a reduction to the defined benefit pension plans liability and in a corresponding net pre-tax gain of USD 225 million (CHF 216 million). The United States pension plans represent the sec- ond largest component of the Group’s total DBO and plan assets. The principal plans (Qualified Plans) are funded, whereas plans providing additional benefits for executives (Restoration Plans) are unfunded. Employer contributions are required for Qualified Plans whenever the statutory funding ratio falls below a certain level. Furthermore, in certain countries, associates are cov- ered under other post-employment benefit plans and post-retirement medical plans. In the US, other post-employment benefit plans con- sist primarily of post-employment healthcare benefits, which have been closed to new members since 2015. Part of the costs of these plans is reimbursable under the Medicare Prescription Drug, Improvement, and Mod- ernization Act of 2003. There is no statutory funding requirement for these plans. The Group is funding these plans to the extent that it is tax efficient. F-58 Notes to the Novartis Group consolidated financial statements The following tables are a summary of the funded and unfunded defined benefit obligation for pension and other post employment benefit plans of associates at December 31, 2018 and 2017: (USD millions) Benefit obligation at January 1 Current service cost Interest cost Past service costs and settlements Administrative expenses Remeasurement (gains)/losses arising from changes in financial assumptions Remeasurement losses/(gains) arising from changes in demographic assumptions Experience-related remeasurement losses/(gains) Currency translation effects Benefit payments Contributions of associates Effect of acquisitions, divestments or transfers Benefit obligation at December 31 Fair value of plan assets at January 1 Interest income Return on plan assets excluding interest income Currency translation effects Novartis Group contributions Contributions of associates Settlements Benefit payments Effect of acquisitions, divestments or transfers Fair value of plan assets at December 31 Funded status Limitation on recognition of fund surplus at January 1 Change in limitation on recognition of fund surplus (incl. exchange rate differences) Interest income on limitation of fund surplus Limitation on recognition of fund surplus at December 31 Pension plans Other post-employment benefit plans 2018 2017 2018 23 210 23 614 1 115 2017 1 158 378 321 – 1 26 – 567 5 264 422 330 – 1 226 27 11 – 26 47 – 374 1 138 – 1 263 – 1 300 169 11 207 – 34 34 39 – 31 1 – 32 – 7 – 46 34 44 – 10 32 – 9 – 87 5 – 51 – 1 22 179 23 210 1 073 1 115 20 275 19 225 249 – 805 – 310 520 169 – 3 236 1 429 909 579 207 – 995 162 5 – 8 153 5 12 6 43 – 1 263 – 1 300 – 46 – 51 6 – 15 18 838 20 275 119 – 3 341 – 2 935 – 954 162 – 953 – 89 25 – 4 – 68 – 54 – 30 – 5 – 89 Net liability in the balance sheet at December 31 – 3 409 – 3 024 – 954 – 953 The reconciliation of the net liability from January 1 to December 31 is as follows: (USD millions) Net liability at January 1 Current service cost Net interest expense Administrative expenses Past service costs and settlements Remeasurements Currency translation effects Novartis Group contributions Effect of acquisitions, divestments or transfers Change in limitation on recognition of fund surplus Net liability at December 31 Amounts recognized in the consolidated balance sheet Prepaid benefit cost Accrued benefit liability F-59 Pension plans Other post-employment benefit plans 2018 2017 2018 2017 – 3 024 – 4 443 – 953 – 1 005 – 378 – 422 – 76 – 26 – 2 – 507 64 520 – 5 25 – 99 – 27 231 1 397 – 229 579 19 – 30 – 34 – 34 – 34 – 39 54 7 6 10 76 – 5 43 1 – 3 409 – 3 024 – 954 – 953 137 133 – 3 546 – 3 157 – 954 – 953 Notes to the Novartis Group consolidated financial statements The following table shows a breakdown of the DBO for pension plans by geography and type of member, and the breakdown of plan assets into the geographical locations in which they are held: (USD millions) Switzerland United States Rest of the world Total Switzerland United States Rest of the world Total Benefit obligation at December 31 14 263 3 348 4 568 22 179 14 606 3 788 4 816 23 210 2018 2017 Thereof unfunded By type of member Active Deferred pensioners Pensioners 649 491 1 140 728 499 1 227 5 618 653 1 616 7 887 5 627 796 1 646 8 069 1 131 1 531 2 662 1 258 1 646 2 904 8 645 1 564 1 421 11 630 8 979 1 734 1 524 12 237 Fair value of plan assets at December 31 13 470 2 160 3 208 18 838 14 445 2 400 3 430 20 275 Funded status – 793 – 1 188 – 1 360 – 3 341 – 161 – 1 388 – 1 386 – 2 935 The following table shows a breakdown of the DBO for other post-employment benefit plans by geography and type of member, and the breakdown of plan assets into the geographical locations in which they are held: (USD millions) Benefit obligation at December 31 Thereof unfunded By type of member Active Deferred pensioners Pensioners Fair value of plan assets at December 31 United States 1 001 882 270 18 713 119 2018 Rest of the world 2017 Total United States Rest of the world 72 72 25 0 47 0 1 073 1 036 954 874 295 18 760 119 310 20 706 162 79 79 26 0 53 0 Total 1 115 953 336 20 759 162 Funded status – 882 – 72 – 954 – 874 – 79 – 953 The following table shows the principal weighted average actuarial assumptions used for calculating defined ben- efit plans and other post- employment benefits of associates: Weighted average assumptions used to determine benefit obligations at December 31 Discount rate Expected rate of pension increase Expected rate of salary increase Interest on savings account Current average life expectancy for a 65-year-old male in years Current average life expectancy for a 65-year-old female in years Pension plans Other post-employment benefit plans 2018 2017 2016 2018 2017 2016 1.6% 0.4% 2.8% 0.8% 22 24 1.5% 0.5% 2.8% 0.6% 22 24 1.4% 0.4% 2.2% 0.5% 22 24 4.4% 3.7% 4.2% 21 23 21 23 21 23 Changes in the aforementioned actuarial assumptions can result in significant volatility in the accounting for the Group’s pension plans in the consolidated financial state- ments. This can result in substantial changes in the Group’s other comprehensive income, long-term liabili- ties and prepaid pension assets. The DBO is significantly impacted by assumptions regarding the rate that is used to discount the actuari- ally determined post-employment benefit liability. This rate is based on yields of high-quality corporate bonds in the country of the plan. Decreasing corporate bond yields decrease the discount rate, so that the DBO increases and the funded status decreases. In Switzerland, an increase in the DBO due to lower discount rates is slightly offset by lower future benefits expected to be paid on the associate’s savings account where the assumption on interest accrued changes in line with the discount rate. The impact of decreasing interest rates on a plan’s assets is more difficult to predict. A significant part of the plan assets is invested in bonds. Bond values usually rise when interest rates decrease and may therefore par- tially compensate for the decrease in the funded status. Furthermore, pension assets also include significant holdings of equity instruments. Share prices tend to rise when interest rates decrease and therefore often coun- F-60 Notes to the Novartis Group consolidated financial statements teract the negative impact of the rising defined benefit obligation on the funded status (although the correlation of interest rates with equities is not as strong as with bonds, especially in the short term). The expected rate for pension increases significantly affects the DBO of most plans in Switzerland, Germany and the United Kingdom. Such pension increases also decrease the funded status, although there is no strong correlation between the value of the plan assets and pension/inflation increases. Assumptions regarding life expectancy significantly impact the DBO. An increase in longevity increases the DBO. There is no offsetting impact from the plan assets, as no longevity bonds or swaps are held by the pension funds. Generational mortality tables are used where this data is available. The following table shows the sensitivity of the defined benefit pension obligation to the principal actu- arial assumptions for the major plans in Switzerland, the United States, the United Kingdom, Germany and Japan on an aggregated basis: Cash and most of the equity and debt securities have a quoted market price in an active market. Real estate and alternative investments, which include hedge fund, pri- vate equity, infrastructure and commodity investments, usually have a quoted market price or a regularly updated net asset value. The strategic allocation of assets of the different pen- sion plans is determined with the objective of achieving an investment return that, together with the contributions paid by the Group and its associates, is sufficient to main- tain reasonable control over the various funding risks of the plans. Based upon the market and economic envi- ronments, actual asset allocations may temporarily be permitted to deviate from policy targets. The asset allo- cation currently includes investments in shares of Novartis AG as per the below table: Investment in shares of Novartis AG Number of shares (in millions) Market Value (in USD billions) December 31, December 31, 2017 2018 11.0 0.9 11.0 0.9 Change in 2018 year-end defined benefit pension obligation (USD millions) 25 basis point increase in discount rate 25 basis point decrease in discount rate 1 year increase in life expectancy 25 basis point increase in rate of pension increase 25 basis point decrease in rate of pension increase 25 basis point increase of interest on savings account 25 basis point decrease of interest on savings account 25 basis point increase in rate of salary increase 25 basis point decrease in rate of salary increase The healthcare cost trend rate assumptions used for other post- employment benefits are as follows: – 718 762 803 502 – 133 56 – 55 46 – 47 The weighted average duration of the defined benefit obligation is 14.6 years (2017: 14.6 years). The Group’s ordinary contribution to the various pen- sion plans is based on the rules of each plan. Additional contributions are made whenever this is required by stat- ute or law (i.e., usually when statutory funding levels fall below predetermined thresholds). The only significant plans that are foreseen to require additional funding are those in the United Kingdom. The expected future cash flows in respect of pension and other post-employment benefit plans at December 31, 2018, were as follows: Healthcare cost trend rate assumed for next year Rate to which the cost trend rate is assumed to decline Year that the rate reaches the ultimate trend rate 2018 2017 2016 (USD millions) Pension plans 7.0% 6.5% 7.0% Novartis Group contributions 2019 (estimated) 4.5% 4.5% 5.0% Expected future benefit payments 2028 2025 2022 The following table shows the weighted average plan asset allocation of funded defined benefit pension plans at December 31, 2018 and 2017: 2019 2020 2021 2022 2023 2024–2028 Other post- employment benefit plans 65 66 69 71 73 74 366 436 1 146 1 135 1 130 1 119 1 109 5 444 (as a percentage) Equity securities Debt securities Real estate Alternative investments Cash and other investments Total Pension plans Long-term Long-term target minimum maximum target 15 20 5 0 0 40 60 20 20 15 2018 2017 28 35 17 16 4 31 35 15 15 4 Defined contribution plans In many subsidiaries, associates are covered by defined contribution plans. Contributions charged to the consol- idated income statement for the defined contribution plans were: 100 100 (USD millions) 2018 2017 2016 Contributions for defined contribution plans 547 406 338 F-61 Notes to the Novartis Group consolidated financial statements 25. Equity-based participation plans for associates The expense related to all equity-based participation plans and the liabilities arising from equity-based pay- ment transactions were as follows: (USD millions) 2018 2017 2016 Expense related to equity-based participation plans 1 011 924 Liabilities arising from equity-based payment transactions 273 261 846 199 Equity-based participation plans can be separated into the following plans: Annual Incentive The Annual Incentive for the Novartis Group CEO and other Executive Committee members is paid 50% in cash and 50% in Novartis restricted shares (RSs) or restricted share units (RSUs). For the Novartis Top Leaders (NTLs), the Annual Incentive is paid 70% in cash and 30% in RSs or RSUs. Cash is paid out during February or March in the year following the end of the performance period, and the shares are granted during January in the year following the end of the performance period. GBP 150) and may also be invited to invest their net Annual Incentive in shares. Two invested shares are matched with one share with a holding period of three years. Starting with the 2017 performance period, United Kingdom associates can only invest a maximum of 50% of their Annual Incentive in shares, and this option is no longer offered to associates who are eli- gible for the equity plan “Select.” • The Leveraged Share Savings Plan (LSSP) was avail- able to key executives for performance periods prior to 2016. At the participant’s election, the Annual Incen- tive was awarded partly or entirely in shares. The elected number of shares is subject to a holding period of five years. At the end of the holding period, Novartis will match the invested shares at a ratio of 1-to-1 (i.e., one share awarded for each invested share). In the United States, both the LSSP award and the corre- sponding match are cash settled. Following the introduction of the new compensation pro- grams in 2014, the Novartis Group CEO and the other Executive Committee members are no longer eligible to participate in the share savings plans. From the 2016 performance period onward, the NTLs are also no lon- ger eligible to participate in the share savings plans. Share savings plans Novartis equity plan “Select” Associates in certain countries and certain key execu- tives worldwide are encouraged to invest their Annual Incentive, and in the United Kingdom specifically, also their base salary in a share savings plan. Under the share savings plan, participants may elect to receive their relevant compensation fully or partially in Novartis shares in lieu of cash. As a reward for their participation in the share savings plan, at no additional cost to the participant, Novartis matches their invest- ments in shares after a holding period of three or five years. Novartis operates three share savings plans, and asso- ciates may only participate in one of the share savings plans in any given year: • In Switzerland, Employee Share Ownership Plan (ESOP) participants may choose to receive their Annual Incentive (i) 100% in shares, (ii) 50% in shares and 50% in cash, or (iii) 100% in cash. After expiration of a three- year holding period for Novartis shares invested under the ESOP, participants will receive one matching share for every two invested shares. Associates eligible for the equity plan “Select” are not eligible to receive ESOP matching shares starting with the 2017 performance period. • In the United Kingdom, associates can invest up to 10% of their monthly salary in shares (up to a maximum of The equity plan “Select” is a global equity incentive plan under which eligible associates may annually be awarded a grant subject to a three-year vesting period. No awards are granted for performance ratings below a certain threshold. Executive Committee members are not eligi- ble for participation in the equity plan “Select” effective from the performance period 2014, and the NTLs are not eligible to participate effective from the performance period 2016. The equity plan “Select” currently allows participants in Switzerland to choose the form of their equity com- pensation in RSs or RSUs. In all other jurisdictions, RSUs are typically granted. Until 2013, participants could also choose to receive part or the entire grant in the form of tradable share options. Tradable share options expire on their 10th anniver- sary from the grant date. Each tradable share option enti- tles the holder to purchase after vesting (and before the 10th anniversary from the grant date) one Novartis share at a stated exercise price that equals the closing market price of the underlying share at the grant date. Options under Novartis equity plan “Select” outside North America The following table shows the activity associated with the share options during the period. The weighted aver- F-62 Notes to the Novartis Group consolidated financial statements age prices in the table below are translated from Swiss francs into USD at historical rates. Long-Term Performance Plan price (USD) Options outstanding at January 1 2018 2017 Weighted average Weighted average Options exercise Options exercise (millions) price (USD) (millions) 7.4 59.5 9.5 59.4 Sold or exercised – 1.8 58.2 – 2.1 59.2 Outstanding at December 31 5.6 59.9 7.4 59.5 Exercisable at December 31 5.6 59.9 7.4 59.5 All share options were granted at an exercise price that was equal to the closing market price of the Group’s shares at the grant date. The weighted average share price at the dates of sale or exercise was USD 73.1. The following table summarizes information about share options outstanding at December 31, 2018: Options outstanding Total/ Weighted averagee Number outstanding (millions) 0.3 0.9 0.8 1.3 2.3 5.6 Remaining contractual life (years) 0 1 2 3 4 2 Exercise price (USD) 46.7 54.5 57.0 57.6 66.0 59.9 Options under Novartis equity plan “Select” for North America The following table shows the activity associated with the American Depositary Receipt (ADR) options during the period: price (USD) Options outstanding at January 1 2018 2017 Weighted ADR average Weighted ADR average options exercise options exercise (millions) price (USD) (millions) 20.3 59.9 25.9 59.9 Sold or exercised – 5.1 57.4 – 5.6 59.9 Outstanding at December 31 15.2 60.7 20.3 59.9 Exercisable at December 31 15.2 60.7 20.3 59.9 All ADR options were granted at an exercise price that was equal to the closing market price of the ADRs at the grant date. The weighted average ADR price at the dates of sale or exercise was USD 86.7. The following table summarizes information about ADR options outstanding at December 31, 2018: ADR options outstanding Total/ Weighted averagee Number outstanding (millions) 0.5 1.7 1.8 4.5 6.7 15.2 Remaining contractual life (years) 0 1 2 3 4 3 Exercise price (USD) 46.4 53.7 57.1 58.3 66.1 60.7 The Long-Term Performance Plan (LTPP) is an equity plan for the Novartis Group CEO, the other Executive Commit- tee members and the NTLs. For the 2018 grant, the target incentive is 200% of base salary for the Novartis Group CEO, and ranges from 130% to 170% of base salary for other Executive Committee members. For the NTLs, the target incentive ranges from 20% to 160% of base salary. The LTPP awards are based on three-year perfor- mance objectives focused on financial and innovation measures. The financial measure is Novartis Cash Value Added (NCVA). The weighting of this measure is 75%. The NCVA target is approved by the Board of Directors. The innovation measure is based on a holistic approach under which Group-wide innovation targets are set at the beginning of the cycle, representing the most important research and development project mile- stones across the Group. The weighting of this measure is 25%. At the end of the performance period, the Research & Development Committee assists the Board of Directors and the Compensation Committee in eval- uating performance against the innovation targets at the end of the cycle. Under the LTPP, participants are granted a target number of performance share units (PSUs) at the begin- ning of every performance period, which are converted into unrestricted Novartis shares after the performance period. Payout is between 0% and 200% of target. PSUs granted under the LTPP do not carry voting rights, but do carry dividend equivalents that are paid in shares at the end of the performance period. Long-Term Relative Performance Plan The Long-Term Relative Performance Plan (LTRPP) is an equity plan for the Novartis Group CEO, other Executive Committee members and NTLs. For the 2018 grant, the target incentive is 125% of base compensation for the Novartis Group CEO, and ranges from 30% to 80% for other Executive Committee members. For the NTLs, the target incentive range is from 10% to 40% of base com- pensation. The LTRPP is based on a ranking of the Novartis total shareholder return (TSR) relative to a global health- care peer group of twelve companies until 2016, and 15 companies from 2017, over rolling three-year performance periods. TSR for Novartis and the peer companies is calcu- lated as the change in the company share price, which is translated to USD at the respective exchange rate, including the reinvestment return of dividends, over the three-year performance period. The calculation is based on Bloomberg standard published TSR data, which is pub- licly available. The position of Novartis in the peer group determines the payout range based on a payout matrix. Under the LTRPP, participants are also granted a target number of PSUs at the beginning of every performance period, which are converted into unrestricted Novartis shares after the performance period. Payout is between 0% and 200% of target. PSUs under the LTRPP do not carry voting rights, but do carry dividend equivalents that are paid in shares at the end of the performance period. F-63 Notes to the Novartis Group consolidated financial statements Worldwide, associates at different levels in the orga- nization were awarded RSs and RSUs in 2018. In addition, in 2018, Board members received unrestricted shares as part of their regular compensation. Other share awards Selected associates, excluding the Executive Commit- tee members, may exceptionally receive Special Share Awards of RSs or RSUs. These Special Share Awards provide an opportunity to reward outstanding achieve- ments or exceptional performance, and aim to retain key contributors. They are based on a formal internal selec- tion process, through which the individual performance of each candidate is thoroughly assessed at several man- agement levels. Special Share Awards have a minimum three-year vesting period. In exceptional circumstances, Special Share Awards may be awarded to attract spe- cial expertise and new talents to the organization. These grants are consistent with market practice and the Novartis philosophy to attract, retain and motivate best- in-class talents around the world. Summary of non-vested share movements The table below provides a summary of non-vested share movements (RSs, RSUs and PSUs) for all plans: Non-vested shares at January 1 23.9 80.6 1 926 21.0 89.5 1 880 2018 Number Weighted Fair value at average fair of shares value at grant grant date in date in USD USD millions in millions 2017 Weighted Number average fair Fair value at of shares value at grant grant date in date in USD USD millions in millions Granted – Annual incentive – Share savings plans – Select North America – Select outside North America – Long-Term Performance Plan – Long-Term Relative Performance Plan – Other share awards Vested Forfeited Non-vested shares at December 31 1.3 4.1 3.9 2.1 1.5 0.3 1.2 – 10.7 – 1.9 25.7 83.9 84.9 77.8 79.7 85.8 52.0 77.9 90.2 76.4 77.1 109 348 303 167 129 16 93 1.3 4.5 4.5 2.0 1.4 0.4 1.3 – 965 – 145 1 981 – 10.7 – 1.8 23.9 69.3 69.4 64.1 65.3 71.5 47.7 67.8 78.2 80.7 80.6 90 312 288 131 100 19 88 – 837 – 145 1 926 Alcon, Inc., equity plans granted to associates prior to the merger At the completion of the merger of Alcon, Inc. into Novartis on April 8, 2011, all awards outstanding under the Alcon equity plans were converted into awards based upon Novartis shares with a conversion factor of 3.0727, as defined in the merger agreement. The plans are fully vested. Share options entitle the recipient to purchase Novartis shares at the closing market price of the former Alcon, Inc., share on the day of grant divided by the con- version factor. Share-settled appreciation rights (SSAR) entitle the participant to receive, in the form of Novartis shares, the difference between the values of the former Alcon, Inc. share at the date of grant, converted into Novartis shares using the conversion factor, and the Novartis share price at the date of exercise. Both options and SSARs expire on their 10th anniver- sary. The last grant was made in 2009, so that only a small residual number of instruments is outstanding as per the end of December 2018. F-64 Notes to the Novartis Group consolidated financial statements 26. Transactions with related parties Genentech/Roche Novartis has two agreements with Genentech, Inc., United States, a subsidiary of Roche Holding AG, which is indirectly included in the consolidated financial state- ments using equity accounting since Novartis holds 33.3% of the outstanding voting shares of Roche (see Note 4). Lucentis Novartis has licensed the exclusive rights to develop and market Lucentis outside the United States for indications related to diseases of the eye. As part of this agreement, Novartis paid Genentech/Roche an initial milestone and shared the cost for the subsequent development by mak- ing additional milestone payments upon the achievement of certain clinical development points and product approval. Novartis also pays royalties on the net sales of Lucentis products outside the United States. In 2018, Lucentis sales of USD 2.0 billion (2017: USD 1.9 billion, 2016: USD 1.8 billion) were recognized by Novartis. Xolair In February 2004, Novartis Pharma AG, Genentech, Inc. and Tanox, Inc. finalized a three-party collaboration to govern the development and commercialization of cer- tain anti-IgE antibodies, including Xolair and TNX-901. Under this agreement, all three parties co-developed Xolair. On August 2, 2007, Genentech, Inc. completed the acquisition of Tanox, Inc. and has taken over its rights and obligations. Novartis and Genentech/Roche are co-promoting Xolair in the United States, where Genen- tech/Roche records all sales. Novartis records sales outside the United States. Novartis markets Xolair and records all sales and related costs outside the United States as well as co-pro- motion costs in the US. Genentech/Roche and Novartis share the resulting profits from sales in the United States, Europe and other countries, according to agreed prof- it-sharing percentages. In 2018, Novartis recognized total sales of Xolair of USD 1 billion (2017: USD 920 mil- lion, 2016: USD 835 million), including sales to them for the United States market. The net income for royalties, cost sharing and profit sharing arising out of the Lucentis and Xolair agreements with Genentech/Roche totaled USD 34 million in 2018 (net expense in 2017: USD 33 million, net expense in 2016: USD 217 million). Furthermore, Novartis has several patent license, supply and distribution agreements with Roche. Executive Officers and Non-Executive Directors compensation During 2018, there were 17 Executive Committee members (“Executive Officers”), including those who stepped down during the year (11 members in 2017 and 14 members in 2016, also including those who stepped down). The total compensation for members of the Executive Committee and the 13 Non-Executive Directors (13 in 2017 and 2016), using the Group’s accounting policies for equity-based compensation and pension benefits was as fol- lows: (USD millions) Cash and other compensation Post-employment benefits Equity-based compensation Total Executive Officers Non-Executive Directors Total 2018 22.5 2.5 42.5 67.5 2017 18.4 2.0 49.9 70.3 2016 20.8 2.2 46.2 69.2 2018 4.0 2017 2016 4.0 4.0 4.8 8.8 4.8 8.8 4.6 8.6 2018 26.5 2.5 47.3 76.3 2017 22.4 2.0 54.7 79.1 2016 24.8 2.2 50.8 77.8 During 2018, there was a decrease in the IFRS compen- sation expense for Executive Officers mainly due to the higher pro-rata accelerated vesting of equity compen- sation in 2017, required by IFRS, in accordance with the plan rules. This was partially offset by the cash portion of buyout payments for new Executive Officers. The decrease in the IFRS compensation expense for Non-Ex- ecutive Directors was due to one less Non-Executive Director following the 2018 Annual General Meeting. During 2017, there was an increase in the IFRS com- pensation expense for Executive Officers, mainly due to the pro-rata accelerated vesting of equity-based com- pensation, required by IFRS, for an ECN member who stepped down on December 31, 2017, in accordance with the plan rules. This was partially offset by the reduction in the number of Executive Officers compared to 2016. The increase in the IFRS compensation expense for Non-Executive Directors was due to one additional Non-Executive Director appointed at the 2017 Annual General Meeting. The Annual Incentive award, which is fully included in equity- based compensation even when paid out in cash, is granted in January in the year following the reporting period. The disclosures on Board and executive compensa- tion required by the Swiss Code of Obligations and in accordance with the Swiss Ordinance against Excessive F-65 Notes to the Novartis Group consolidated financial statements Compensation in Stock Exchange Listed Companies are shown in the compensation report of the Group. Transactions with former members of the Board of Directors During 2018, 2017 and 2016, the following payments (or waivers of claims) were made to former Board members or to “persons closely” linked to them: Currency 2018 2017 2016 Prof. Dr. Brody CHF Prof. Dr. Zinkernagel CHF 0 0 0 0 25 000 50 000 Dr. Krauer Dr. Vasella CHF CHF USD 60 000 60 000 60 000 18 228 26 279 0 0 0 250 000 Prof. Dr. William R. Brody and Prof. Dr. Rolf M. Zinkernagel, who stepped down from the Board of Directors at the 2014 AGM, received in 2016 and 2015 delegated Board membership fees for their work on the Boards of the Novartis Institute for Tropical Diseases (Prof. Dr. Zinkernagel) and the Genomics Institute of the Novartis Research Foundation (Prof. Dr. Brody and Prof. Dr. Zinkernagel). No payments were made in 2018 and 2017, as their respective mandates ended in 2016. Dr. Alex Krauer, Honorary Chairman, is entitled to an amount of CHF 60 000 for annual periods from one AGM to the next. This amount was fixed in 1998 upon his departure from the Board in 1999, and has not been revised since that date. Dr. Daniel Vasella, Honorary Chairman, was paid CHF 18 228 in 2018, and CHF 26 279 in 2017, for reimburs- able costs under his agreement with the Company. In 2016, Dr. Daniel Vasella received the contractual mini- mum compensation under an agreement that became effective on November 1, 2013, and ended in 2016. Under this agreement, Dr. Vasella was compensated at a rate of USD 25 000 per day, with an annual guaranteed min- imum fee of USD 250 000. This amount was in line with compensation practices at other large companies when retired chairmen or CEOs were retained in consulting agreements after leaving the board of directors. Novartis Pension Fund A Group subsidiary has provided an uncommitted over- night credit facility to the Novartis Pension Fund, Swit- zerland, for up to USD 500 million with interest at the US Federal Funds Rate. This credit facility was not utilized during the year and there are no outstanding balances. 27. Commitments and contingencies Leasing commitments The Group has entered into various fixed-term opera- tional leases, mainly for cars and real estate. As of December 31, 2018, the Group’s commitments with respect to these leases, including estimated payment dates, were as follows: (USD millions) 2019 2020 2021 2022 2023 Thereafter Total Expense of current year 2018 372 275 225 195 182 2 363 3 612 383 Research and development commitments The Group has entered into long-term research and development agreements with various institutions, which provide for potential milestone payments by Novartis that may be capitalized. As of December 31, 2018, the Group’s commitments to make payments under those agree- ments, and their estimated timing, were as follows: (USD millions) 2019 2020 2021 2022 2023 Thereafter Total 2018 228 850 782 604 1 059 894 4 417 Other commitments The Group has entered into various purchase commit- ments for services and materials as well as for equip- ment in the ordinary course of business. These commit- ments are generally entered into at current market prices and reflect normal business operations. For disclosure of Property, Plant end Equipment purchase commit- ments see Note 9. Contingencies Group companies have to observe the laws, government orders and regulations of the country in which they operate. F-66 Notes to the Novartis Group consolidated financial statements A number of Novartis companies are, and will likely continue to be, subject to various legal proceedings and investigations that arise from time to time, including pro- ceedings regarding product liability; sales and market- ing practices; commercial disputes; employment and wrongful discharge; and antitrust, securities, health and safety, environmental, tax, international trade, privacy and intellectual property matters. As a result, the Group may become subject to substantial liabilities that may not be covered by insurance and that could affect our business, financial position and reputation. While Novartis does not believe that any of these legal proceedings will have a material adverse effect on its financial position, litigation is inherently unpredictable and large judgments sometimes occur. As a consequence, Novartis may in the future incur judgments or enter into settlements of claims that could have a material adverse effect on its results of operations or cash flow. Governments and regulatory authorities around the world have been stepping up their compliance and law enforcement activities in recent years in key areas, including marketing practices, pricing, corruption, trade restrictions, embargo legislation, insider trading, anti- trust, cyber security and data privacy. Further, when one government or regulatory authority undertakes an inves- tigation, it is not uncommon for other governments or regulators to undertake investigations regarding the same or similar matters. Responding to such investiga- tions is costly and requires an increasing amount of man- agement’s time and attention. In addition, such investi- gations may affect our reputation, create a risk of potential exclusion from government reimbursement programs in the United States and other countries, and lead to (or arise from) litigation. These factors have con- tributed to decisions by Novartis and other co mpanies in the healthcare industry, when deemed in their interest, to enter into settlement agreements with governmental authorities around the world prior to any formal decision by the authorities or a court. Those government settle- ments have involved and may continue to involve, in cur- rent government investigations and proceedings, large cash payments, sometimes in the hundreds of millions of dollars or more, including the potential repayment of amounts allegedly obtained improperly and other pen- alties, including treble damages. In addition, settlements of government healthcare fraud cases often require companies to enter into corporate integrity agreements, which are intended to regulate company behavior for a period of years. Our affiliate Novartis Pharmaceuticals Corporation is a party to such an agreement, which will expire in 2020. Also, matters underlying governmental investigations and settlements may be the subject of separate private litigation. While provisions have been made for probable losses, which management deems to be reasonable or appro- priate, there are uncertainties connected with these estimates. Note 19 contains additional information on these mat- ters. A number of Group companies are involved in legal proceedings concerning intellectual property rights. The inherent unpredictability of such proceedings means that there can be no assurances as to their ultimate out- come. A negative result in any such proceeding could potentially adversely affect the ability of certain Novartis companies to sell their products, or require the payment of substantial damages or royalties. In the opinion of management, however, the outcome of these actions will not materially affect the Group’s financial position but could be material to the results of operations or cash flow in a given period. The Group’s potential environmental remediation lia- bility is assessed based on a risk assessment and inves- tigation of the various sites identified by the Group as at risk for environmental remediation exposure. The Group’s future remediation expenses are affected by a number of uncertainties. These uncertainties include, but are not limited to, the method and extent of remediation, the per- centage of material attributable to the Group at the reme- diation sites relative to that attributable to other parties, and the financial capabilities of the other potentially responsible parties. Note 19 contains additional information on environ- mental liabilities. F-67 Notes to the Novartis Group consolidated financial statements 28. Financial instruments – additional disclosures (USD millions) Cash and cash equivalents Financial assets – measured at fair value through other comprehensive income Marketable securities Debt securities Fund investments Total marketable securities – fair value through other comprehensive income Total marketable securities – available-for-sale marketable securities Long-term financial investments Equity securities Debt securities Fund investments Total long-term financial investments – fair value through other comprehensive income Total available-for-sale long-term financial investments Note 15 2018 1 2017 1 13 271 8 860 15 15 12 12 12 325 325 802 31 833 328 34 362 1 073 36 166 1 275 Total financial assets – measured at fair value through other comprehensive income 1 158 1 637 Financial assets – measured at amortized costs Trade receivables, income tax receivables, and other current assets (excluding contingent consideration receivables and pre-payments) Accrued interest on debt securities and time deposits Time deposits and short term investments with original maturity more than 90 days Long-term loans and receivables from customers and finance lease, advances, security deposits Total financial assets – measured at amortized costs Financial assets – measured at fair value through the consolidated income statement Equity securities Fund investments Associated companies at fair value through profit and loss Derivative financial instruments Contingent consideration receivables 14/16 11 024 10 650 15 15 12 12 2 087 512 1 125 574 13 635 11 350 12 12/15 15 12/16 353 286 145 130 396 216 31 844 Total financial assets – measured at fair value through the consolidated income statement 1 310 1 091 Total financial assets 29 374 22 938 Financial liabilities – measured at amortized costs Current financial debt Interest-bearing accounts of associates payable on demand Bank and other financial debt Commercial paper Current portion of non-current debt Total current financial debt Non-current financial debt Straight bonds Liabilities to banks and other financial institutions Finance lease obligations Current portion of non-current debt Total non-current financial debt Trade payables and commitment for repurchase of own shares 2 Total financial liabilities – measured at amortized costs Financial liabilities – measured at fair value through the consolidated income statement Contingent consideration (see Note 19/21) and other financial liabilities Derivative financial instruments Total financial liabilities – measured at fair value through the consolidated income statement Total financial liabilities 1 Except for straight bonds (see Note 18), the carrying amount is a reasonable approximation of fair value. 2 Note 17 and Note 21 provide additional disclosures related to commitment for repurchase of own shares. F-68 20 20 20 20 18 18 18 18 1 778 701 3 951 3 190 9 620 1 822 692 2 328 359 5 201 25 283 22 957 285 92 539 87 – 3 190 – 359 22 470 23 224 5 840 5 169 37 930 33 594 20 917 58 975 924 107 1 031 38 905 34 625 Notes to the Novartis Group consolidated financial statements Derivative financial instruments The following tables show the contract or underlying principal amounts and fair values of derivative financial instruments analyzed by type of contract at Decem- ber 31, 2018 and 2017. Contract or underlying principal amounts indicate the gross volume of business outstand- ing at the consolidated balance sheet date and do not represent amounts at risk. The fair values are determined by reference to market prices or standard pricing mod- els that use observable market inputs at December 31, 2018 and 2017. (USD millions) Currency-related instruments Contract or underlying principal amount Positive fair values Negative fair values 2018 2017 2018 2017 2018 2017 Forward foreign exchange rate contracts 10 823 8 410 130 Total derivative financial instruments included in marketable securities and in current financial debts 10 823 8 410 130 31 31 – 58 – 107 – 58 – 107 The following table shows by currency contract or underlying principal amount the derivative financial instruments at December 31, 2018 and 2017: (USD millions) Currency-related instruments Forward foreign exchange rate contracts Total derivative financial instruments (USD millions) Currency-related instruments Forward foreign exchange rate contracts Total derivative financial instruments EUR 2018 USD Other Total 2 989 2 989 6 558 6 558 1 276 10 823 1 276 10 823 EUR 2017 USD Other Total 2 768 2 768 4 361 4 361 1 281 1 281 8 410 8 410 Derivative financial instruments effective for hedge accounting purposes At the end of 2018 and 2017, there were no open hedg- ing instruments for anticipated transactions. Fair value by hierarchy As required by IFRS, financial assets and liabilities recorded at fair value in the consolidated financial state- ments are categorized based upon the level of judgment associated with the inputs used to measure their fair value. There are three hierarchical levels, based on an increasing amount of subjectivity associated with the inputs to derive fair valuation for these assets and liabil- ities, which are as follows: The assets carried at Level 1 fair value are equity and debt securities listed in active markets. The assets generally included in Level 2 fair value hierarchy are foreign exchange and interest rate deriva- tives and certain debt securities. Foreign exchange and interest rate derivatives are valued using corroborated market data. The liabilities generally included in this fair value hierarchy consist of foreign exchange and interest rate derivatives. Level 3 inputs are unobservable for the asset or lia- bility. The assets generally included in Level 3 fair value hierarchy are various investments in hedge funds and unquoted equity security investments. Contingent con- sideration carried at fair value is included in this cate- gory. F-69 Notes to the Novartis Group consolidated financial statements 2 087 2 087 Level 1 Level 2 2018 Valued at Level 3 amortized cost 302 35 337 337 698 698 23 23 130 153 – 58 – 58 12 2 099 512 512 488 251 396 1 135 145 – 907 – 10 – 917 Level 1 Level 2 2017 Valued at Level 3 amortized cost 125 1 126 574 574 303 34 337 337 672 672 28 25 25 31 56 – 107 – 107 437 166 394 997 188 450 – 852 – 72 – 924 Total 325 35 360 130 12 2 589 1 186 251 396 512 2 345 145 0 – 907 – 10 – 58 – 975 Total 328 34 362 125 31 1 519 1 109 166 394 574 2 243 216 450 – 852 – 72 – 107 – 1 031 (USD millions) Financial assets Debt securities Fund investments Total marketable securities Time deposits and short term investments with original maturity more than 90 days Derivative financial instruments Accrued interest on debt securities, time deposits and short term investments Total marketable securities, time deposits and derivative financial instruments Long term financial investments Fund investments Contingent consideration receivables Long-term loans and receivables from customers and finance lease, advances, security deposits Financial investments and long-term loans Associated companies at fair value through profit and loss Contingent consideration receivables short-term Financial liabilities Contingent consideration payables Other financial liabilities Derivative financial instruments Total financial liabilities at fair value (USD millions) Financial assets Debt securities Fund investments Total available-for-sale marketable securities Time deposits with original maturity more than 90 days Derivative financial instruments Accrued interest on debt securities Total marketable securities, time deposits and derivative financial instruments Available-for-sale financial investments Fund investments Contingent consideration receivables Long-term loans and receivables from customers and finance lease, advances, security deposits Financial investments and long-term loans Associated companies at fair value through profit and loss Contingent consideration receivables short-term Financial liabilities Contingent consideration payables Other financial liabilities Derivative financial instruments Total financial liabilities at fair value The analysis above includes all financial instruments, including those measured at amortized cost. F-70 Notes to the Novartis Group consolidated financial statements The change in carrying values associated with Level 3 financial instruments using significant unobservable inputs during the year ended December 31 is set forth below: 2018 (USD millions) January 1 Fair value gains and other adjustments, including from divestments recognized in the consolidated income statement Fair value losses (including impairments and amortizations) and other adjustments recognized in the consolidated income statement Fair value adjustments recognized in the consolidated statement of comprehensive income Purchases Cash receipts and payments Disposals Associated companies at fair value through Fund profit and loss investments investments receivables Long term Contingent Contingent financial consideration consideration payables Other financial liabilities 188 166 437 844 – 852 – 72 93 36 213 – 22 24 22 – 5 – 10 123 – 6 – 30 – 25 – 100 – 182 – 484 11 62 Contingent consideration payable related to disposal group held for sale 3 Reclassification December 31 – 39 145 251 – 32 488 396 – 907 – 10 Total of fair value gains and losses recognized in the consolidated income statement for assets and liabilities held at December 31, 2018 – 22 93 – 5 36 113 0 (USD millions) January 1 Fair value gains and other adjustments, including from divestments recognized in the consolidated income statement Fair value losses (including impairments and amortizations) and other adjustments recognized in the consolidated income statement Fair value adjustments recognized in the consolidated statement of comprehensive income Purchases Cash receipts and payments Disposals Reclassification December 31 2017 Available- Associated companies at fair value through Fund profit and loss investments investments receivables for-sale Contingent Contingent financial consideration consideration payables Other financial liabilities 188 107 476 586 – 889 – 129 45 – 34 37 – 19 – 29 188 32 278 362 – 45 – 40 113 – 52 – 47 437 45 28 – 18 4 166 – 193 – 37 – 238 – 20 106 94 844 – 852 – 72 Total of fair value gains and losses recognized in the consolidated income statement for assets and liabilities held at December 31, 2017 11 0 – 13 278 169 – 37 During 2018, there were several individually non-signifi- cant transfers of financial investments from Level 3 to Level 1 for USD 78 million (2017: USD 73 million), mainly due to initial public offerings of the invested companies. Realized gains and losses associated with Level 3 marketable securities are recorded in the consolidated income statement under “Other financial income and expense,” and realized gains and losses associated with Level 3 long-term financial investments measured at fair value through the consolidated income statement are recorded in the consolidated income statement under “Other income” or “Other expense,” respectively. Real- ized gains and losses associated with Level 3 long-term financial investments measured at fair value through other comprehensive income are not recycled through the consolidated income statement but reclassified to retained earnings instead. During the year, the net loss and net gain recorded on equity securities and fund investments at fair value through the consolidated income statement is USD 56 million and USD 93 million, respectively. If the pricing parameters for the Level 3 input were to change for associated companies at fair value through profit and loss, fund investments and financial invest- F-71 Notes to the Novartis Group consolidated financial statements ments by 10% positively or negatively, this would change the amounts recorded in the 2018 consolidated state- ment of comprehensive income by USD 88 million. For the determination of the fair value of a contingent consideration, various unobservable inputs are used. A change in these inputs might result in a significantly higher or lower fair value measurement. The inputs used are, among others, the probability of success, sales fore- cast and assumptions regarding the discount rate, tim- ing and different scenarios of triggering events. The inputs are interrelated. The significance and usage of these inputs to each contingent consideration may vary due to differences in the timing and triggering events for payments or in the nature of the asset related to the con- tingent consideration. If the most significant parameters for the Level 3 input were to change by 10% positively or negatively, or where the probability of success (POS) is the most significant input parameter, 10% were added or deducted from the applied probability of success, for contingent consider- ation payables, other financial liabilities and contingent consideration receivables, this would change the amounts recorded in the 2018 consolidated income statement by USD 341 million and USD 330 million, respectively. Equity securities measured at fair value through other comprehensive income Equity securities held as strategic investments, typically held outside the Novartis Venture Fund, are generally designated at date of acquisition as financial assets val- ued at fair value through other comprehensive income with no subsequent recycling through profit and loss. These are made up of individually non-significant invest- ments. At December 31, 2018, the Group holds 41 non- listed equity securities and 26 listed equity securities in this category with the following fair values: (USD millions) Listed equity securities Non-listed equity securities Total equity securities 2018 1 597 205 802 1 These investments were classified as available-for-sale in 2017, prior to the adoption of IFRS 9 Financial Instruments, see Note 1. There were no dividends recognized during 2018 from these equity securities. In 2018, equity securities that were no longer considered strategic, with a fair value of USD 21 million, were sold, and the USD 16 million gain was transferred from other comprehensive income to retained earnings during 2018 (see Note 8.) Nature and extent of risks arising from financial instruments Market risk Novartis is exposed to market risk, primarily related to foreign currency exchange rates, interest rates, and the market value of the investments of liquid funds. The Group actively monitors and seeks to reduce, where it deems it appropriate to do so, fluctuations in these expo- sures. It is the Group’s policy and practice to enter into a variety of derivative financial instruments to manage the volatility of these exposures and to enhance the yield on the investment of liquid funds. It does not enter into any financial transactions containing a risk that cannot be quantified at the time the transaction is concluded. In addition, it does not sell short assets it does not have, or does not know it will have, in the future. The Group only sells existing assets or enters into transactions and future transactions (in the case of anticipatory hedges) that it confidently expects it will have in the future, based on past experience. In the case of liquid funds, the Group writes call options on assets it has, or writes put options on positions it wants to acquire and has the liquidity to acquire. The Group expects that any loss in value for these instruments generally would be offset by increases in the value of the underlying transactions. Foreign currency exchange rate risk The Group uses the US dollar as its reporting currency. As a result, the Group is exposed to foreign currency exchange movements, primarily in European, Japanese and emerging market currencies. Fluctuations in the exchange rates between the US dollar and other curren- cies can have a significant effect on both the Group’s results of operations, including reported sales and earn- ings, as well as on the reported value of our assets, lia- bilities and cash flows. This, in turn, may significantly affect the comparability of period-to-period results of operations. Because our expenditures in Swiss francs are sig- nificantly higher than our revenues in Swiss francs, vol- atility in the value of the Swiss franc can have a signifi- cant impact on the reported value of our earnings, assets and liabilities, and the timing and extent of such volatility can be difficult to predict. In addition, there is a risk that certain countries could take other steps that could sig- nificantly impact the value of their currencies. The Group is exposed to a potential adverse devalu- ation risk on its intercompany funding and total invest- ment in certain subsidiaries operating in countries with exchange controls. The most significant foreign exchange losses (USD 0.3 billion) occurred in Venezuela in 2016. The net outstanding intercompany payable balance of Venezuela subsidiaries was not significant at December 31, 2018, and at December 31, 2017, due to reserves against the intercompany balances. The Group manages its global currency exposure by engaging in hedging transactions where management deems appropriate. Novartis may enter into various con- tracts that reflect the changes in the value of foreign cur- rency exchange rates to preserve the value of assets, commitments and anticipated transactions. Novartis also uses forward contracts and foreign currency option con- tracts to hedge. Net investments in subsidiaries in foreign countries are long-term investments. Their fair value changes through movements of foreign currency exchange rates. The Group has designated a certain portion of its long- term euro-denominated straight bonds as hedges of the translation risk arising on certain of these net invest- ments in foreign operations with euro functional cur- F-72 Notes to the Novartis Group consolidated financial statements rency. As of December 31, 2018, long-term financial debt with a carrying amount of EUR 1.8 billion (USD 2.1 billion) (2017: USD 2.2 billion) has been designated as a hedge instrument. During 2018, USD 95 million (unrealized loss in 2017: USD 237 million) of unrealized income was rec- ognized in other comprehensive income and accumu- lated in currency translation effects in relation with this net investment hedge. The hedge remained effective since inception, and no amount was recognized in the consolidated income statement in 2018 and 2017. During 2016, the Group did not apply net investment hedge accounting. The Group’s largest customer accounted for approx- imately 16% of net sales, and the second largest and third largest customers accounted for 13% and 7% of net sales, respectively (2017: 17%, 12% and 7%, respectively; 2016: 16%, 12% and 6%, respectively). No other customer accounted for 5% or more of net sales in either year. The highest amounts of trade receivables outstand- ing were for these same three customers and amounted to 12%, 10% and 6%, respectively, of the Group’s trade receivables at December 31, 2018 (2017: 14%, 9% and 5%, respectively). There is no other significant concen- tration of customer credit risk. Commodity price risk The Group has only a very limited exposure to price risk related to anticipated purchases of certain commodities used as raw materials by the Group’s businesses. A change in those prices may alter the gross margin of a specific business, but generally by not more than 10% of the margin and thus below the Group’s risk management tolerance levels. Accordingly, the Group does not enter into significant commodity futures, forward and option contracts to manage fluctuations in prices of anticipated purchases. Interest rate risk The Group addresses its net exposure to interest rate risk mainly through the ratio of its fixed-rate financial debt to variable-rate financial debt contained in its total financial debt portfolio. To manage this mix, Novartis may enter into interest rate swap agreements, in which it exchanges periodic payments based on a notional amount and agreed-upon fixed and variable interest rates. Equity risk The Group may purchase equities as investments of its liquid funds. As a policy, it limits its holdings in an unre- lated company to less than 5% of its liquid funds. Poten- tial investments are thoroughly analyzed. Call options are written on equities that the Group owns, and put options are written on equities that the Group wants to buy and for which cash is available. Credit risk Credit risks arise from the possibility that customers may not be able to settle their obligations as agreed. To man- age this risk, the Group periodically assesses country and customer credit risk, assigns individual credit limits, and takes actions to mitigate credit risk where appropri- ate. The provisions for expected credit losses for cus- tomers are based on a forward-looking expected credit loss, which includes possible default events on the trade receivables over the entire holding period of the trade receivable. In measuring the expected credit losses, trade receiv- ables are grouped based on shared credit risk charac- teristics (such as private versus public receivables) and days past due. In determining the expected credit loss rates, the Group considers current and forward-looking macroeconomic factors that may affect the ability of the customers to settle the receivables, and historical loss rates for each category of customers. Counterparty risk Counterparty risk encompasses issuer risk on market- able securities and money market instruments, credit risk on cash, time deposits and derivatives, as well as settlement risk for different instruments. Issuer risk is reduced by only buying securities that are at least A- rated. Counterparty credit risk and settlement risk are reduced by a policy of entering into transactions with counterparties (banks or financial institutions) that fea- ture a strong credit rating. Exposure to these risks is closely monitored and kept within predetermined param- eters. The limits are regularly assessed and determined based upon credit analysis, including financial statement and capital adequacy ratio reviews. In addition, reverse repurchasing agreements are contracted, and Novartis has entered into credit support agreements with various banks for derivative transactions. The Group’s cash and cash equivalents are held with major regulated financial institutions; the three largest ones hold approximately 9.4%, 7.6% and 7.0%, respec- tively (2017: 20.2%, 15.0% and 12.7%, respectively). The Group does not expect any losses from non-per- formance by these counterparties and does not have any significant grouping of exposures to financial sector or country risk. Liquidity risk Liquidity risk is defined as the risk that the Group could not be able to settle or meet its obligations on time or at a reasonable price. Group Treasury is responsible for liquidity, funding and settlement management. In addi- tion, liquidity and funding risks, and related processes and policies, are overseen by management. Novartis manages its liquidity risk on a consolidated basis accord- ing to business needs and tax, capital or regulatory con- siderations, if applicable, through numerous sources of financing in order to maintain flexibility. Management monitors the Group’s net debt or liquidity position through rolling forecasts on the basis of expected cash flows. Novartis has two US commercial paper programs under which it can issue up to USD 9.0 billion in the aggregate of unsecured commercial paper notes. Novartis also has a Japanese commercial paper program under which it can issue up to JPY 150 billion (approxi- mately USD 1.4 billion) of unsecured commercial paper notes. Commercial paper notes totaling USD 4.0 billion under these three programs were outstanding as per December 31, 2018 (2017: USD 2.3 billion). Novartis fur- ther has a committed credit facility of USD 6.0 billion, entered into on September 23, 2015. This credit facility is provided by a syndicate of banks and is intended to be F-73 Notes to the Novartis Group consolidated financial statements used as a backstop for the US commercial paper pro- grams. It matures in September 2020 and was undrawn as per December 31, 2018, and December 31, 2017. The following table sets forth how management monitors net debt or liquidity based on details of the remaining contractual maturities of current financial assets and liabilities, excluding trade receivables and payables as well as contingent considerations at December 31, 2018, and December 31, 2017: 2018 (USD millions) Current assets Marketable securities, time deposits and short-term investments with original maturity more than 90 days Commodities Derivative financial instruments and accrued interest Cash and cash equivalents Total current financial assets Non-current liabilities Financial debt Financial debt – undiscounted Total non-current financial debt Current liabilities Financial debt Financial debt – undiscounted Derivative financial instruments Total current financial debt Due later than Due later than Due later than one year Due within but less than but less than but less than five years one month three months three months one month one year 39 56 2 091 198 40 3 571 3 650 75 9 700 9 831 27 Due after five years Total 63 104 2 447 104 142 13 271 2 118 198 167 15 964 – 8 980 – 13 490 – 22 470 – 9 025 – 13 623 – 22 648 – 8 980 – 13 490 – 22 470 – 5 217 – 4 084 – 5 217 – 4 084 – 16 – 34 – 319 – 319 – 8 – 5 233 – 4 118 – 327 – 9 620 – 9 620 – 58 – 9 678 Net debt – 1 583 5 713 1 791 – 8 782 – 13 323 – 16 184 2017 (USD millions) Current assets Due later than Due later than Due later than one year Due within but less than but less than but less than five years one month three months three months one month one year Marketable securities and time deposits 71 72 105 181 Commodities Derivative financial instruments and accrued interest Cash and cash equivalents Total current financial assets Non-current liabilities Financial debt Financial debt – undiscounted Total non-current financial debt Current liabilities Financial debt Financial debt – undiscounted Derivative financial instruments Total current financial debt Due after five years 58 106 Total 487 106 32 8 860 9 485 7 4 260 4 338 19 4 600 4 691 6 111 181 164 – 9 849 – 13 375 – 23 224 – 9 893 – 13 519 – 23 412 – 9 849 – 13 375 – 23 224 – 4 576 – 4 576 – 31 – 4 607 – 169 – 169 – 48 – 217 – 456 – 456 – 28 – 484 – 5 201 – 5 201 – 107 – 5 308 Net debt – 269 4 474 – 373 – 9 668 – 13 211 – 19 047 F-74 Notes to the Novartis Group consolidated financial statements The consolidated balance sheet amounts of financial lia- bilities included in the above analysis are not materially different to the contractual amounts due on maturity. The positive and negative fair values on derivative financial instruments represent the net contractual amounts to be exchanged at maturity. The Group’s contractual undiscounted potential cash flows from derivative financial instruments to be settled on a gross basis are as follows: (USD millions) Derivative financial instruments and accrued interest on derivative financial instruments 2018 Due later than Due later than one month three months Due within but less than but less than one month one year three months Total Potential outflows in various currencies – from financial derivative liabilities – 1 305 – 2 949 – 598 – 4 852 Potential inflows in various currencies – from financial derivative assets 1 328 2 974 593 4 895 (USD millions) Derivative financial instruments and accrued interest on derivative financial instruments 2017 Due later than Due later than one month three months Due within but less than but less than one month one year three months Total Potential outflows in various currencies – from financial derivative liabilities – 953 – 972 – 2 824 – 4 749 Potential inflows in various currencies – from financial derivative assets 928 948 2 778 4 654 Other contractual liabilities that are not part of management’s monitoring of the net debt or liquidity consist of the following items: 2018 (USD millions) one month Due later than Due later than Due later than one year three months but less than but less than but less than five years three months one year Due after five years Total Contractual interest on non-current liabilities – 113 – 459 – 1 667 – 3 755 – 5 994 Trade payables – 5 556 – 5 556 2017 (USD millions) one month Due later than Due later than Due later than one year three months but less than but less than but less than five years three months one year Due after five years Total Contractual interest on non-current liabilities – 113 – 507 – 1 765 – 3 859 – 6 244 Trade payables – 5 169 – 5 169 Capital risk management Value at risk Novartis strives to maintain a strong credit rating. In man- aging its capital, Novartis focuses on maintaining a strong balance sheet. As of December 31, 2018, Moody’s Investor Service rated the Company A1 for long-term maturities and P-1 for short-term maturities and S&P Global Ratings had a rating of AA- for long-term matur- ities and A-1+ for short-term maturities. The debt/equity ratio increased to 0.41:1 at December 31, 2018, compared to 0.38:1 at the beginning of the year. The Group uses a value at risk (VAR) computation to esti- mate the potential 10-day loss in the fair value of its finan- cial instruments. A 10-day period is used because of an assumption that not all positions could be undone in one day given the size of the positions. The VAR computation includes all financial assets and financial liabilities as set forth in the table on page F-68, except trade receivables, income tax receivables and other current assets, contingent considerations, finance lease obligations, long-term loans and receivables from customers and finance lease, advances and security deposits and trade payables. F-75 Notes to the Novartis Group consolidated financial statements The VAR computation is a risk analysis tool designed to statistically estimate the potential 10-day loss from adverse movements in foreign currency exchange rates, equity prices and interest rates under normal market conditions. The computation does not purport to repre- sent actual losses in fair value on earnings to be incurred by the Group, nor does it consider the effect of favorable changes in market rates. The Group cannot predict actual future movements in such market rates, and it does not claim that these VAR results are indicative of future movements in such market rates or are represen- tative of any actual impact that future changes in market rates may have on the Group’s future results of opera- tions or financial position. In addition to these VAR analyses, the Group uses stress-testing techniques that aim to reflect a worst-case scenario on the marketable securities that are monitored by Group Treasury. For these calculations, the Group uses the six-month period with the worst performance observed over the past 20 years in each category. For 2018 and 2017, the worst case loss scenario was calcu- lated as follows: (USD millions) All financial instruments Analyzed by components: Instruments sensitive to foreign currency exchange rates Instruments sensitive to equity market movements Instruments sensitive to interest rates 2018 7 2017 7 7 7 In the Group’s risk analysis, Novartis considered this worst-case scenario acceptable, as it could reduce income but would not endanger the solvency or invest- ment grade credit rating of the Group. The VAR estimates are made assuming normal mar- ket conditions, using a 95% confidence interval. The Group uses a “Delta Normal” model to determine the observed interrelationships between movements in inter- est rates, stock markets and various currencies. These inter-relationships are determined by observing interest rate, stock market movements and forward foreign cur- rency rate movements over a 60-day period for the cal- culation of VAR amounts. The estimated potential 10-day loss in the fair value of the Group’s foreign currency positions (including for- eign exchange translation risk), the estimated potential 10-day loss of its equity holdings, and the estimated potential 10-day loss in fair value of its interest rate-sen- sitive instruments (primarily financial debt and invest- ments of liquid funds under normal market conditions) as calculated in the VAR model are the following: (USD millions) All financial instruments Analyzed by components: Instruments sensitive to foreign currency exchange rates Instruments sensitive to equity market movements Instruments sensitive to interest rates 2018 337 2017 498 217 122 221 184 27 242 The average, high and low VAR amounts are as follows: (USD millions) All financial instruments Analyzed by components: Instruments sensitive to foreign currency exchange rates Instruments sensitive to equity market movements Instruments sensitive to interest rates Average 443 2018 High 553 Low 337 324 473 217 60 122 22 253 361 169 (USD millions) All financial instruments Analyzed by components: Instruments sensitive to foreign currency exchange rates Instruments sensitive to equity market movements Instruments sensitive to interest rates Average 521 2017 High 560 Low 466 277 352 184 28 35 21 282 338 219 F-76 Notes to the Novartis Group consolidated financial statements 29. Impacts of adoption of new IFRS standards Note 1 explains the changes and new accounting poli- cies introduced on January 1, 2018, resulting from the adoption of the new accounting standards IFRS 9 Finan- cial Instruments and IFRS 15 Revenue from Contracts with Customers. The most significant impact from the adoption of IFRS 15 Revenue from Contracts with Customers relates to the timing of the recognition of income from upfront and milestone payments received under co-marketing and co-promotion agreements. Under IFRS 15, as these agreements are accounted for as a right to use license of intellectual property (IP), and the performance obliga- tion to transfer the licenses to the counterparty to the agreement (the licensee) has been satisfied, revenue is recognized at the point in time when the upfront payment is received and when the milestone criteria is highly prob- able to be met. Under IAS 18, upfront and milestone pay- ments received under co-marketing and co-promotion agreements were deferred and amortized to other rev- enue over the term of the agreements. Therefore, upon adoption of IFRS 15, the deferred revenue and related deferred taxes, in relation to the upfront payments and milestone payments received, have been derecognized and the impact to retained earnings has been accord- ingly recognized in the amount of USD 60 million. The following table shows the changes to the line items of the January 1, 2018, consolidated balance sheet by the adoption of IFRS 15: January 1, 2018 Adjustment IFRS 15 Adjusted January 1, 2018 8 229 104 871 133 079 – 4 – 4 – 4 8 225 104 867 133 075 73 299 74 227 60 60 73 359 74 287 (USD millions) Assets Non-current assets Deferred tax assets Total non-current assets Total assets Equity and liabilities Equity Reserves Total equity Non-current liabilities Deferred tax liabilities 5 168 12 5 180 Provision and other non-current liabilities 7 057 Total non-current liabilities 35 449 – 69 – 57 6 988 35 392 Current liabilities Provision and other current liabilities Total current liabilities 11 203 23 403 – 7 – 7 11 196 23 396 Total equity and liabilities 133 079 – 4 133 075 The amount by which the line items in the December 31, 2018, consolidated income statement and consolidated statement of cash flow were affected by the application of IFRS 15 Revenue from Contracts with Customers, as compared to IAS 18 Revenues and related interpreta- tions, was not significant. The adoption of IFRS 9 Financial Instruments had no impact to the line items of the January 1, 2018, consoli- dated balance sheet. The transition impact of IFRS 9 Financial Instruments was from the previously recognized unrealized gains accumulated in “Other comprehensive income” (OCI) in equity related to fund investments (USD 75 million) and on equity securities held by the Novartis Venture Fund (USD 102 million). The total amount of USD 177 million was transferred from OCI reserves into retained earn- ings on January 1, 2018. With the adoption of IFRS 9, from January 1, 2018, these investments are measured at fair value through profit and loss (formerly under IAS 39 measured at fair value through OCI (FVOCI), with impairments recognized in profit and loss and gains recy- cled out of OCI to profit and loss at the date the finan- cial instrument was divested). There was no transition impact on financial instru- ments held for long-term purposes, recorded as long- term financial assets on the consolidated balance sheet, where the irrevocable FVOCI option was applied, as they continue to be measured at fair value through OCI. In subsequent periods, upon a divestment of these invest- ments, the OCI reserves amount will be transferred directly to retained earnings. Prior to the adoption of IFRS 9, unrealized gains recognized in OCI reserves were recycled to profit and loss. There is no significant impact from the new expected credit loss (ECL) impairment model under IFRS 9 to the Group’s allowances and provisions for trade receivable, finance lease receivables and other short- and long-term receivables. The following table shows the changes to the line items of the January 1, 2018, consolidated statement of changes in equity by the adoption of IFRS 9 and IFRS 15: (USD millions) January 1, 2018 Adjustment IFRS 9 Adjustment IFRS 15 Adjusted January 1, 2018 Retained earnings 77 639 177 60 77 876 Total fair value adjustments – 4 340 – 177 – 4 517 Total equity 74 227 60 74 287 F-77 Notes to the Novartis Group consolidated financial statements The following condensed table shows the changes to the line items of the January 1, 2018, financial instruments additional disclosures table by the adoption of IFRS 9: (USD millions) Cash and cash equivalents Financial assets – measured at fair value through other comprehensive income Marketable securities Debt securities Fund investments Total marketable securities Long-term financial investments Equity securities Debt securities Fund investments Total long-term financial investments Total financial assets – measured at fair value through other comprehensive income Financial assets – measured at amortized costs Financial assets – measured at fair value through the consolidated income statement Carrying value January 1, 2018 8 860 Reclassi- fications Adjusted carrying value January 1, 2018 8 860 Retained earnings effect January 1, 2018 OCI reserves effect January 1, 2018 328 34 362 – 34 – 34 1 073 – 386 36 166 1 275 – 166 – 552 328 328 687 36 723 102 – 102 75 177 – 75 – 177 1 637 – 586 1 051 177 – 177 11 350 11 350 1 091 586 1 677 Total financial assets 22 938 22 938 177 – 177 Financial liabilities – measured at amortized costs Financial liabilities – measured at fair value through the consolidated income statement 33 594 1 031 33 594 1 031 Total financial liabilities 34 625 34 625 F-78 Notes to the Novartis Group consolidated financial statements 30. Events subsequent to the December 31, 2018, consolidated balance sheet date Dividend proposal for 2018 and approval of the Group’s 2018 consolidated financial statements On January 29, 2019, the Novartis AG Board of Direc- tors proposed the acceptance of the 2018 consolidated financial statements of the Novartis Group for approval by the Annual General Meeting on February 28, 2019. Furthermore, also on January 29, 2019, the Board pro- posed a dividend of CHF 2.85 per share to be approved at the Annual General Meeting on February 28, 2019. If approved, total dividend payments would amount to approximately USD 6.7 billion (2017: USD 7.0 billion), using the CHF/USD December 31, 2018, exchange rate. Corporate – proposal to the Annual General Meeting of Shareholders to approve a spin-off transaction of the Alcon Division On June 29, 2018, Novartis announced its intention to seek shareholder approval for the spin-off of the Alcon business into a separately traded standalone company, following the complete and structural separation of the Alcon business into a standalone company. If the spin- off is approved at the 2019 AGM and the conditions prec- edent for the distribution are met, Novartis will effect the spin-off and distribute to its shareholders and ADR hold- ers, by way of a dividend in kind, 1 Alcon share for every 5 dividend bearing share of Novartis AG (the Distribu- tion). No dividend in kind will be declared on treasury shares held by Novartis AG or its fully owned subsidiar- ies. Completion of the Distribution is subject to shareholder approval at the 2019 AGM in line with Swiss corporate law and the following conditions precedent: (i) The Alcon Shares shall have been admitted to listing on the SIX Swiss Exchange and the New York Stock Exchange as from the ex-dividend date (subject to technical deliverables only); (ii) The U.S. Securities and Exchange Commission (“SEC”) shall have declared effective the registration statement on Form 20-F for the Alcon Shares under the U.S. Securities Exchange Act of 1934, as amended, and no stop order suspending the effec- tiveness of this registration statement shall be in effect and no proceedings for that purpose shall be pending before or threatened by the SEC; (iii) No order, injunction or decree issued by any govern- mental authority of competent jurisdiction or other legal restraint or prohibition preventing consumma- tion of the spin-off of Alcon shall be in effect, and no other event outside the control of Novartis shall have occurred or failed to occur that prevents the con- summation of the spin-off of Alcon (including, but not limited to, Novartis not being able to complete the internal transactions to separate the businesses cur- rently constituting the eye care devices business of Novartis, comprising its Surgical and Vision Care operations, from the other businesses, due to ele- ments outside of its reasonable control); and (iv) No other events or developments shall have occurred prior to the ex-dividend date of the Distribution that, in the judgment of the Novartis Board of Directors, would result in the spin-off of Alcon having a mate- rial adverse effect (including, but not limited to, mate- rial adverse tax consequences or risks) on Novartis or its shareholders. The Board of Directors shall (i) determine whether these conditions precedent are satisfied and, to the extent legally permissible, have authority to waive any condi- tions precedent if such waiver is, in the judgment of the Board of Directors, in the best interest of Novartis and its shareholders; and (ii) set the record, ex-dividend and settlement dates of the Distribution, which shall occur as soon as practicable following the satisfaction (or waiver) of these conditions precedent. The Group expects the fair value of the distribution liability of the Alcon business, which will be recognized upon shareholders’ approval, to be in excess of the car- rying value of the net assets of the Alcon business at the date of the Distribution to the Novartis AG shareholders, assuming no significant changes in market conditions or Alcon’s business performance outlook. F-79 Notes to the Novartis Group consolidated financial statements 31. Principal Group subsidiaries and associated companies The following table lists the principal subsidiaries controlled by Novartis, associated companies in which Novartis is deemed to have significant influence and foundations required to be consolidated under IFRS. It includes all sub- sidiaries, associated companies and consolidated foundations with total assets or net sales to third parties in excess of USD 25 million. The equity interest percentage shown in the table also represents the share in voting rights in those entities, except where explicitly noted. As at December 31, 2018 Algeria Société par actions SANDOZ, Algiers Argentina Novartis Argentina S.A., Buenos Aires Share capital Equity 1 interest As at December 31, 2018 Share capital Equity 1 interest DZD 650.0 m 100% ARS 906.1 m 100% France Novartis Groupe France S.A., Rueil-Malmaison Novartis Pharma S.A.S., Rueil-Malmaison Advanced Accelerator Applications S.A., Saint-Genis-Pouilly Sandoz S.A.S., Levallois-Perret Laboratoires Alcon S.A.S., Rueil-Malmaison EUR EUR EUR EUR EUR 903.0 m 43.4 m 100% 100% 9.6 m 99.07% 100% 5.4 m 100% 12.9 m Australia Novartis Australia Pty Ltd, Macquarie Park, NSW Novartis Pharmaceuticals AUD Australia Pty Ltd, Macquarie Park, NSW Sandoz Pty Ltd, Macquarie Park, NSW AUD Alcon Laboratories (Australia) Pty Ltd, Macquarie Park, NSW AUD AUD 2 100% 3.8 m 11.6 m 2.6 m 100% 100% 100% Austria Novartis Austria GmbH, Vienna Novartis Pharma GmbH, Vienna Sandoz GmbH, Kundl EBEWE Pharma Ges.m.b.H Nfg. KG, Unterach am Attersee Bangladesh Novartis (Bangladesh) Limited, Gazipur Belgium Novartis Pharma NV, Vilvoorde Sandoz NV, Vilvoorde Alcon – Couvreur NV, Puurs Alcon Laboratories Belgium BVBA, Puurs Alcon NV, Vilvoorde Bermuda Novartis Investment Ltd., Hamilton 3 Novartis Securities Investment Ltd., Hamilton Novartis Finance Services Ltd., Hamilton Triangle International Reinsurance Limited, Hamilton Trinity River Insurance Co Ltd., Hamilton Germany Novartis Deutschland GmbH, Nuremberg Novartis Business Services GmbH, Wehr Novartis Pharma GmbH, Nuremberg Novartis Pharma Produktions GmbH, Wehr Sandoz International GmbH, Holzkirchen 1 A Pharma GmbH, Oberhaching HEXAL AG, Holzkirchen Salutas Pharma GmbH, Barleben Aeropharm GmbH, Rudolstadt Alcon Pharma GmbH, Freiburg im Breisgau CIBA Vision GmbH, Grosswallstadt WaveLight GmbH, Erlangen EUR EUR EUR EUR 1.0 m 1.1 m 32.7 m 1.0 m 100% 100% 100% 100% BDT 162.5 m 60% EUR EUR EUR EUR EUR 7.1 m 19.2 m 110.6 m 18 550 141 856 12 000 30 000 20 000 USD CHF CHF CHF USD 370 000 1.0 m 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% Greece Novartis (Hellas) S.A.C.I., Metamorphosis / Athens Hungary Novartis Hungary Healthcare Limited Liability Company, Budapest Sandoz Hungary Limited Liability Company, Budapest India Novartis India Limited, Mumbai Novartis Healthcare Private Limited, Mumbai Sandoz Private Limited, Mumbai Alcon Laboratories (India) Private Limited, Bangalore Brazil Novartis Biociências S.A., São Paulo Sandoz do Brasil Indústria Farmacêutica Ltda., Cambé, PR BRL BRL 265.0 m 190.0 m 100% 100% Indonesia PT. Novartis Indonesia, Jakarta PT. CIBA Vision Batam, Batam Canada Novartis Pharmaceuticals Canada Inc., Dorval, Quebec Sandoz Canada Inc., Boucherville, Quebec Alcon Canada Inc., Mississauga, Ontario CIBA Vision Canada Inc., Mississauga, Ontario Chile Novartis Chile S.A., Santiago de Chile Alcon Laboratorios Chile Ltd., Santiago de Chile China Beijing Novartis Pharma Co., Ltd., Beijing Novartis Pharmaceuticals (HK) Limited, Hong Kong China Novartis Institutes for BioMedical Research Co., Ltd., Shanghai Suzhou Novartis Pharma Technology Co., Ltd., Changshu Shanghai Novartis Trading Ltd., Shanghai Sandoz (China) Pharmaceutical Co., Ltd., Zhongshan Alcon Hong Kong, Limited, Hong Kong Alcon (China) Ophthalmic Product Co., Ltd., Beijing Colombia Novartis de Colombia S.A., Santafé de Bogotá Laboratorios Alcon de Colombia S.A., Santafé de Bogotá Croatia Sandoz d.o.o. farmaceutska industrija, Zagreb Czech Republic Novartis s.r.o., Prague Sandoz s.r.o., Prague Alcon Pharmaceuticals (Czech Republic) s.r.o., Prague Denmark Novartis Healthcare A/S, Copenhagen Sandoz A/S, Copenhagen Alcon Nordic A/S, Copenhagen Ecuador Novartis Ecuador S.A., Quito Egypt Novartis Pharma S.A.E., Cairo Sandoz Egypt Pharma S.A.E., New Cairo City Finland Novartis Finland Oy, Espoo CAD CAD CAD CAD CLP CLP USD HKD USD USD USD USD HKD USD COP COP 1.2 m 80.8 m 2 500 82 886 100% 100% 100% 100% 2.0 bn 2.0 bn 100% 100% 30.0 m 200 100% 100% 320.0 m 109.4 m 3.2 m 57.6 m 77 000 60.0 m 100% 100% 100% 100% 100% 100% 7.9 bn 20.9 m 100% 100% HRK 25.6 m 100% CZK CZK CZK 51.5 m 44.7 m 31.0 m 100% 100% 100% DKK DKK DKK 501 000 14.0 m 12.0 m 100% 100% 100% USD 4.0 m 100% EGP EGP 250 000 193.8 m 99.77% 100% EUR 459 000 100% Ireland Novartis Ireland Limited, Dublin Novartis Ringaskiddy Limited, Ringaskiddy, County Cork Alcon Laboratories Ireland Limited, Cork City Israel Novartis Israel Ltd., Petach Tikva Italy Novartis Farma S.p.A., Origgio Sandoz S.p.A., Origgio Sandoz Industrial Products S.p.A., Rovereto Alcon Italia S.p.A., Milan Japan Novartis Holding Japan K.K., Tokyo Novartis Pharma K.K., Tokyo Ciba-Geigy Japan Limited, Tokyo Sandoz K.K., Tokyo Alcon Japan Ltd., Tokyo Latvia Novartis Baltics SIA, Riga Luxembourg Novartis Investments S.à r.l., Luxembourg City 3 Novartis Finance S.A., Luxembourg City Malaysia Novartis Corporation (Malaysia) Sdn. Bhd., Kuala Lumpur Alcon Laboratories (Malaysia) Sdn. Bhd., Petaling Jaya CIBA Vision Johor Sdn. Bhd., Kuala Lumpur Mexico Novartis Farmacéutica, S.A. de C.V., Mexico City Sandoz, S.A. de C.V., Mexico City Alcon Laboratorios, S.A. de C.V., Mexico City Morocco Novartis Pharma Maroc SA, Casablanca Netherlands Novartis Netherlands B.V., Arnhem Novartis Pharma B.V., Arnhem Sandoz B.V., Almere Alcon Nederland B.V., Arnhem New Zealand Novartis New Zealand Ltd, Auckland F-80 155.5 m 25.6 m 2.0 m 25 000 EUR EUR EUR EUR EUR 100 000 EUR 26 000 EUR EUR EUR 26 000 EUR 512 000 EUR EUR 93.7 m 42.1 m 15.4 m 6.6 m 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% EUR 23.4 m 100% HUF HUF 545.6 m 883.0 m 100% 100% INR INR INR INR IDR IDR 123.5 m 70.68% 100% 60.0 m 100% 32.0 m 100% 1.1 bn 7.7 bn 11.9 bn 100% 100% EUR EUR EUR 25 000 2.0 m 541 251 100% 100% 100% ILS 1 000 100% EUR EUR EUR EUR JPY JPY JPY JPY JPY 18.2 m 1.7 m 2.6 m 3.7 m 10.0 m 6.0 bn 8.5 m 100.0 m 500.0 m 100% 100% 100% 100% 100% 100% 100% 100% 100% EUR 3.0 m 100% USD USD 100 000 100.0 m 100% 100% MYR MYR MYR MXN MXN MXN 3.3 m 1.0 m 10.0 m 100% 100% 100% 205.0 m 468.2 m 5.9 m 100% 100% 100% MAD 80.0 m 100% 1.4 m 4.5 m EUR EUR EUR 907 560 18 151 EUR 100% 100% 100% 100% NZD 820 000 100% Notes to the Novartis Group consolidated financial statements As at December 31, 2018 Taiwan Novartis (Taiwan) Co., Ltd., Taipei Thailand Novartis (Thailand) Limited, Bangkok Alcon Laboratories (Thailand) Limited, Bangkok Turkey Novartis Saglik, Gida ve Tarim Ürünleri Sanayi ve Ticaret A.S., Istanbul Farmanova Saglik Hizmetleri Ltd. Sti., Istanbul Sandoz Ilaç Sanayi ve Ticaret A.S., Istanbul Sandoz Grup Saglik Ürünleri Ilaçlari Sanayi ve Ticaret A.S., Gebze – Kocaeli Alcon Laboratuvarlari Ticaret A.S., Istanbul Ukraine Sandoz Ukraine LLC, Kiev United Arab Emirates Novartis Middle East FZE, Dubai United Kingdom Novartis UK Limited, Frimley / Camberley Novartis Pharmaceuticals UK Limited, Frimley / Camberley Novartis Grimsby Limited, Frimley / Camberley Ziarco Group Limited, Frimley / Camberley Sandoz Limited, Frimley / Camberley Alcon Eye Care UK Limited, Frimley / Camberley Share capital Equity 1 interest TWD 170.0 m 100% THB THB 302.0 m 228.1 m 100% 100% TRY TRY TRY TRY TRY 98.0 m 6.7 m 100% 100% 165.2 m 99.99% 50.0 m 25.2 m 100% 100% UAH 8.0 m 100% AED 7.0 m 100% 25.5 m 5.4 m 250.0 m 3 904 GBP GBP GBP GBP GBP GBP 550 000 2.0 m USD USD USD USD -- USD United States of America Novartis Corporation, East Hanover, NJ 3 Novartis Finance Corporation, New York, NY Novartis Capital Corporation, New York, NY Novartis Services, Inc., East Hanover, NJ Novartis US Foundation, New York, NY Novartis Pharmaceuticals Corporation, East Hanover, NJ 3 Novartis Institutes for BioMedical USD Research, Inc., Cambridge, MA USD CoStim Pharmaceuticals Inc., Cambridge, MA USD Encore Vision, Inc., New York, NY USD Endocyte, Inc., Lafayette, IN USD Navigate BioPharma Services, Inc., Carlsbad, CA USD Reprixys Pharmaceuticals Corporation, East Hanover, NJ Spinifex Pharmaceuticals, Inc., Wilmington, NC USD Novartis Institute for Functional Genomics, Inc., San Diego, CA USD USD Advanced Accelerator Applications USA, Inc., New York, NY USD AveXis, Inc., Bannockburn, IL USD Sandoz Inc., Princeton, NJ USD Oriel Therapeutics, Inc., Durham, NC USD Fougera Pharmaceuticals Inc., Melville, NY USD Eon Labs, Inc., Princeton, NJ Alcon Laboratories, Inc., Fort Worth, TX 3 USD USD Alcon Refractivehorizons, LLC, Fort Worth, TX Alcon Research, Ltd., Fort Worth, TX 3 USD USD Alcon Lensx, Inc., Fort Worth, TX USD Alcon Laboratories Holding Corporation, Fort Worth, TX USD WaveLight, Inc., Sterling, VA USD Tear Film Innovations, Inc., Fort Worth, TX USD TrueVision Systems, Inc., Fort Worth, TX CIBA Vision Corporation LLC, Duluth, GA 3 USD USD Novartis Vaccines and Diagnostics, Inc., Cambridge, MA USD ClarVista Medical, Inc., Aliso Viejo, CA USD Transcend Medical, Inc., Lake Forest, IL 72.2 m 1 000 1 1 -- 5.2 m 1 1 1 1 100 1 1 1 000 1 1 25 000 1 1 1 1 000 10 12.5 1 10 1 1 1 1.3 m 3 1 1 Venezuela Novartis de Venezuela, S.A., Caracas Alcon Pharmaceutical, C.A., Caracas VES VES 14 55 100% 100% In addition, the Group is represented by subsidiaries and associated companies in the following countries: Bosnia/Herzegovina, Bulgaria, Dominican Republic, Guatemala, Kenya, the Former Yugoslav Republic of Macedonia, Nigeria, Puerto Rico and Uruguay 1 Share capital may not reflect the taxable share capital and does not include any paid-in surplus 2 Approximately 33% of voting shares; approximately 6% of total net income and equity attributable to Novartis 3 Significant subsidiary under SEC Regulation S-X Rule 1-02(w) m = million; bn = billion 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 99% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% As at December 31, 2018 Norway Novartis Norge AS, Oslo Pakistan Novartis Pharma (Pakistan) Limited, Karachi Panama Novartis Pharma (Logistics), Inc., Panama City Alcon Centroamerica S.A., Panama City Peru Novartis Biosciences Perú S.A., Lima Philippines Novartis Healthcare Philippines, Inc., Manila Sandoz Philippines Corporation, Manila Poland Novartis Poland Sp. z o.o., Warsaw Sandoz Polska Sp. z o.o., Warsaw Lek S.A., Strykow Alcon Polska Sp. z o.o., Warsaw Portugal Novartis Portugal SGPS Lda., Porto Salvo Novartis Farma – Produtos Farmacêuticos S.A., Porto Salvo Sandoz Farmacêutica Lda., Porto Salvo Alcon Portugal-Produtos e Equipamentos Oftalmológicos Lda., Porto Salvo Romania Novartis Pharma Services Romania S.R.L., Bucharest Sandoz S.R.L., Targu-Mures Russian Federation Novartis Pharma LLC, Moscow Novartis Neva LLC, St. Petersburg ZAO Sandoz, Moscow Alcon Farmacevtika LLC, Moscow Saudi Arabia Saudi Pharmaceutical Distribution Co. Ltd., Riyadh Singapore Novartis (Singapore) Pte Ltd., Singapore Novartis Singapore Pharmaceutical Manufacturing Pte Ltd, Singapore Novartis Asia Pacific Pharmaceuticals Pte Ltd, Singapore Alcon Singapore Manufacturing Pte. Ltd., Singapore CIBA Vision Asian Manufacturing and Logistics Pte Ltd., Singapore Slovakia Novartis Slovakia s.r.o., Bratislava Slovenia Lek Pharmaceuticals d.d., Ljubljana Sandoz Pharmaceuticals d.d., Ljubljana South Africa Novartis South Africa (Pty) Ltd, Midrand Sandoz South Africa (Pty) Ltd, Kempton Park Alcon Laboratories (South Africa) (Pty) Ltd., Midrand South Korea Novartis Korea Ltd., Seoul Alcon Korea Ltd., Seoul Spain Novartis Farmacéutica, S.A., Barcelona Sandoz Farmacéutica S.A., Madrid Sandoz Industrial Products S.A., Les Franqueses del Vallés / Barcelona Alcon Cusi S.A., Barcelona Abadia Retuerta S.A., Sardón de Duero / Valladolid Sweden Novartis Sverige AB, Stockholm Share capital Equity 1 interest NOK 1.5 m 100% PKR 3.9 bn 99.99% USD PAB 10 000 1 000 100% 100% PEN 6.1 m 100% PHP PHP 298.8 m 30.0 m 100% 100% PLN PLN PLN PLN 750 000 44.2 m 25.6 m 11.4 m 100% 100% 100% 100% EUR 500 000 EUR EUR 499 900 2.4 m 100% 100% 100% EUR 4.5 m 100% RON RON 3.0 m 105.2 m 100% 100% RUB RUB RUB RUB 20.0 m 500.0 m 57.4 m 44.1 m 100% 100% 100% 100% SAR 26.8 m 75% SGD 100 000 100% SGD SGD SGD 45.0 m 39.0 m 101 000 100% 100% 100% SGD 1.0 m 100% EUR 2.0 m 100% EUR EUR 48.4 m 1.5 m 100% 100% ZAR ZAR ZAR 201 820 86.3 m 3.0 m 100% 100% 100% KRW KRW 24.5 bn 98.55% 100% 33.8 bn EUR EUR 270 450 63.0 m 100% 100% EUR EUR EUR 9.3 m 10.1 m 6.0 m 100% 100% 100% SEK 5.0 m 100% 1.0 m 10 m 100.2 m 50 000 -- -- -- -- CHF CHF CHF CHF Switzerland Novartis Overseas Investments AG, Basel Japat AG, Basel Novartis International AG, Basel Novartis Holding AG, Basel 3 Novartis International Pharmaceutical Investment AG, Basel 3 CHF 100 000 CHF 100 000 Novartis Ophthalmics AG, Fribourg CHF 100 000 Novartis Bioventures AG, Basel -- Novartis Forschungsstiftung, Basel -- Novartis Stiftung für Kaderausbildung, Basel -- Novartis Mitarbeiterbeteiligungsstiftung, Basel Novartis Stiftung für Mensch und Umwelt, Basel -- Stiftung der Novartis AG für Erziehung, -- Ausbildung und Bildung, Basel Novartis Pharma AG, Basel 3 CHF Novartis International Pharmaceutical AG, Basel 3 CHF 100 000 CHF Novartis Pharma Services AG, Basel CHF Novartis Pharma Schweizerhalle AG, Muttenz CHF 251 000 Novartis Pharma Stein AG, Stein Novartis Pharma Schweiz AG, Risch CHF Advanced Accelerator Applications International SA, Geneva CHF Advanced Accelerator Applications Switzerland SA, Geneva Sandoz AG, Basel Sandoz Pharmaceuticals AG, Risch Alcon AG, Fribourg Alcon Management SA, Geneva Alcon Switzerland SA, Risch Alcon Pharmaceuticals Ltd., Fribourg 3 Roche Holding AG, Basel CHF 200 000 CHF CHF 100 000 CHF 100 000 CHF 100 000 CHF 100 000 CHF 200 000 CHF -- 350.0 m 20.0 m 18.9 m 5.0 m 9.3 m 5.0 m 160.0 m 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 99% 99% 100% 100% 100% 100% 100% 100% 33/6 2 F-81 Report of Independent Registered Public Accounting Firm Report of Independent Registered Public Accounting Firm To the shareholders and Board of Directors of Novartis AG Opinions on the Financial Statements and Internal Control over Financial Reporting We have audited the accompanying consolidated balance sheets of Novartis AG and its subsidiaries (the “Company”) as of December 31, 2018 and December 31, 2017, and the related consolidated income statements, consolidated statements of comprehensive income, consolidated state- ments of changes in equity, and consolidated statements of cash flow for each of the three years in the period ended December 31, 2018, including the related notes (collectively referred to as the “consolidated financial statements”). We also have audited the Company’s internal control over finan- cial reporting as of December 31, 2018, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organiza- tions of the Treadway Commission (COSO). In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2018 and December 31, 2017, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2018 in conformity with International Financial Reporting Standards (“IFRS”) as issued by the International Accounting Standards Board. Also in our opin- ion, the Company maintained, in all material respects, effec- tive internal control over financial reporting as of Decem- ber 31, 2018, based on criteria established in Internal Control – Integrated Framework (2013) issued by the COSO. Basis for Opinions The Company’s management is responsible for these con- solidated financial statements, for maintaining effective inter- nal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the “Report of Novartis Management on Internal Control Over Financial Reporting” appearing under Item 15(b). The Board of Directors is also responsible for the preparation of the consolidated financial statements in accordance with IFRS, and for such internal control as the Board of Directors determines is necessary to enable the preparation of consol- idated financial statements that are free from material mis- statement, whether due to fraud or error. Our responsibility is to express opinions on the Company’s consolidated finan- cial statements and on the Company’s internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Account- ing Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. free of material misstatement, whether due to error or fraud, and whether effective internal control over financial report- ing was maintained in all material respects. Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstate- ment of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evi- dence regarding the amounts and disclosures in the consoli- dated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an under- standing of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evalu- ating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included perform- ing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reason- able basis for our opinions. Definition and Limitations of Internal Control over Financial Reporting A company’s internal control over financial reporting is a process designed to provide reasonable assurance regard- ing the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with IFRS. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dis- positions of the assets of the company; (ii) provide reason- able assurance that transactions are recorded as neces- sary to permit preparation of financial statements in accordance with IFRS, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the com- pany; and (iii) provide reasonable assurance regarding pre- vention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inad- equate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. /s/ PricewaterhouseCoopers AG Basel, Switzerland January 29, 2019 We conducted our audits in accordance with the stan- dards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are We have served as the Company’s or its predecessors’ auditor since at least 1940. We have not been able to determine the specific year we began serving as auditor of the Company’s predecessors. The report of the Independent Registered Public Accounting Firm set out above is reprinted for information purposes only and is a copy of the report included in the Novartis AG Annual Report pursuant to section 13 or 15(d) of the securities exchange act of 1934 as filed with the US Securities and Exchange Commission (SEC), on Form 20-F. The report does not form part of the reporting to the general meeting as required by Swiss Law. F-82 Report of the statutory auditor on the consolidated financial statements of Novartis AG Report of the statutory auditor on the consolidated financial statements of Novartis AG To the general meeting of Novartis AG, Basel Opinion We have audited the consolidated financial statements of Novartis AG and its subsidiaries (the “Group”), which comprise the consolidated income statements, consol- idated statements of comprehensive income, consoli- dated balance sheets, consolidated statements of changes in equity, and consolidated statements of cash flow, and notes to the consolidated financial statements (pages F-1 to F-81), including a summary of significant accounting policies, for the year ended December 31, 2018. In our opinion, the consolidated financial statements give a true and fair view of the consolidated financial position of the Group as at December 31, 2018, and its consolidated financial performance and its consolidated cash flows for the year then ended in accordance with International Financial Reporting Standards (IFRS), as issued by the International Accounting Standards Board, and comply with Swiss law. Basis for opinion We conducted our audit in accordance with Swiss law, International Standards on Auditing (ISAs) and Swiss Auditing Standards. Our responsibilities under those pro- visions and standards are further described in the “Audi- tor’s responsibilities for the audit of the consolidated financial statements” section of our report. We are independent of the Group in accordance with the provisions of Swiss law and the requirements of the Swiss audit profession, as well as the IESBA Code of Ethics for Professional Accountants, and we have ful- filled our other ethical responsibilities in accordance with these requirements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our opinion. Our audit approach Overview • Overall Group materiality: USD 400 million, which rep- resents 5% of income before taxes, adjusted by the USD 5.8 billion gain on divestment of GSK Consumer Healthcare. • We conducted full scope audit work at the Group’s three operating divisions and at 13 reporting entities, including reporting entities of the Corporate division, in six countries. • In addition, full scope audit work on account balances was performed at 21 reporting entities in 13 countries. • Our audit scope addressed 69% of the Group’s net sales and 85% of Group’s total assets. As key audit matters, the following areas of focus have been identified: • Carrying value of Alcon goodwill • Carrying value of the Innovative Medicines division intangible assets other than goodwill, including newly acquired intangible assets • Governmental investigations and litigation • Rebates, discounts and sales returns Context of our audit 2018 The context of our audit is set by the Group’s major activ- ities in the reporting period during which the acquisitions of AveXis, Inc., Advanced Accelerator Applications S.A. (AAA) and Endocyte, Inc. have been significant events. As each of these three acquisitions included a primary prod- uct candidate and therefore substantial intangible assets, during the audit process we placed appropriate additional focus on the purchase price allocation. The rest of the audit process was largely unchanged as compared to prior year. Audit scope We designed our audit by determining materiality and assessing the risks of material misstatement in the con- solidated financial statements. In particular, we consid- ered areas where subjective judgments were made, such as significant accounting estimates that involved making assumptions and consideration of future events that are inherently uncertain. As in all of our audits, we also addressed the risk of management override of internal controls, including – among other matters – consider- ation of whether there was evidence of bias that repre- sented a risk of material misstatement due to fraud. How we tailored the audit scope We tailored the scope of our audit in order to perform sufficient work to enable us to provide an opinion on the financial statements as a whole, taking into account the structure of the Group, the accounting processes and controls, and the industry in which the Group operates. The Group financial statements are a consolidation of over 300 reporting entities. We identified 13 reporting enti- ties that, in our view, required an audit of their complete finan- cial information due to their size or risk characteristics. We worked very closely with and received full scope reporting from the divisional audit teams for Innovative Medicines, Alcon and Sandoz, each being a global business with head- quarters based in Switzerland, the United States of Amer- ica, and Germany, respectively. We also received full scope reporting from reporting entity audit teams for the full scope audit work performed on account balances, carried out at 21 reporting entities, to obtain appropriate coverage of mate- rial balances. None of the reporting entities excluded from our Group audit scope individually contributed more than 5% to net sales or total assets. Audit procedures were also performed by the Group audit team over the Group’s Cor- porate segment, certain Group functions (including account- ing for associated companies, taxation, treasury, certain employee benefits, government investigations and litigation) and Group consolidation. F-83 Report of the statutory auditor on the consolidated financial statements of Novartis AG To exercise the appropriate direction and supervision over the work of the divisional and reporting entity audit teams, the Group audit team made several site visits, reviewed audit working papers, participated in meetings between the divisional and reporting entity audit teams, and attended selected meetings between divisional manage- ment and divisional audit teams. In addition, we hosted a planning workshop in May 2018 for audit partners and man- agers responsible for divisional and reporting entities. Materiality The scope of our audit was influenced by our applica- tion of materiality. Our audit opinion aims to provide rea- sonable assurance that the consolidated financial state- ments are free from material misstatement. Misstatements may arise due to fraud or error. They are considered material, if individually or in aggregate, they could rea- sonably be expected to influence the economic deci- sions of users taken on the basis of the consolidated financial statements. Based on our professional judgment, we determined certain quantitative thresholds for materiality, including the overall Group materiality for the consolidated financial statements as a whole, as set out below. These, together with qualitative considerations, helped us to determine the scope of our audit and the nature, timing and extent of our audit procedures, and to evaluate the effect of misstate- ments, if any, both individually and in aggregate, on the consolidated financial statements as a whole. Overall Group materiality USD 400 million How we determined it Provisionally as 5% of estimated 2018 income before taxes, adjusted by the gain on divestment of GSK Con- sumer Healthcare. This level was reassessed and con- firmed as part of our completion procedures. Rationale for the materiality benchmark applied We chose income before taxes as the measure because, in our view, it is the measure against which the perfor- mance of the Group is most commonly assessed and is a generally accepted benchmark. We adjusted for the exceptional gain on the divestment to use a measure of underlying profit as the basis of our calculation. We agreed with the Audit and Compliance Committee that we would report to them misstatements identified during our audit above USD 20 million as well as any mis- statements below that amount which, in our view, war- ranted reporting for qualitative reasons. Key Audit Matters Key audit matters are those matters that, in our professional judgment, were of most significance in our audit of the consolidated financial statements of the current period. These matters were addressed in the context of our audit of the consolidated financial statements as a whole, and in forming our opinion thereon, and we do not provide a separate opinion on these matters. Key audit matter How our audit addressed the key audit matter Carrying value of Alcon goodwill The Group has goodwill of USD 35.3 billion at December 31, 2018, of which USD 8.9 billion relates to Alcon. The assessment of the carrying value of the goodwill balances is dependent on the estimation of future cash flows. In particular, those assessments and judgments made to support the carrying value of the goodwill allocated to the Alcon Division were critical, given the performance of the business in prior years, which led the Group to initiate a turnaround plan, followed by the ongoing strategic review. Refer to “Note 1. Significant accounting policies” (pages F-6 to F-15) and “Note 10. Goodwill and intangible assets” (pages F-37 to F-39). We assessed and tested the design and operating effec- tiveness of the Group’s controls over the assessment of the carrying value of Alcon goodwill and concluded that these operate effectively. We tested, with the support of our valuation specialists, the Alcon goodwill carrying value as at December 31, 2018. We also challenged management to substantiate their key assumptions including growth rate in the cash flow projec- tions during the forecast period and the terminal growth rate assumption. We also evaluated management’s inten- tion and ability to execute their strategic initiatives and eval- uated the reasonableness of the discount rate applied to those future cash flows. We assessed management’s sensitivity analysis around key estimates to quantify the downside changes in assump- tions that could result in an impairment and the disclosures included in “Note 10. Goodwill and intangible assets” (pages F-37 to F-39) of the Annual Report. In conjunction with the intended spin-off of Alcon, man- agement provided a range of estimate for the valuation of the business that indicates the value of the goodwill is not impaired. Finally, we did not identify any material differences between management cash flow forecasts from last year and the actual results reached this year. As a result of our procedures, as discussed with the Audit and Compliance Committee, we determined that the conclusions reached by management with regard to the carrying value of Alcon goodwill were reasonable and sup- portable. F-84 Report of the statutory auditor on the consolidated financial statements of Novartis AG Key audit matter How our audit addressed the key audit matter Carrying value of the Innovative Medicines division intan- gible assets other than goodwill, including newly acquired intangible assets The Group has intangible assets in its Innovative Medicines division other than goodwill totaling USD 26.0 billion at December 31, 2018, comprising research and development acquired, currently marketed products, and other intangi- ble assets. The Group recognized specific impairments of intangible assets in its Innovative Medicines division other than goodwill of USD 592 million during the year. In 2018, the Group entered into significant transactions, including the acquisitions of Advanced Accelerator Appli- cations S.A., AveXis, Inc. and Endocyte, Inc. The related pur- chase price allocations resulted in the identification and rec- ognition of a fair value of USD 12.5 billion in newly acquired intangible assets, excluding goodwill. The assessment of the carrying values of intangible assets is dependent on future cash flows. The assessments of carrying values per- formed by the Group contain a number of significant judg- ments and estimates such as scientific success, revenue growth, the success of new product launches, profit mar- gins and discount rates. The carrying value assessments of the following intan- gible assets include the most significant risk and highest level of judgment: • Certain currently marketed products that have per- formed below management’s expectation or were, in our view, at a greater risk of impairment • Currently marketed products recognized as intangible assets in the purchase price allocation • Products in development, as the assessment of their carrying value is challenging due to management being required to make judgments both as to the probability of scientific success and regulatory approval of the devel- opments across indications, as well as the probability of commercial success of the subsequent product launches Refer to “Note 1. Significant accounting policies” (pages F-6 to F-15), “Note 10. Goodwill and intangible assets” (pages F-37 to F-39), “Note 2. Significant transactions in 2018” (pages F-16 to F-18) and “Note 23. Acquisitions of business” (page F-57). We assessed and tested the design and operating effec- tiveness of the Group’s controls over the assessment of the carrying value of intangible assets other than goodwill and concluded that these operate effectively, specifically in respect to the identification of impairment triggering events. We assessed and tested the design and operating effec- tiveness of the Group’s controls over the identification and the valuation of intangible assets acquired in a business combination. We utilized a risk-based approach to select certain sig- nificant intangible assets to test the carrying value calcula- tions and assess the key assumptions. For the currently marketed products, these assumptions specifically included pricing, market size and share, and competitive environment assumptions. Finally, we did not identify any material differences between management cash flow forecasts from last year and the actual results reached this year. For selected currently marketed products and products in development, with the support of our valuation special- ists, we considered third-party sources to challenge expected future revenues due to actions by competitors or due to changes in relevant markets. Furthermore, for products in development, we also con- sidered key scientific developments. We performed our own sensitivity analysis around these key estimates to ascertain the extent of change in those assumptions that either indi- vidually or collectively would be required for the intangible assets tested to be impaired. As a result of our procedures, we did not propose any adjustments to the amount of impairment recognized in 2018 or to the value of intangible assets recognized in the purchase price allocations. For intangible assets other than goodwill where management determined that no impairment was required, we found that the assessments made by man- agement were based upon reasonable assumptions, con- sistently applied. Key audit matter How our audit addressed the key audit matter Governmental investigations and litigation The pharmaceutical industry is heavily regulated, which increases inherent litigation risk. The Group is subject to various historic and ongoing government investigations, of which the most significant are disclosed in “Note 19. Provisions and other non-current lia- bilities.” We specifically assessed the investigations and related litigation in the US, given their significance and the inherent uncertainty of outcomes. Refer to “Note 1. Significant accounting policies” (pages F-6 to F-15), and “Note 19. Provisions and other non-current liabilities” (pages F-48 to F-52). We assessed and tested the design and operating effec- tiveness of the Group’s controls over the completeness, assessment for recognition, measurement and disclosures of provisions for governmental investigations and other legal matters and concluded that these operate effectively. We evaluated management’s judgments in connection with the investigations and related litigation in the US, read the respective court filings and minutes of Board of Direc- tors and management meetings, and inquired with manage- ment as well as internal and external legal counsel. We concluded that the judgments made by management were in accordance with the accounting policies described in Note 1. F-85 Report of the statutory auditor on the consolidated financial statements of Novartis AG Key audit matter How our audit addressed the key audit matter We performed procedures to assess the design and oper- ating effectiveness of the controls related to the recording of rebates, discounts and sales returns, and the estimation of related period-end reserves. We obtained management’s calculations for the respec- tive estimates and performed one or more of the following procedures on each of them: developed an independent expectation of the reserve and/or tested management’s estimation process to assess the reasonableness of the recorded reserve balances, performed retrospective reviews, and assessed subsequent events. We also per- formed testing of credits issued and payments made throughout the year, reviewed related contracts, and per- formed procedures to validate contractual terms and inven- tory levels of significant customers and wholesalers. We did not identify any material differences between our expectations and the accruals, and we found the judgments made by management to be reasonable. Rebates, discounts and sales returns Commencing in 2018, the Group has applied IFRS 15 “Rev- enue from Contracts with Customers”. The Group distrib- utes its products primarily through wholesale distributors. In many cases the ultimate net selling prices are determined based on government mandated rebates as well as contrac- tual arrangements that the Group has with the ultimate patient’s insurer or other payment program. Under IFRS 15, revenue is recognized when control has passed to the customer, which is usually upon shipment to the distributor. The transaction price is the amount of con- sideration an entity expects to be entitled to from a cus- tomer in exchange for providing the goods or services. IFRS 15 requires an entity to estimate the amount of variable con- sideration to which it will be entitled to the extent that such amount is not highly probable to reverse. Variable consid- eration may include rebates, discounts and sales returns. The estimate depends on contract terms and regulation, historical experience, as well as forecasts of sales volumes by sales channel. Additionally, the dispensing of the prod- uct to the patient and the final determination of the net sell- ing price may be several months later. This key audit matter is focused on the valuation and accuracy of the accruals for rebates, discounts and sales returns recognized at the year-end because, specifically for US Medicaid and Medicare or similar programs, the estima- tion processes involves large volumes of data, requires sig- nificant judgment, and contains risk of management bias. The provision reported as of December 31, 2018, for rev- enue deductions related to rebates, discounts, allowances and sales returns amounted to USD 5.3 billion. Refer to “Note 21. Provisions and other current liabili- ties” (pages F-53 and F-55). Other information in the Annual Report The Board of Directors is responsible for the other infor- mation in the Annual Report. The other information com- prises all information included in the Annual Report, but does not include the consolidated financial statements, the stand-alone financial statements and our auditor’s reports thereon. Our opinion on the consolidated financial statements does not cover the other information in the Annual Report, and we do not express any form of assurance conclusion thereon. In connection with our audit of the consolidated finan- cial statements, our responsibility is to read the other information in the Annual Report and, in doing so, con- sider whether the other information is materially incon- sistent with the consolidated financial statements or our knowledge obtained in the audit, or otherwise appears to be materially misstated. If, based on the work we have performed, we conclude that there is a material misstate- ment of this other information, we are required to report that fact. We have nothing to report in this regard. Responsibilities of the Board of Directors for the consolidated financial statements The Board of Directors is responsible for the prepara- tion of the consolidated financial statements that give a true and fair view in accordance with IFRS and the pro- visions of Swiss law, and for such internal control as the Board of Directors determines is necessary to enable the preparation of consolidated financial statements that are free from material misstatement, whether due to fraud or error. In preparing the consolidated financial statements, the Board of Directors is responsible for assessing the Group’s ability to continue as a going concern, disclos- ing, as applicable, matters related to going concern and using the going concern basis of accounting unless the Board of Directors either intends to liquidate the Group or to cease operations, or has no realistic alternative but to do so. Auditor’s responsibilities for the audit of the consolidated financial statements Our objectives are to obtain reasonable assurance about whether the consolidated financial statements as a whole are free from material misstatement, whether due to fraud or error, and to issue an auditor’s report that includes our opinion. Reasonable assurance is a high level of assurance but is not a guarantee that an audit conducted in accordance with Swiss law, ISAs and Swiss Auditing Standards will always detect a material mis- statement when it exists. Misstatements can arise from fraud or error and are considered material if, individually or in the aggregate, they could reasonably be expected F-86 Report of the statutory auditor on the consolidated financial statements of Novartis AG to influence the economic decisions of users taken on the basis of these consolidated financial statements. As part of an audit in accordance with Swiss law, ISAs and Swiss Auditing Standards, we exercise professional judgment and maintain professional skepticism through- out the audit. We also: • Identify and assess the risks of material misstatement of the consolidated financial statements, whether due to fraud or error; design and perform audit procedures responsive to those risks; and obtain audit evidence that is sufficient and appropriate to provide a basis for our opinion. The risk of not detecting a material mis- statement resulting from fraud is higher than for one resulting from error, as fraud may involve collusion, forgery, intentional omissions, misrepresentations, or the override of internal control. • Obtain an understanding of internal control relevant to the audit in order to design audit procedures that are appropriate in the circumstances • Evaluate the appropriateness of accounting policies used and the reasonableness of accounting estimates and related disclosures made • Conclude on the appropriateness of the Board of Directors’ use of the going concern basis of account- ing and, based on the audit evidence obtained, whether a material uncertainty exists related to events or con- ditions that may cast significant doubt on the Group’s ability to continue as a going concern. If we conclude that a material uncertainty exists, we are required to draw attention in our auditor’s report to the related dis- closures in the consolidated financial statements or, if such disclosures are inadequate, to modify our opin- ion. Our conclusions are based on the audit evidence obtained up to the date of our auditor’s report. How- ever, future events or conditions may cause the Group to cease to continue as a going concern. • Evaluate the overall presentation, structure and con- tent of the consolidated financial statements, including the disclosures, and whether the consolidated finan- cial statements represent the underlying transactions and events in a manner that achieves fair presentation • Obtain sufficient appropriate audit evidence regarding the financial information of the entities or business activities within the Group to express an opinion on the consolidated financial statements. We are responsible for the direction, supervision and performance of the Group audit. We remain solely responsible for our audit opinion. We communicate with the Board of Directors, mostly through the Audit and Compliance Committee, regard- ing – among other matters – the planned scope and tim- ing of the audit and significant audit findings, including any significant deficiencies in internal control that we identify during our audit. We also provide the Board of Directors with a state- ment that we have complied with relevant ethical require- ments regarding independence, and to communicate with them all relationships and other matters that may reasonably be thought to bear on our independence, and where applicable, related safeguards. From the matters communicated with the Board of Directors, we determine those matters that were of most significance in the audit of the consolidated financial statements of the current period and are therefore the key audit matters. We describe these matters in our audi- tor’s report, unless law or regulation precludes public disclosure about the matter or when, in extremely rare circumstances, we determine that a matter should not be communicated in our report because the adverse consequences of doing so would reasonably be expected to outweigh the public interest benefits of such commu- nication. Report on other legal and regulatory requirements In accordance with article 728a paragraph 1 item 3 CO and Swiss Auditing Standard 890, we confirm that an internal control system exists, which has been designed for the preparation of consolidated financial statements according to the instructions of the Board of Directors. We recommend that the consolidated financial state- ments submitted to you be approved. PricewaterhouseCoopers AG Luc Schulthess Audit expert Auditor in charge Stephen Johnson Global relationship partner Basel, January 29, 2019 The report set out on pages F-83 to F-87 is included in accordance with the requirements of Swiss Law and does not form part of the Novartis AG Annual Report pursuant to section 13 or 15(d) of the securities exchange act of 1934 as filed with the US Securities and Exchange Commission (SEC) on Form 20-F. The report of the Independent Registered Public Accounting Firm as included in the Form 20-F is reprinted for information purposes on page F-82. F-87 Financial statements of Novartis AG Financial statements of Novartis AG Income statements (For the years ended December 31, 2018 and 2017) (CHF millions) Income from investment in Group subsidiaries License income Gain from disposal of intangible assets Other income Total income Amortization of goodwill and other intangible assets Impairment of investment in Group subsidiaries Administrative expenses Other expenses Total expenses Operating income Financial income Financial expenses Income before taxes Direct taxes Net income of the year The accompanying Notes form an integral part of these financial statements. Note 2018 10 761 1 475 91 8 2017 7 633 1 588 274 5 3 4 5 5 12 335 9 500 – 1 140 – 1 141 – 263 – 23 – 2 – 23 – 2 – 1 428 – 1 166 10 907 8 334 488 – 231 11 164 – 197 10 967 449 – 180 8 603 – 176 8 427 A-1 Financial statements of Novartis AG Balance sheets (At December 31, 2018 and 2017) (CHF millions) Assets Current assets Cash and cash equivalents Interest-bearing current receivables Group subsidiaries Other current receivables Group subsidiaries Third parties Total current assets Non-current assets Financial assets Group subsidiaries Investments Group subsidiaries Goodwill and other intangible assets Total non-current assets Total assets Liabilities and equity Current liabilities Other current liabilities Group subsidiaries Third parties Accrued expenses Deferred income Total current liabilities Non-current liabilities Interest-bearing non-current liabilities Bonds Non-current provisions Total non-current liabilities Equity Share capital Legal capital reserves – capital contribution reserve General reserve Reserve for treasury shares held by subsidiaries Total legal retained earnings Free reserves Retained earnings Net income of the year Retained earnings available for distribution at the end of the year Total unappropriated earnings and free reserves Treasury shares held by Novartis AG Total equity Total liabilities and equity The accompanying Notes form an integral part of these financial statements. A-2 Note 2018 2017 3 60 4 574 1 777 102 7 120 6 4 686 1 963 14 966 14 965 6 3 13 011 12 398 13 226 14 366 41 203 41 729 45 889 43 692 37 30 201 268 36 84 186 16 322 7 1 377 1 378 486 488 1 863 1 866 8 1 275 1 308 198 320 2 596 2 916 198 320 3 005 3 325 9 10 25 433 30 178 4 833 10 967 3 281 8 427 15 800 11 708 41 233 41 886 9 – 1 864 – 5 213 43 758 41 504 45 889 43 692 Notes to the financial statements of Novartis AG Notes to the financial statements of Novartis AG 1. Introduction The financial statements of Novartis AG, with its regis- tered office in Basel, comply with the requirements of the Swiss accounting legislation of the Swiss Code of Obligations (SCO). Novartis AG is presenting consolidated financial statements according to IFRS. As a result, Novartis AG has applied the exemption included in Art. 961d SCO and has not included additional disclosures, a cash flow statement or a management report in its financial state- ments. 2. Accounting policies Financial income and expenses Investments Current assets and current liabilities denominated in foreign currencies are converted at year-end exchange rates. Realized exchange gains and losses, and all unreali zed exchange losses arising from these as well as those from business transactions are recorded net as financial income or financial expenses. Derivative financial instruments Derivative financial instruments are used for hedging pur- poses. These instruments are valued at fair value. When different accounting policies apply for the hedged item and the derivative financial instrument, hedge accounting is applied through measuring the hedged item together with the derivative financial instrument. Financial assets Financial assets are valued at acquisition cost less adjustments for foreign currency losses and any other impairment of value. Investments are initially recognized at cost. Investments in Novartis Group subsidiaries are assessed annually, and in case of an impairment, adjusted to their recover- able amount within their category. Goodwill and other intangible assets Goodwill and other intangible assets are capitalized and amortized over a period of between five and 20 years. Goodwill and other intangible assets are reviewed for impairment on a yearly basis. If necessary, an impairment loss is recognized. Bonds Bonds are valued at nominal value. Any bond premium is accrued over the duration of the bond so that at maturity, the balance sheet amount will equal the amount that is due to be paid. Provisions Provisions are made to cover general business risks of the Group. A-3 Notes to the financial statements of Novartis AG 3. Goodwill and other intangible asset movements (CHF millions) Goodwill Gross cost 1 Accumulated amortization January 1 Amortization charges December 31 Net book value at December 31 Other intangible assets Cost January 1 1 Transfer to Group subsidiaries December 31 Accumulated amortization January 1 1 Transfer to Group subsidiaries Net book value at December 31 Goodwill and other intangible assets Net book value at December 31 1 There was no change during 2017. 2018 2017 22 350 22 350 – 7 984 – 6 843 – 1 140 – 1 141 – 9 124 – 7 984 13 226 14 366 11 – 11 – 11 11 11 11 – 11 13 226 14 366 4. Impairment of investment in Group subsidiaries Novartis AG impaired certain Group participations in conjunction with the separation of the Alcon business as described in Note 6. 5. Financial income and expenses (CHF millions) Interest Foreign exchange Others Total 2018 2017 Income Expenses Income Expenses 488 – 114 – 116 – 1 449 – 111 – 68 – 1 488 – 231 449 – 180 6. Investments The principal direct and indirect subsidiaries and other holdings of Novartis AG are shown in Note 31 to the Group’s consolidated financial statements. During the year, Alcon Pharmaceuticals Ltd. (APL), a wholly owned subsidiary of the Company, was separated into two distinct entities (Novartis Ophthalmics AG (NOAG) and APL) in preparation for the anticipated spin- off of Alcon (see Note 14). The transaction consisted of a contribution of the net assets of APL, unrelated to the Alcon business to NOAG, with a subsequent distribution of the participation in NOAG to Novartis AG. To reflect the economics of the transaction, the dividend income and the related NOAG investment value (with an approx- imate book value of CHF 4.3 billion) were offset ensur- ing that Novartis AG’s combined carrying value of NOAG and APL equals the previous carrying value of APL. A-4 Notes to the financial statements of Novartis AG 7. Bonds Straight bonds Coupon 0.250% 0.625% 1.050% Nominal Currency amount Issuance year Maturity year Issuer CHF CHF CHF 500 550 325 2015 2015 2015 2025 Novartis AG, Basel, Switzerland 2029 Novartis AG, Basel, Switzerland 2035 Novartis AG, Basel, Switzerland Total straight bonds Breakdowns by maturity (CHF millions) After 2023 Total 2017 (CHF Issue price millions) millions) 2018 (CHF 100.640% 100.502% 100.479% 501 551 325 501 551 326 1 377 1 378 2018 1 377 1 377 2017 1 378 1 378 Comparison of balance sheet and fair value (CHF millions) Straight bonds Total 2018 Balance sheet 2018 2017 Fair value Balance sheet 2017 Fair values 1 377 1 377 1 373 1 373 1 378 1 378 1 408 1 408 8. Share capital January 1 2 616 844 820 1 308.4 2 627 114 820 Number of shares canceled/capital reduced during the period – 66 220 000 – 33.1 – 10 270 000 December 31 2 550 624 820 1 275.3 2 616 844 820 2018 Number of shares Share capital CHF millions 2017 Number of shares Share capital CHF millions 1 313.6 – 5.2 1 308.4 The Novartis AG share capital consists of registered shares with a nominal value of CHF 0.50 each. The total share capital decreased from CHF 1 308.4 million at December 31, 2017, to CHF 1 275.3 million at December 31, 2018, due to a share capital reduction as a result of the cancellation of 66.2 million repurchased shares with a nominal value of CHF 33.1 million. The cancellation was approved at the Annual General Meeting of March 2, 2018, and became effective on May 9, 2018. During 2017, the total share capital decreased from CHF 1 313.6 million at December 31, 2016, to CHF 1 308.4 million at December 31, 2017, due to a share capital reduction as a result of the cancellation of 10.3 million repurchased shares with a nominal value of CHF 5.2 mil- lion. The cancellation was approved at the Annual Gen- eral Meeting of February 28, 2017, and became effective on May 9, 2017. A-5 Notes to the financial statements of Novartis AG 9. Reserve for treasury shares Treasury shares held by subsidiaries 1 January 1 Number of shares purchased/sold; reserves transferred December 31 1 Excluding foundations 2018 2017 Reserve for treasury shares held by subsidiaries CHF millions Number of shares Reserve for treasury shares held by subsidiaries CHF millions Number of shares 50 506 375 – 7 276 905 43 229 470 3 005 – 409 2 596 56 847 803 – 6 341 428 50 506 375 3 417 – 412 3 005 2018 2017 Reserve for treasury shares held by Novartis AG CHF millions Number of shares Reserve for treasury shares held by Novartis AG CHF millions Number of shares Treasury shares held by Novartis AG January 1 117 527 458 5 213 61 577 458 Number of shares purchased/canceled; reserves transferred – 42 970 000 – 3 349 55 950 000 December 31 74 557 458 1 864 117 527 458 792 4 421 5 213 Total treasury shares 1 January 1 Total number of shares purchased/sold or canceled; reserves transferred December 31 1 Excluding foundations 2018 Number of shares Total reserve for treasury shares CHF millions 2017 Number of shares Total reserve for treasury shares CHF millions 168 033 833 8 218 118 425 261 – 50 246 905 117 786 928 – 3 758 49 608 572 4 460 168 033 833 4 209 4 009 8 218 Novartis AG has met the legal requirements for legal reserves under Articles 659 et. seq. and 663b.10 SCO for the treasury shares. Treasury share purchases during 2018 totaled 24.4 million (2017: 70.6 million), with an average purchase price of CHF 79 (2017: CHF 78). Treasury share sales totaled 0.8 million (2017: 1.8 million), with an average sale price of CHF 67 (2017: CHF 61), and share-based compensation transactions totaled 7.6 million shares (2017: 9.0 million shares). The number of treasury shares held by the company and its subsidiaries meet the definitions and require- ments of Article 659b SCO. At December 31, 2018, treasury shares held by Novartis AG and its subsidiaries totaled 117 786 928. As per the dividend payment date, Novartis AG and its subsidiaries are expected to hold 107 251 448 shares. These shares are non- dividend- bearing shares. It should be noted that within the Novartis Group’s IFRS consolidated financial statements, some Novartis entities are included in the consolidation scope – mainly foundations, which do not qualify as subsi diaries in the sense of Article 659b SCO. A-6 Notes to the financial statements of Novartis AG 10. Free reserves (CHF millions) January 1 Reduction due to cancellation of treasury shares (CHF 5 188 million / CHF 767 million of repurchased shares less their nominal value of CHF 33 million / CHF 5 million) Transfer from reserve for treasury shares December 31 2018 2017 30 178 30 527 – 5 154 409 – 761 412 25 433 30 178 11. Contingent liabilities (CHF millions) Dec 31, 2018 Dec 31, 2017 Guarantees in favor of subsidiaries to cover capital and interest of bonds, credit facilities and commercial paper programs – total maximum amount CHF 45 768 million (2017: CHF 43 195 million) 27 635 23 512 Other guarantees in favor of subsidiaries, associated companies and others – total maximum amount CHF 3 379 million (2017: CHF 4 010 million) Total contingent liabilities 1 649 1 592 29 284 25 104 Novartis AG is part of the Swiss Novartis value-added tax (VAT) group and is therefore jointly liable for existing and future VAT claims from the Swiss Federal Tax Administration. 12. Registration, voting restrictions and major shareholders The Company’s Articles of Incorporation state that no person or entity shall be registered with the right to vote for more than 2% of the share capital, as set forth in the commercial register. In particular cases, the Board of Directors may allow exemptions from the limitation for registration in the Novartis Share Register. According to the Novartis Share Register, sharehold- ers owning 2% or more of the Company’s capital at December 31, 2018 and being entitled to voting rights on all of their shares, excluding treasury shares held by Novartis AG or its fully owned subsidiaries, are as fol- lows: % Holding of share capital Dec 31, 2018 % Holding of share capital Dec 31, 2017 Emasan AG, Basel Novartis Foundation for Employee Participation, Basel UBS Fund Management (Switzerland) AG, Basel 3.5 2.3 2.2 3.4 2.5 2.0 Furthermore, there are the following other significant share holders: Shareholders registered as nominees: Chase Nominees Ltd., London The Bank of New York Mellon, New York Through The Bank of New York Mellon, Everett Through The Bank of New York Mellon, New York 1.3% Through The Bank of New York Mellon, SA/NV, Brussels Nortrust Nominees Ltd., London 0.7% 3.6% 2018 2017 9.8% 4.1% 2.1% 7.8% 4.3% 2.0% 2.3% 3.8% Shareholder acting as American Depositary Share (ADS) depositary: JPMorgan Chase Bank, N.A., New York 13.3% 12.3% The following shareholder is disclosed through a notifi- cation filed with Novartis AG, but not registered as of December 31, 2018 in the Novartis Share Register: • Norges Bank (Central Bank of Norway), Oslo, holds 2.1% (2017: 2.1%). The following shareholders are disclosed through notifications filed with Novartis AG and the SIX Swiss Exchange, but not registered or registered with less than 2% of the share capital as of December 31, 2018 in the Novartis Share Register: • BlackRock, Inc., New York, holds between 3% and 5%; • The Capital Group Companies, Inc., Los Angeles, holds between 3% and 5%. A-7 Notes to the financial statements of Novartis AG 13. Equity instrument disclosures for the Board of Directors and Executive Committee members Share ownership requirements for Board members The Chairman is required to own a minimum of 30 000 Novartis shares, and other members of the Board of Directors are required to own at least 5 000 Novartis shares within five years after joining the Board of Direc- tors, to ensure their interests are aligned with those of shareholders. Board members are prohibited from hedging or pledging their ownership positions in Novartis shares that are part of their guideline share ownership require- ment, and are required to hold these shares for 12 months after retiring from the Board of Directors. As at Decem- ber 31, 2018, all current and former members of the Board of Directors who were required to meet the mini- mum share ownership requirements did so. Shares, ADRs and share options owned by Board members As at December 31, 2018, no member of the Board of Directors, either individually or together with “persons closely linked”1 to them, owned 1% or more of the out- standing shares (or ADRs) of Novartis. As at the same date, no member of the Board of Directors held any share options to purchase Novartis shares. The total number of vested Novartis shares and ADRs owned by members of the Board of Directors and “ persons closely linked”1 to them as at December 31, 2018 is shown in the table below. Shares and ADRs owned by Board members1 Number of shares 1,2 At At December 31, December 31, 2017 2018 Joerg Reinhardt Enrico Vanni Nancy Andrews Dimitri Azar Ton Buechner Srikant Datar Elizabeth Doherty Ann Fudge Frans van Houten (from February 28, 2017) Andreas von Planta Charles L. Sawyers William T. Winters Total 3 542 199 518 310 23 500 5 739 20 101 4 042 14 863 13 094 8 069 4 428 39 383 37 239 4 882 14 818 2 728 2 761 15 457 978 133 493 130 634 9 460 15 371 7 763 12 397 814 505 767 204 NA – Not applicable. 1 Includes holdings of “persons closely linked” to Board members (see definition in this Note 12) 2 Each share provides entitlement to one vote. 3 Pierre Landolt stepped down from the Board of Directors on March 2, 2018. On March 2, 2018, Mr. Landolt owned 62 520 shares. According to Mr. Landolt, the Sandoz Family Foundation is the economic beneficiary of the shares. Share ownership requirements for Executive Committee members Executive Committee members are required to own at least a minimum multiple of their annual base salary in Novartis shares or Restricted Share Units (RSUs) within five years of hire or promotion, as set out in the table below. In the event of a substantial rise or drop in the share price, the Board of Directors may, at its discretion, amend that time period accordingly. Function CEO Ownership level 5 x base compensation Other Executive Committee members 3 x base compensation The determination of equity amounts against the share ownership requirements is defined to include vested and unvested Novartis shares or ADRs, as well as RSUs acquired under the company’s compensation plans. However, unvested matching shares granted under the Leveraged Share Savings Plan (LSSP) and any unvested Performance Share Units (PSUs) are excluded. The determination also includes other shares as well as vested options of Novartis shares or ADRs that are owned directly or indirectly by “persons closely linked”1 to an Executive Committee member. The Compensation Committee reviews compliance with the share owner- ship guideline on an annual basis. As at December 31, 2018, all members who have served at least five years on the Executive Committee have met or exceeded their personal Novartis share own- ership requirements. Shares, ADRs, equity rights and share options owned by Executive Committee members As at December 31, 2018, no member of the Executive Committee, either individually or together with “persons closely linked”1 to them, owned 1% or more of the out- standing shares (or ADRs) of Novartis. As at the same date, no member of the Executive Committee held any share options to purchase Novartis shares. The following table shows the total number of shares, ADRs, and other equity rights owned by Executive Committee members and “persons closely linked”1 to them as at December 31, 2018. 1 “Persons closely linked” are (i) their spouse, (ii) their children below age 18, (iii) any legal entities that they own or otherwise control, and (iv) any legal or natural person who is acting as their fiduciary. A-8 Notes to the financial statements of Novartis AG Shares, ADRs and other equity rights owned by Executive Committee members1 Vested shares and ADRs Unvested shares Total at and other December 31, 2018 equity rights 2 Vested shares Unvested shares Total at and other December 31, 2017 and ADRs equity rights 2 Vasant Narasimhan (CEO from February 1, 2018) Steven Baert Elizabeth Barrett (from February 1, 2018) 3 Bertrand Bodson (from April 1, 2018) James Bradner Richard Francis Paul Hudson Harry Kirsch Shannon Thyme Klinger (from April 1, 2018) Steffen Lang (from April 1, 2018) Klaus Moosmayer (from December 1, 2018) John Tsai (from May 1, 2018) Robert Weltevreden (from June 1, 2018) Total 4 25 240 117 855 143 095 16 279 85 726 102 005 23 365 62 059 85 424 10 955 55 125 66 080 0 0 0 0 8 514 8 514 924 90 190 91 114 NA NA 0 NA NA NA NA 47 364 47 364 48 079 67 015 115 094 35 117 57 758 92 875 16 756 63 174 79 930 6 616 36 193 42 809 97 081 100 302 197 383 64 769 95 378 160 147 14 007 40 111 54 118 23 793 33 577 57 370 0 3 274 3 274 6 429 18 634 25 063 150 3 690 3 840 NA NA NA NA NA NA NA NA NA NA NA NA NA NA NA 255 824 608 395 864 219 133 736 377 544 511 280 NA – Not applicable. 1 Includes holdings of “persons closely linked” to Executive Committee members (see definition in this Note 12) 2 Includes restricted shares, RSUs and target number of PSUs. Matching shares under the ESOP and LSSP, and target number of PSUs are disclosed pro-rata to December 31, unless the award qualified for full vesting under the relevant plan rules. Awards under all other incentive plans are disclosed in full. 3 Elizabeth Barrett stepped down from the role of CEO, Novartis Oncology and from the Executive Committee as at the end of the 2018 business year. The LTPP and LTRPP grants (16 284 and 6 107 PSUs, respectively) for the 2018-2020 performance cycle, and the 2018 buyout award of 21 267 performance shares were forfeited in full upon her departure on December 31, 2018. 4 Joseph Jimenez, F. Michael Ball, Felix Ehrat and André Wyss stepped down from the Executive Committee in 2018. At the time they stepped down from the Executive Committee, Mr. Jimenez owned 4 750 vested shares, and 244 297 unvested shares and other equity rights; Mr. Ball owned no vested shares, and 165 810 unvested shares and other equity rights; Mr. Ehrat owned 236 886 vested shares, and 114 038 unvested shares and other equity rights; and Mr. Wyss owned 81 347 vested shares and 49 344 unvested shares and other equity rights. A-9 Notes to the financial statements of Novartis AG 14. Event subsequent to December 31, 2018 In preparation for the proposed spin-off of Alcon, which will contain the Novartis eye care devices business, from Novartis, Novartis AG will contribute certain participa- tions in Alcon subsidiaries from Novartis AG to Alcon Inc. Furthermore, Alcon Inc. will increase its capital to create the shares necessary for the distribution of Alcon Inc. shares to the Novartis AG shareholders (such distribu- tion subject to approval by the Annual General Meeting of Novartis AG). On January 29, 2019, the Board pro- posed to distribute, by way of a dividend in kind, 1 share in Alcon Inc. for every 5 dividend bearing shares of Novartis AG (treasury shares owned by Novartis AG or its fully owned subsidiaries will not receive shares of Alcon Inc.). No dividend in kind will be declared on trea- sury shares held by Novartis AG or its fully owned sub- sidiaries. A-10 Appropriation of available earnings and reserves of Novartis AG Appropriation of available earnings and reserves of Novartis AG 1. Appropriation of available earnings of Novartis AG as per balance sheet and declaration of dividend (CHF) Available unappropriated earnings Balance brought forward Net income of the year Total available earnings at the disposal of the Annual General Meeting Appropriation proposed by the Board of Directors (cash dividend) Payment of a gross dividend (before taxes and duties) of CHF 2.85 (2017: CHF 2.80) on 2 443 373 372 (2017: 2 460 329 729) dividend-bearing shares1 with a nominal value of CHF 0.50 each Total available earnings after appopriation of cash dividends Dividend waived for additional treasury shares held by the Company Balance to be carried forward after cash dividends 1 No dividend will be declared on treasury shares held by Novartis AG or its fully owned subsidiaries 2018 2017 4 833 109 672 3 281 006 904 10 966 901 239 8 427 115 178 15 800 010 911 11 708 122 082 – 6 963 614 110 – 6 888 923 241 8 836 396 801 4 819 198 841 13 910 831 8 836 396 801 4 833 109 672 Assuming that this proposal by the Board of Directors is approved by the Annual General Meeting of Sharehold- ers, payment of the dividend will be made as from March 6, 2019. The last trading day with entitlement to receive the dividend is March 1, 2019. As from March 4, 2019, the shares will be traded ex-dividend. The Distribution is subject to the following conditions precedent: (i) The Alcon Shares shall have been admitted to listing on the SIX Swiss Exchange and the New York Stock Exchange as from the ex-dividend date (subject to technical deliverables only); 2. Special Distribution by Way of a Dividend in Kind to Effect the Spin-off of Alcon Inc. The Board of Directors proposes to distribute, by way of a dividend in kind, 1 share in Alcon Inc. (an “Alcon Share”) for every 5 dividend-bearing shares of Novartis AG1 (the “Distribution”). On Novartis AG’s stand-alone balance sheet, the Distribution shall be made at the book value of Alcon Inc., amounting immediately prior to the Distri- bution to a total of approximately CHF 17 bn2 (estimated), but in any case not exceeding the free reserves of Novartis AG amounting to CHF 25.4 bn (as of December 31, 2018), and be booked against (i) CHF 19’548’000.- of capital contribution reserves and (ii) for the remaining part, against free reserves. The Board of Directors shall determine in its discretion the treatment of fractions and holders of physical share certificates (“Heimverwahrer”) that do not timely provide the necessary details to receive Alcon Shares (it being understood that respective Alcon Shares shall generally be sold, and cash proceeds shall be delivered in lieu of fractions or Alcon Shares of such holders). 1. No dividend in kind will be declared on treasury shares held by Novartis AG or its fully (ii) The U.S. Securities and Exchange Commission (“SEC”) shall have declared effective the registration statement on Form 20-F for the Alcon Shares under the U.S. Securities Exchange Act of 1934, as amended, and no stop order suspending the effectiveness of this registration statement shall be in effect and no pro- ceedings for that purpose shall be pending before or threatened by the SEC; (iii) No order, injunction or decree issued by any govern- mental authority of competent jurisdiction or other legal restraint or prohibition preventing consummation of the spin-off of Alcon shall be in effect, and no other event outside the control of Novartis shall have occurred or failed to occur that prevents the consummation of the spin-off of Alcon (including, but not limited to, Novartis not being able to complete the internal trans- actions to separate the businesses currently constitut- ing the eye care devices business of Novartis, compris- owned subsidiaries. 2. The distribution amount represents the Novartis AG estimated statutory book values of the participation in Alcon Inc. immediately before the Distribution. This amount does not represent the expected fair market value of the Alcon business to be distributed to the Novartis AG shareholders. A-11 Appropriation of available earnings and reserves of Novartis AG ing its Surgical and Vision Care operations, from the other businesses, due to elements outside of its rea- sonable control); and (iv) No other events or developments shall have occurred prior to the ex-dividend date of the Distribution that, in the judgment of the Novartis Board of Directors, would result in the spin-off of Alcon having a material adverse effect (including, but not limited to, material adverse tax consequences or risks) on Novartis or its share- holders. The Board of Directors shall (i) determine whether these conditions precedent are satisfied and, to the extent legally permissible, have authority to waive any condi- tions precedent if such waiver is, in the judgment of the Board of Directors, in the best interest of Novartis and its shareholders; and (ii) set the record, ex-dividend and settlement dates of the Distribution, which shall occur as soon as practicable following the satisfaction (or waiver) of these conditions precedent. A-12 Report of the statutory auditor on the financial statements of Novartis AG Report of the statutory auditor on the financial statements of Novartis AG To the General Meeting of Novartis AG, Basel Opinion As statutory auditor, we have audited the financial state- ments of Novartis AG, which comprise the balance sheet as at December 31, 2018, income statement, and notes to the financial statements (pages A-1 to A-10) for the year then ended, including a summary of significant accounting policies. In our opinion, the accompanying financial state- ments as at December 31, 2018, comply with Swiss law and the Company’s Articles of Incorporation. Basis for opinion We conducted our audit in accordance with Swiss law and Swiss Auditing Standards. Our responsibilities under those provisions and standards are further described in the “Auditor’s responsibilities for the audit of the finan- cial statements” section of our report. We are independent of the entity in accordance with the provisions of Swiss law and the requirements of the Swiss audit profession, and we have fulfilled our other ethical responsibilities in accordance with these require- ments. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our opinion. Our audit approach Audit scope We designed our audit by determining materiality and assessing the risks of material misstatement in the finan- cial statements. In particular, we considered areas where subjective judgments were made, such as significant accounting estimates that involved making assumptions and consideration of future events that are inherently uncertain. As in all of our audits, we also addressed the risk of management override of internal controls, includ- ing – among other matters – consideration of whether there was evidence of bias that represented a risk of material misstatement due to fraud. Materiality The scope of our audit was influenced by our applica- tion of materiality. Our audit opinion aims to provide rea- sonable assurance that the financial statements are free from material misstatement. Misstatements may arise due to fraud or error. They are considered material if, individually or in aggregate, they could reasonably be expected to influence the economic decisions of users taken on the basis of the financial statements. Based on our professional judgment, we determined certain quantitative thresholds for materiality, including the overall materiality for the financial statements as a whole, as set out below. These, together with qualitative considerations, helped us to determine the scope of our audit and the nature, timing and extent of our audit pro- cedures, and to evaluate the effect of misstatements, both individually and in aggregate, on the financial state- ments as a whole. • Overall materiality: CHF 400 million • How we determined it: With reference to our bench- mark of 5% and for consistency with the Novartis Group consolidated financial statements, we determined materiality at CHF 400 million which is 3.6% of income before taxes • Rationale for the materiality benchmark applied: We chose income before taxes as the measure because, in our view, it is the measure against which the perfor- mance of the entity is most commonly assessed and is a generally accepted benchmark We agreed with the Audit and Compliance Committee that we would report to them misstatements identified during our audit above CHF 20 million as well as any mis- statements below that amount which, in our view, war- ranted reporting for qualitative reasons. Key audit matters Key audit matters are those matters that, in our profes- sional judgment, were of most significance in our audit of the financial statements of the current period. We have determined that there are no key audit matters to com- municate in our report. Responsibilities of the Board of Directors for the financial statements The Board of Directors is responsible for the prepara- tion of the financial statements in accordance with the provisions of Swiss law and the Company’s Articles of Incorporation, and for such internal control as the Board of Directors determines is necessary to enable the preparation of financial statements that are free from material misstatement, whether due to fraud or error. In preparing the financial statements, the Board of Directors is responsible for assessing the entity’s ability to continue as a going concern, disclosing, as applica- ble, matters related to going concern and using the going concern basis of accounting unless the Board of Direc- tors either intends to liquidate the entity or to cease oper- ations, or has no realistic alternative but to do so. A-13 Report of the statutory auditor on the financial statements of Novartis AG We also provide the Board of Directors with a state- ment that we have complied with relevant ethical require- ments regarding independence, and to communicate with them all relationships and other matters that may reasonably be thought to bear on our independence, and where applicable, related safeguards. From the matters communicated with the Board of Directors, we determine those matters that were of most significance in the audit of the financial statements of the current period and are therefore the key audit mat- ters. We describe these matters in our auditor’s report, unless law or regulation precludes public disclosure about the matter or when, in extremely rare circum- stances, we determine that a matter should not be com- municated in our report because the adverse conse- quences of doing so would reasonably be expected to outweigh the public interest benefits of such communi- cation. Report on other legal and regulatory requirements In accordance with article 728a paragraph 1 item 3 CO and Swiss Auditing Standard 890, we confirm that an internal control system exists, which has been designed for the preparation of financial statements according to the instructions of the Board of Directors. We further confirm that the proposed appropriation of available earnings and reserves complies with Swiss law and the Company’s Articles of Incorporation. We rec- ommend that the financial statements submitted to you be approved. PricewaterhouseCoopers AG Luc Schulthess Audit expert Auditor in charge Stephen Johnson Global relationship partner Basel, January 29, 2019 Auditor’s responsibilities for the audit of the financial statements Our objectives are to obtain reasonable assurance about whether the financial statements as a whole are free from material misstatement, whether due to fraud or error, and to issue an auditor’s report that includes our opinion. Reasonable assurance is a high level of assurance but is not a guarantee that an audit conducted in accordance with Swiss law and Swiss Auditing Standards will always detect a material misstatement when it exists. Misstate- ments can arise from fraud or error and are considered material if, individually or in the aggregate, they could reasonably be expected to influence the economic deci- sions of users taken on the basis of these financial state- ments. As part of an audit in accordance with Swiss law and Swiss Auditing Standards, we exercise professional judgment and maintain professional skepticism through- out the audit. We also: • Identify and assess the risks of material misstatement of the financial statements, whether due to fraud or error; design and perform audit procedures responsive to those risks; and obtain audit evidence that is suffi- cient and appropriate to provide a basis for our opin- ion. The risk of not detecting a material misstatement resulting from fraud is higher than for one resulting from error, as fraud may involve collusion, forgery, intentional omissions, misrepresentations, or the over- ride of internal control. • Obtain an understanding of internal control relevant to the audit in order to design audit procedures that are appropriate in the circumstances, but not for the pur- pose of expressing an opinion on the effectiveness of the entity’s internal control. • Evaluate the appropriateness of accounting policies used and the reasonableness of accounting estimates and related disclosures made. • Conclude on the appropriateness of the Board of Directors’ use of the going concern basis of account- ing and, based on the audit evidence obtained, whether a material uncertainty exists related to events or con- ditions that may cast significant doubt on the entity’s ability to continue as a going concern. If we conclude that a material uncertainty exists, we are required to draw attention in our auditor’s report to the related dis- closures in the financial statements or, if such disclo- sures are inadequate, to modify our opinion. Our con- clusions are based on the audit evidence obtained up to the date of our auditor’s report. However, future events or conditions may cause the entity to cease to continue as a going concern. We communicate with the Board of Directors, mostly through the Audit and Compliance Committee, regard- ing – among other matters – the planned scope and tim- ing of the audit and significant audit findings, including any significant deficiencies in internal control that we identify during our audit. A-14

Continue reading text version or see original annual report in PDF format above