Merck KGaA

XETRA:MRK

Earnings Call Analysis

Q1 2024: Healthcare and Electronics Shine Despite Overall Sales Dip

In Q1 2024, despite a 1% organic decline in group sales and a 5% drop in EBITDA pre, Merck saw strong performance in its Healthcare and Electronics sectors. Healthcare excelled with a 10% organic sales increase, driven by products like Erbitux, Mavenclad, and Bavencio. Electronics grew 6% organically, led by Semiconductor Solutions. However, Life Science faced a 13% organic sales decline. The company reaffirmed its goal to return to growth in 2024, providing guidance of EUR 20.6-22.1 billion in sales, EUR 5.7-6.3 billion in EBITDA pre, and EPS pre of EUR 8.05-9.10.

Introduction

The company presented its first-quarter 2024 earnings, revealing a stable but challenging performance landscape. The quarter saw mixed results across its three core business sectors: Healthcare, Electronics, and Life Science. Despite some setbacks, positive momentum is expected to continue throughout the year.

Overall Financial Summary

The company reported a 1% organic decline in group sales and a 5% decrease in EBITDA pre. Currency headwinds had a dilutive effect, leading to a reported sales decline of 3% to EUR 5.120 billion, with EBITDA pre down 8% to EUR 1.454 billion. EPS pre dropped by 13% year-on-year to EUR 2.06.

Healthcare Sector Performance

Healthcare was the standout performer with a 10% organic sales growth, driven by key products such as Erbitux, Mavenclad, and Bavencio. This sector not only delivered strong sales but also saw EBITDA pre increase by more than 28% organically, boosted by product repatriation and cost discipline.

Electronics Sector Performance

Electronics showed positive organic growth of 6%, particularly driven by an 8% rise in Semiconductor Solutions. The sector experienced a 4% organic EBITDA pre growth due to positive product mix effects. However, margins faced pressure from underutilization costs and continued price pressures in liquid crystal business.

Life Science Sector Challenges

Life Science experienced a 13% organic sales decline due to high base effects from the previous year and ongoing customer destocking in Process Solutions. While order intake showed positive signs, the segment remains under pressure with a 30% drop in organic EBITDA pre.

Financial Health and Debt

Net financial debt remained stable compared to the end of the previous year, primarily due to short-term investments. The equity ratio strengthened from 55% to 57%, supported by increased operating cash flow, which rose by 21.4% to EUR 1.035 billion.

Guidance for 2024

The company issued its first quantitative guidance for 2024, forecasting net sales between EUR 20.6 billion and EUR 22.1 billion. EBITDA pre is expected to range from EUR 5.7 billion to EUR 6.3 billion, and EPS pre between EUR 8.05 and EUR 9.10. Organic sales growth is anticipated to be 1% to 5%, with organic EBITDA pre growth expected between 1% and 7%, driven mainly by the positive performance in Healthcare.

Conclusion

Despite a challenging start to the year, the company remains optimistic about its trajectory, backed by robust performances in Healthcare and Electronics. The company is strategically focused on overcoming Life Science challenges and is well-positioned for a return to growth for the remainder of 2024.

Earnings Call Transcript 2024-Q1

[Operator]

Dear ladies and gentlemen, welcome to the Merck Investor and Analyst Conference Call on First Quarter 2024. [Operator Instructions] I am now handing over to Constantin Fest, Head of Investor Relations, who will lead you through this conference. Please go ahead, sir.

[Constantin Fest, executive]

Thank you very much, Heidi, and a very warm welcome to this Merck Q1 2024 Results Call. My name is Constantin Fest, I'm Head of Investor Relations here, and I'm delighted to be joined by Belen Garijo, Group CEO; as well as Helene von Roeder, Group CFO. For the Q&A part of this call, we will also be joined by Matthias Heinzel, CEO of Life Science; by Peter Guenter, CEO of Healthcare; as well as Kai Beckmann, CEO of Electronics.

In the first couple of minutes of this call, we'd like to run you through the key slides of this presentation, which will then be followed by Q&A.

With this, I'd like to hand over now to Belen to start. Over to you, Belen.

[Belén Garijo López, executive]

Thanks, Constantin, and welcome, everybody, to our Q1 earnings call. I am now on Slide #5 of the presentation, and we'll start with the highlights.

So as you have seen earlier today, we delivered a very solid quarter despite we observed a slight organic revenue decline, and we are trending in the right direction with two of our three business sectors having shown a very strong performance in Q1. And we expect growth to continue to improve from here.

Organically, group sales declined by 1% and EBITDA pre went down by 5%. This, paired with a 2 percentage point currency headwind, leads to reported sales of EUR 5.120 billion, which is a decline of 3%. The currency had a slightly dilutive effect on EBITDA pre, which was down by 8% to EUR 1.454 billion. EPS pre of EUR 2.06 decreased 13% year-on-year.

Healthcare was the top performer, with 10% organic sales growth driven by Erbitux, by Mavenclad, and Bavencio.

Electronics also showed a positive organic sales development in Q1, up 6%, and this was driven by Semiconductor Solutions, which returned to growth year-on-year at an increase of 8%. As expected, Life Science showed an organic sales decline again, a particularly high base. As you may remember, we have not yet seen the full impact of the customer destocking in our Process Solutions business in Q1 last year. Therefore, Life Science was down by 13%.

While we no longer segregate the effect of COVID-related sales, it still represents a headwind for Life Science as well as for the group in 2024.

In Life Science, we also saw positive signals from order intake in our Process Solutions business in quarter 1. Order intake grew both sequentially and year-on-year. Book-to-bill went up to around 1, reflecting the sequential increase in order intake.

With the presentation of our financial results last year, we confirmed our goal of returning to growth in 2024. Q1 showed an overall positive business momentum and confirmed our previously anticipated trajectory for the remainder of the year and the guidance.

I'm talking about the guidance. And as usual, at this time of the year, we are further specifying that we now anticipate net sales in a range of EUR 20.6 billion to EUR 22.1 billion, EBITDA pre of EUR 5.7 billion to EUR 6.3 billion, and EPS pre of EUR 8.05 to EUR 9.10, thereby confirming our qualitative guidance with a slightly more positive tonality on EBITDA pre. We will share more details on our assumptions later.

Turning to Slide #6. We will provide a bit more color on our business sector. As you can see, Healthcare and Electronics contributed positively to organic sales growth in Q1, largely offsetting the decline in Life Science. Our key growth engines in the quarter were: first, our new Healthcare products, our new launches, as well as Semiconductor Solutions within the Electronics business sector.

In fact, in a still challenging operating environment in Q1, Healthcare took the lead with a strong organic growth of 10%. And this was driven by 15% growth from recent launches, with Bavencio up by 14% and Mavenclad up 12% in Q1, and further supported by a strong performance of our established product portfolio with a stellar performance of Erbitux. Our established product portfolio increased by 9%.

From a franchise perspective, Oncology was the highlight, again, with an organic growth of 19%. Life Science showed a decline of 13% organically against a strong base as we flagged already in March, with all three business being down in the quarter. Process Solutions declined organically by 19%. Science & Lab Solutions was down by 7%, both against very tough comparables in Q1 2023.

In Electronics, our semi business was up 8% in the quarter, driving the growth of the sector, which was up 6% organically in Q1. Display Solutions and Surface also showed positive organic growth in Q1. FX was a headwind across the board on sales with a minus 2% impact on sales at group level, in line with the guidance that we provided in March.

On earnings, EBITDA pre came in at EUR 1.45 billion, down organically by 5% or minus EUR 82 million in absolute values. And this was due to Life Science, where organic EBITDA pre was down by minus 30% in Q1 against high comparables. EBITDA pre in Healthcare was up strongly by more than 28% organically in quarter 1, driven by a strongly leverage growth as well as the positive impact of the Bavencio repatriation. EBITDA pre in Electronics was up by 4% organically due to positive mix in advanced nodes in Semi Materials and in DS&S combined with volume effects.

Last, FX was a stronger headwind on EBITDA pre than on sales, and this is mainly due to Healthcare.

And with this, let me hand it over to Helene for a more detailed review of our financials.

[Helene von Roeder, executive]

Thank you very much, Belen, and a warm welcome also from my side. I'm now on Slide 8 for an overview of our key figures in the first quarter.

Let me emphasize, we had a solid start to 2024 in a still challenging business environment. Taking into account currency headwinds, net sales declined by 3.3% to EUR 5.120 billion -- no, EUR 5.120 billion. EBITDA pre was down by 8.4% to EUR 1.454 billion, with a slightly higher FX headwind on EBITDA pre compared with sales, and EPS pre declined by 12.7% to EUR 2.06. Operating cash flow came in strong at EUR 1.035 billion, which is an increase of 21.4% over the year-earlier period. Now that's attributable mainly to lower bonus payments, lower tax payments as well as a lower cash outflow from net working capital.

Net financial debt was stable compared with the end of December, mainly due to short-term investments in non-financial assets.

Let me also briefly comment on our reported results. So -- and with that, I'm now on the Slide 9. EBIT was down by 10% year-on-year. This was above the decline in EBITDA pre mainly due to the high level of D&A. The financial result was down by EUR 11 million, mainly driven by lower income from financial investments. The effective tax rate came in at 22.2%, which is in line with our guidance range of 21.0% to 23%, but above the effective tax rate of 21% of the earlier year period.

Now as mentioned previously, this was mainly due to additional pillar 2 tax expense, having increased our effective tax rate by roughly 1 percentage point. Reported EPS came in at EUR 1.60, which represents a decline of 12.6% year-on-year.

And with that, let's move on to the review by business sector. I'm starting with Life Science, which is on Slide 10. As we mentioned in our qualitative guidance for March, H1 compares against a high base. Hence, overall, sales in Life Science were down 12.6% organically in Q1. We do expect Q1 to be the softest quarter for our Life Science business sector in 2024. In fact, it also had the toughest comparative quarter in Q1 of last year. Also bear in mind, that while we no longer specify the effect of COVID headwinds, COVID-related sales still represent a headwind for Life Science in 2024.

All three businesses in Life Science declined organically in Q1. So looking at Process Solutions first. Sales were down 19% organically in Q1, which is actually a similar level compared with Q4 2023. We are comparing against tough comps as we only started to see the first effect of customer destocking during Q1 last year. But as we already mentioned in March, we've seen positive signals from order intake. Order intake this quarter was solid and went up sequentially as well as year-on-year. I am happy to state that book-to-bill increased to around 1.

Now taking a closer look at Science & Lab Solutions. Here, sales were down by 6.9% organically. That is because of demand from pharma companies remaining soft, both in North America as well as China. China overall has remained a challenge, but we saw signs of stabilization sequentially. In addition, academic research spending was impacted in North America by Q1 and the delayed signing of the NIH budget.

And do not forget that Q1 last year was unaffected by the temporary headwinds, such as the muted spending behavior by pharma companies and the macro environment in China, we have been experiencing since Q2 2023. Notably, sales in Science & Lab Solutions were up sequential, underlining our expectation of a gradual recovery during 2024.

Turning to the third sector, which is Life Science Services. Our third and smallest business, which is within Life Science. Sales were down 16.6% organically, driven by the streamlining of the supply chain by one of our CDMO customers and an organic sales decline in our CDMO activities, which was mainly due to negative project phasing. EBITDA pre declined 30% organically in Q1, mainly due to lower volumes and negative mix effect.

Q1 '24 had the highest margin comparator also. Sequentially, EBITDA pre increased slightly with the margin having moved up by 220 basis points, which is mainly on positive product mix effects driven -- driving gross margin.

I'm now on Slide 11 for an overview of the performance of the Healthcare business sector. Healthcare did deliver strong organic sales growth of 10.1% in Q1, which is above the level we have guided for, for the full year in our qualitative guidance from early March. Wave 1 projects grew by 15% organically, and the established portfolio was up 9% organically.

By franchise, Oncology was the star performer, with 19% increase organically which is mainly driven by Erbitux growing 19%. Here, China, in particular, stood out positively, with prior year sales impacted by a spike in COVID infection rates while supported by continued strong commercial uptake. Bavencio was up 14% in line with our expectations.

Our N&I franchise was also up by 9% in Q1, that was driven by Mavenclad, which actually increased 12% organically. Rebif grew as well by 4% organically in Q1. That was due to channel dynamics, which led to a low base. On the latter, I do want to reiterate that we are not seeing a trend change for the interferon market.

Fertility performed strongly again, with an 8% organic sales growth against a lower base in China. In general, and as projected, we are also seeing that stock out effects of our competitor products are beginning to moderate.

We are also very pleased with the performance of our CM&E portfolio, resulting in 4% organic growth, supported by a positive contribution across all segments. Within Endocrinology, the strong growth of the past quarters was driven by stock-outs of a major competitor. As we are at manufacturing capacity for Saizen, we do not expect a continuation of double-digit growth rates, even if the market supply remains constrained.

Now regarding our pipeline, for xevinapant, we are on track for the interim analysis of TrilynX, our Phase III study in locally advanced squamous cell carcinoma of the head and neck in this eligible population. In addition, we have seen positive momentum built in our early oncology pipeline for ADC and DDR assets. We will present new data at ASCO. And in addition, I can recommend that you join our R&D update call on June 3, which will focus on early oncology assets.

The strong organic sales growth in Q1 helped us to achieve an even stronger performance on EBITDA pre. EBITDA pre was boosted by higher operating leverage and benefited from the repatriation of Bavencio, which came into effect only as of July 1, 2023, and amid ongoing cost discipline. Overall, EBITDA pre amounted to EUR 708 million in Q1, which resulted in a margin of 34.6%, which is 370 basis points above Q1 '23. As a result, organic EBITDA pre increased by 28.3%, which is well above the organic increase in sales.

So moving on to our third sector, Electronics, which is on Slide 12. The Electronics sector had a strong start to the year, with all business having performed positively. Organically, sales increased by 6.3% in Q1. The key driver was the core business within Electronics, Semiconductor Solutions, which was up by 8% organically. Both our DS&S and our Semi Materials businesses contributed to this development.

In DS&S, we generated revenues towards the end of a large project in the U.S. We have seen customers push out the timing of new fabs, but we are already building a strong pipeline for '25 and '26.

Our Semiconductor Materials business has now delivered 3 quarters of sequential growth in a row, driven by Thin Film applications in advanced logic nodes in semiconductors. Mainstream semiconductor end markets, particularly 3D NAND and Analog have, however, remained weak in Q1. There was early buying behavior from some customers, which has yet to become a broader trend. Therefore, we did see an encouraging start to the year, but we do not call it an inflection yet.

Our Display Solutions business also saw a sales increase of 4% organically. That was mainly due to volume growth having overcompensated continuous price pressure against low comps for Q1 '23. And Surface Solutions was up by 2% organically, driven by increased demand for cosmetics pigments and automotive coatings, which overcompensated weaker demand for the industrial pigments.

While the EBITDA pre margin went down by 19 basis points year-over-year to 25.5% compared to a still high base in Q1 '23, we did see a 370 basis point margin increase sequentially. The sequential margin increase was mainly driven by positive mix effects from advanced semiconductor nodes and the sales increase, especially in Semi Materials and the resulting positive leverage amongst amid strict cost discipline.

For the further margin evolution during 2024, please do have in mind that we continue to have ongoing price pressure in the liquid crystal business and higher underutilization costs due to the ongoing site ramp-up in semi.

As we continue to be convinced of the long-term secular growth of semiconductors, we also sustained higher R&D and are continuing with our capacity expansions.

So before handing back to Belen, let me also briefly comment on our balance sheet as well as cash flow statement.

As you can see on Slide 13, our balance sheet increased by EUR 1 billion compared with the end of December 2023. So let's take a closer look on the asset side. Cash and cash equivalents increased by EUR 2.2 billion from EUR 2 billion at the end of December '23, and that was driven by strong operating cash flow in this quarter.

Inventories went slightly up as did receivables. Property, plant and equipment increased driven by investments. And lastly, intangible assets increased due to FX effects on our goodwill.

Turning to the liabilities side. Financial debt increased slightly, pension provisions were down due to changes in interest rates. Payables decreased from EUR 3.4 billion to EUR 3 billion due to in-license deals which were signed in the prior period, and resulted in payments in Q1 of this year. And net equity increased by EUR 1.3 billion, thanks to growth in profit after tax and higher gains recognized in equity, mainly driven by FX.

As a result, our equity ratio strengthened further from 55% at the end of December 2023, now to 57%.

So turning to cash flow on Slide 14. Operating cash flow came in strong at EUR 1.035 billion, and was up more than EUR 180 million compared with Q1 last year despite a decline in profit after tax. This was mainly due to changes in other assets and liabilities in turn, driven by lower bonus payouts and taxes in the quarter amid a slower increase in working capital.

Cash out for investing activities decreased primarily due to lower investment of our excess liquidity in non-financial assets. CapEx on property, plant and equipment went down slightly, while we do continue to invest for capacity expansions. And last but not least, the difference in financing cash flow can be explained mainly by proceeds from bank loans in the year earlier quarter.

Now with that, let me hand back to Belen for the outlook.

[Belén Garijo López, executive]

Thank you, Helene. So let's take a look at our guidance on Slide #16. Let me emphasize that back in March, when we provided qualitative targets for 2024, we also confirm our confidence to return to organic growth in 2024. I am happy to confirm this goal with our first quantitative guidance for 2024.

We are now expecting group net sales in 2024 in a range of EUR 20.6 billion to EUR 22.1 billion, EBITDA pre in a range of EUR 5.7 billion to EUR 6.3 billion and EPS pre in a range of EUR 8.05 to EUR 9.10. And this is based on organic sales growth of plus 1% to plus 5%, in line with our qualitative outlook provided in March.

Regarding organic EBITDA predevelopment, we have become slightly more optimistic than we were in our qualitative outlook for March, and we expect plus 1% to plus 7%, and this is mainly driven by the strong performance of our Healthcare business sector. We continue to expect FX to have an impact of minus 3% to 0% on revenues and minus 4% to minus 1% on EBITDA pre.

For some additional detail by business sector, please take a look at Slide 17. Our Q1 performance is providing increased confidence in the 2024 period. Therefore, we broadly confirm our qualitative guidance from March for Life Science and Electronics, and we have become more optimistic about Healthcare. So for Healthcare, we now guide for organic sales growth of plus 4% to plus 7%, slightly above the qualitative guidance from March, with a number of drivers playing in our favor, including the continued strong performance of our established product businesses.

We raised our guidance on organic EBITDA growth to plus 13% to 18%, and this is mainly in relation to the strong leverage growth, combined with continued cost discipline in the Healthcare business sector.

Moving on to Life Science. We confirm our guidance for organic sales growth and expect an organic sales development between minus 2% and plus 2%. For organic EBITDA pre we guide to an organic year-on-year change of minus 6% to plus 1%, thereby broadly confirming our qualitative guidance from March. We continue to expect sequential recovery during 2024, with organic sales growth turning positive in the second half of the year.

We see Q1 as the softest quarter in 2024, both in absolute terms as well as on a year-on-year basis, given the high comparables in 2023 that we mentioned several times.

For Electronics, we forecast an organic sales development between 0% and 4% and an organic EBITDA pre development between minus 3% to plus 4%. Once again, broadly confirming our previous qualitative guidance range. We have had a positive start to the year, but the general market inflection is yet to come in semiconductors. And you know that we continue to base our guidance on the semiconductor market returning in early H2.

Overall, I'm very pleased to say that Q1 is providing increased confidence in our return to organic growth in 2024. And as a group, we also have the ambition to return to profitable organic growth in 2024 as our guidance ranges imply.

With this, let me thank you for your attention, and we will be happy to take your questions.

[Constantin Fest, executive]

Heidi, first question please.

[Operator]

[Operator Instructions] Your first question comes from the line of Richard Vosser from JPMorgan.

[Richard Vosser, analyst]

Two, please. Firstly, on Process Solutions. When we're thinking about the pace of recovery, how are you seeing the consumables ordering [Technical Difficulty]

[Operator]

Excuse me, Mr. Vosser. Your line has been cut out. We shall move to our next question. Your next question comes from the line of Sachin Jain from Bank of America.

[Sachin Jain, analyst]

Sachin Jain, Bank of America. First one for Matthias, I just wonder if you'd be willing to quantify some of the positive commentary. So book-to-bill around 1. Has that been above 1 at any point? And then order intake growth in 1Q sequentially, again, are you willing to quantify low single digit, mid-single digit sequentially? Some of your peers have made comments.

And then second question just for Peter. Obviously, a very strong quarter from a sales perspective at 10%. Just wonder if you could touch on fact as you see through the rest of year from a phasing perspective, that means that guide is at 4% to 7%. And I think you've called that [ reverting ] the size, but anything else we should bear in mind?

[Matthias Heinzel, executive]

Yes. Thanks, Sachin, it's Matthias, for your question. No, I don't want to quantify at this point. I mean, we certainly see the positive momentum, right, both in terms of what intake sequentially year-over-year. We see also the absolute number, going absolutely in the right direction and steering us towards the guidance for the full year. So I think that's sending I think, a clear signal.

[Peter Guenter, executive]

Yes, Sachin, I would agree with you, very strong quarter across the board in all product lines or franchises and geographies. And it is true though that beyond this very good structural performance, we had a bit of one-timers. Helene had already mentioned in her speech, [indiscernible] so some channel dynamics that will not repeat itself in the quarters to come.

And then you should also bear in mind that, as also mentioned already in the prepared remarks, that there was a spike in COVID in Q1 last year, which benefited especially Erbitux and Fertility. But I would -- and then, of course, there is the yet-to-come effect of Padcev in the U.S. for Bavencio.

I think these are the big, let's say, moving pieces for the rest of the year. But again, overall, structurally very strong performance. If you think about Erbitux and the growth rate, bear in mind that this is also a real performance. Erbitux's becoming more and more the backbone in several combinations. We have the -- had a net performance in China, post-NRDL and so on and so forth. So I hope that gives you a little bit more color.

[Operator]

Your next question comes from the line of Richard Vosser from JPMorgan.

[Richard Vosser, analyst]

I hope you can hear me now, and apologies for that line drop. So just a question on Process Solutions. When we're thinking about the pace of recovery, how are you seeing the improvement in consumables ordering? Is this more sort of [Technical Difficulty] pace going forward?

And then a second question on display. Could you give us context important the conversion of iPads to OLED [Technical Difficulty]

[Matthias Heinzel, executive]

Richard, it's Matthias. Your line was still a bit out, but I think I got your question about consumables sales trending for PS.

Look, the way I see it unfolding is that Q1 certainly was the lowest quarter in PS for the year. We will see a gradual improvement quarter-over-quarter throughout the year. Certainly, what I mentioned before, the order intake, absolute increase from last quarter to this quarter, expected to continue will drive that.

So now how much quarter-over-quarter, that's hard to predict, but I would see a gradual improvement and certainly then come H2 having a -- and demonstrating for PS, again, positive growth year-over-year.

[Kai Beckmann, executive]

Yes, Richard, on the OLED question. Of course, we don't disclose any specific customer interactions, and that's why I can't comment on the specific point on the iPad. But as a leader in the OLED materials space, I think there's always a pretty high likelihood that we are involved in the most sophisticated end products. And I think this confirms the validity of our assumptions in the OLED technology development. And it's a good news for us all, yes.

[Operator]

Your next question comes from the line of Colin White from UBS.

[Colin White, analyst]

First question from me. It's Colin White from UBS. The first question was about the upcoming interim analysis for xevinapant. Clearly, we've not had it yet. Is it still on track for the threshold events perhaps to be met in the second quarter. But I wanted to ask, what is your current best estimate as of when the interim analysis is carried out, when we might hear from that and after you've had the interactions with IDMC and when the best guess still is for the full final readout?

And then a second question on bioprocessing, please. Last quarter, we heard about the customer survey that you had done and the expectation that CDMOs would reach their target level and start ordering earlier. And so just any update on what you've seen in terms of that and if you've seen it already seen evidence of this CDMOs reordering and your latest thoughts on and as you know how that's likely to progress?

[Peter Guenter, executive]

Yes, Colin. Thank you. I will take the xevinapant question. So I can confirm to you that we have the number of events that we need to go for the interim analysis. We have those events accrued. So now there are a couple of steps to be taken, database lock, data cleaning and then the DSMB will look at the data.

There are two scenarios. I remind you that the base case scenario is that the study continues, and the upside scenario is that indeed, we have overwhelming efficacy according to the DSMB then our teams -- a Chinese world team would be unblinded and then we would have a conversation with the FDA. So in other words, in the base case scenario, you will -- no news is good news and the study continues. It's only in the upside scenario that we will communicate.

In terms of timing, to completely answer your question, we do expect to have let's say, a view on that by the end of the second quarter or early third quarter, so end of June, early July.

[Matthias Heinzel, executive]

Yes. And on your BioP question, indeed, we see the ordering patterns unfolding more or less in line with the survey we took a couple of months ago. So yes, we do have CDMOs kind of going back to more normal ordering patterns, but also other customers. So the answer is yes.

[Operator]

Your next question comes from the line of Peter Verdult from Citi.

[Peter Verdult, analyst]

I'm Peter Verdult. I have 2 questions, please. Peter, just can you dig into Bavencio a little bit more. I know you don't disclose by geography, but I would like to understand the dynamics. Could you give any soft commentary on that sort of U.S. versus Europe and Japan? So basically what I'm trying to get at is, is this ad-serving Keytruda playing out as you expected and being fully offset by what's going on in Europe and Japan? Or is U.S. actually holding up better? So that's question number one.

And then number two, Belen, on the M&A environment, it's almost 2 years since management started articulating a message that your appetite increased and the firepower that you were willing to deploy. Now I realize you're not going to identify targets on a Q1 conference call, but can you at least characterize current M&A environment and whether you think conditions are more conducive than they perhaps were in '23 to actually see that balance sheet deployed? I'd just be interested in your latest thoughts there.

[Peter Guenter, executive]

Yes, Peter, let me take the Bavencio question first. So just again, if you take a step back, you will remind that we have always characterized, without giving precise numbers, is actually the U.S. part of Bavencio is less than 30%, yes. So that's number one.

And what we see is -- what we anticipated is that if you look at internal sales in Q1, we don't really see an impact yet. We are actually -- we slightly grew our sales even in Q1 in the U.S. But of course, that is more a factor of what was initiated in Q4 by platinum-based chemotherapy. And then, as you know, the maintenance therapy with Bavencio and the responders is then started a little bit later. So what we do see is, indeed, a decrease of platinum-based chemotherapy in Q1. So we should anticipate indeed some impact in Q2. But we need a couple of more data points to really try to quantify that impact in the U.S., but of course, there will be an impact. What I can also tell you is the brand continues to grow very strongly in Europe and Japan. So that from an overall guidance for this year for Bavencio, we still are confident that the brand globally will continue to grow.

Now perhaps one or more qualitative points here, first of all, we always said and we stand by that is that it will take time and effort for EV302 to get priced and reimbursed in Europe, that's number one. Number two, in Japan, chemotherapy is really extremely well embedded, and the market is not -- is very sensitive to toxicity.

And talking about toxicity, you know that, of course, many patients treated with EV302 got pretty nasty side effects, very burdensome for the patient. So thinking about skin toxicity, thinking about neurotoxicity, which also led a lot of editorials and comments by KOL that we have to be careful and also take into account quality of life considerations, preferences of the patients and so on and so forth.

Last but not least, you will remember that we also published at ASCO GU, the sequencing data where we have a real-life cohort coming from France, where we actually demonstrated that if you start with maintenance with Bavencio followed by Padcev in second line, that you also come to more than 40 months of overall survival. So we are battling very hard to get these messages across and I would say so far, so good.

[Belén Garijo López, executive]

Peter, on your M&A question, you know us very well, we have discussed this several times. First of all, as you know, we had a cash buyer preferably and our cash situation is good. It's allowing for us to allocate our capital according to our priorities, which we have outlined many, many times, with a top priority on Life Science, both SLS, and peers.

Obviously, continues in licensing in Healthcare as we have seen -- as you have seen, we have progress on that late last year and early this year and obviously, identification of potential technology opportunities in Electronics. So the environment is in terms of multiples for Life Science became a bit more accessible, multiples coming down a bit. Number of targets is really not a problem. But as you know, confirming a timing, right, for our portfolio moves and mainly for acquisition is almost mission impossible because it takes two to tango. And you know that we have a very good track record on right time, right price, right target.

So we aim to keep that. We have a very clearly defined financial frame, which is -- as well as a strategic frame. So first of all, supporting our profitable growth strategy is our main priority, followed by keeping our credit ratings, delivering an IRR of the acquisition, which is above our WACC. And then obviously, EPS pre accretion. So that goes as a high-level frame and have no doubt that we will keep you informed whenever we have relevant news to communicate. And this is really occupying us.

[Operator]

Your next question comes from the line of Emily Field from Barclays.

[Emily Field, analyst]

I'll ask two. The first is a follow-up question on the earlier answer to the xevinapant scenarios. Peter, you mentioned two scenarios, I think continuation of the study or early stoppage, but you didn't mention three. And obviously, that would be the bad one of that, the three being [indiscernible]. So is that still a plausible scenario that the drug could fail at interim? If you could just clarify that?

And then secondly, in the prepared remarks, going back to Life Sciences, sorry. You mentioned the impact of softness in China is impacting SLS in the quarter, but that you saw some signs of, I believe, stabilization sequentially. Could you provide some more granularity on what you're seeing here? And what sort of that path is expected for China? And also, if you could confirm that China is 10% of the Life Sciences business overall?

[Peter Guenter, executive]

Yes, Emily. So on xevinapant, of course, you are totally right, in this unlikely scenario that futility would be would be hit, of course, then that would be the best -- the worst case scenario, and we would then also communicate. So you are totally right.

[Matthias Heinzel, executive]

Emily, it's Matthias. So on your China question, yes, indeed, total China sales for total Life Science is below 10%. Obviously, we are very active in China, and we monitor the situation. We are still down year-over-year in sales for the first quarter. At the same time, what we see in our sales is somewhat stabilizing. So if I look at quarter-by-quarter, I would see a stabilizing trend.

Now the question is how will that unfold throughout the year? We do believe that things will progress positively throughout the year. But obviously, that depends on the macro situation in China.

[Operator]

Your next question comes from the line of Thibault Boutherin from Morgan Stanley.

[Thibault Boutherin, analyst]

First question is on the negative product mix impacting the margins in Life Science in the third quarter. Just if you could tell us if this is about the shift between the subsegment of Life Science or if you're talking about product categories within segments?

Second question is on the Healthcare growth. So solid outlook on top line this year without your launches, but also some positive one-offs or base effects. Just conceptually, when we think beyond '24, do you have a strong confidence in the ability to grow the portfolio ex pipeline? So basically, it's kind of base portfolio in Wave 1 on the next couple of years, at least until the loss of exclusivity on Mavenclad.

[Matthias Heinzel, executive]

This is Matthias. Let me try to answer your first question, and I was not sure on what reference you're taking. So year-over-year, first quarter versus last year, indeed, we do have a substantial decline in our margin following, if you will, the volume drop, right, losing the COVID sales, which had a higher margin profile. So that is kicking in.

However, I think sequentially, and we mentioned that before, Q4 to Q1, we already see a sequential margin improvement, about 220 basis points. That, if I look at the sequential improvement, it's also partially due to mix, but on a positive side, if you will, because the share of our PS and SLS business is a bit higher in Q1 versus Q4 because LSS is a bit weaker. So I hope with both answers, I address your question because it's a bit -- whether you look at Q1 last year or sequentially.

[Peter Guenter, executive]

Sorry. Yes, Thibault, on your outlook beyond 2024, we actually already characterized that, and I think Belen did it in the last call, that if we include xevinapant, that we're still confident to be at the lower end of the mid-single-digit growth, so without evobrutinib. But of course, obviously, you see the pipeline maturing. You see the pipeline getting larger, we will have readouts of enpatoran coming up in SLE and CLE later this year or early next year for SLE. We have the R&D update call on the earlier oncology portfolio. So lots of news there on the DDR portfolio and the ADCs.

You have seen that we have been quite active in the in-licensing space. We have added a Phase III asset Pimocotinib to our pipeline. So we are confident, of course, in the long-term outlook for our product. We will start cladribine in MG in Phase III in Q3. So as you can see, we are working hard and making a lot of progress to further enhance the growth profile of the company.

[Operator]

Your next question comes from the line of Oliver Metzger from ODDO BHF.

[Oliver Metzger, analyst]

Yes. The first one is on SLS. So you mentioned in your comments weaker farmer spending and also governmental funding delays in the U.S. Can you give us your view of the situation whether you see a driver as a temporary means Q1 effect or potentially more prolonged? And also in this context, do these delays trigger some pent-up demand afterwards in your view? That's number one.

The second one is on your guidance. So if I look on the midpoints of the segmented guidances and compared with the group organic growth guidance, the midpoint of the group guidance appears not too high, mathematically, range rather 0% to 5%, which would describe some better. Can you therefore elaborate for which segment do you see more positively executed outcome of your guidance range?

And my last one is a strategic question on Healthcare. So the guidance for '24 looks pretty good, in particular, on the bottom line. I understand that the healthy top line provide some attractive funding and the leverage for existing portfolio is quite good. So I don't want to focus too much on the EVO failure. But can you make a comment whether you're looking more intensified on strengthening the outlook -- portfolio outlook for the internal or external innovations, so that also from a pure portfolio perspective, the segment does not become smaller versus the other segments over time. So it's basically also an active decision not growing effect, and not so aggressively in the future anymore, and therefore, it can become smaller. So these are my questions.

[Matthias Heinzel, executive]

Yes. Oliver, it's Matthias. On your first question around SLS. Indeed, we have experienced a somewhat softer market situation for SLS, especially in North America and in China for the last several months or even a couple of quarters. Q1 was also somewhat impacted due to the delayed release of the NIH funding, which came a little bit later during Q1.

All of that, I would say, is more temporary, and we expect also here a gradual improvement. And if you look at SLS of the year sequentially, our business grew from Q4 to Q3 and now Q1 to Q4 quite nicely. And we expect that trend to continue. If there is a catch-up effect, it's hard to predict. I probably would not bang on that, but a solid continuous improvement with the market conditions also going in the right directions.

[Belén Garijo López, executive]

On your guidance question, let me basically emphasize that we are offering our best view of expectations and we capture the business assumptions that are visible to us as accurately as possible for the three sectors. And then something that you have to take into consideration is that the three sectors do not need to add up very precisely, right? So you need to understand that when we talk about Healthcare, for example, we are now raising the guidance versus the qualitative guidance that we -- that we gave in March, simply because we have further visibility and expectations on the way our base portfolio is going to move. Just take this as an example. But this in the Slide 16 of your presentation, you can see all the details and the drivers behind our guidance and do not expect that everything adds up.

[Peter Guenter, executive]

Yes, Oliver, on your third question, we've actually already introduced the concept that we want to become and we have become much more aggressive on the in-licensing front. And again, I don't want to repeat, but we have seen actually a flurry of deals end of last year, early this year. And the aim is really to have a pipeline that is at least 50% coming from external innovation to increase our shots on goal and to live up to the expectation to launch at least one new product or one major indication every 18 months. So this is very high on our agenda. And we are convinced that by doing that, we will continue to drive growth in Healthcare, as I mentioned earlier.

[Operator]

Your next question comes from the line of Ed Hall from Stifel.

[Edward Hall, analyst]

Just a couple of questions on Life Sciences. So firstly, more on the Process Solutions side. You touched on the China market slowdown, but could you necessarily talk about the U.S. and Europe ordering patterns, especially in the U.S. in terms of the Bio Secure Act uncertainties. Did this play any sort of impact in customer ordering patterns?

And then second question would be, you mentioned book-to-bill of around 1. I was wondering if you could qualitatively talk about Q2 and what you've seen so far? Is this tracking in line with expectations? And is this above Q1?

[Matthias Heinzel, executive]

All right. So on your first question, there was a few things mixed and maybe I'll start with Bio Secure Act. Obviously, we are monitoring that very carefully. There's a lot of dynamics there. I think it's really too early to assess the real impact. What I certainly can say, we feel we are very well positioned. Our in-region, 4-region supply chain model works well, and I think it's positioning us well, our portfolio as well. Also, none of our customers has more than like 2% of sales. So at the same time, and maybe you're pointing also to that direction, what could it mean on the upside, it's too early to tell. And for sure, we don't see it yet in order patterns or in sales.

What I can say that there's probably more inquiries coming in around the topic, but we need to see the next few months how that really unfolds.

Broader questions from you around the order pattern, I think I talked about that before. In general, we see as the trend unfolding as expected, that come Q2, the majority of our customers should be having the destocking behind them, both on the CDMO, but also on the other customers or the large customers. And yes, we see already larger customers already going back to an ordering pattern. We're also anticipating and seeing from us shorter lead times, that's an important component. So by and large, we are seeing things unfolding as expected.

And I think, then your question around the book-to-bill. Look, it's around 1, right? We are monitoring carefully every week, if you will, every month. It's not the right time now obviously to talk about Q2. I think, I gave enough indications based on the Q1 dynamics and the momentum and our expectation is that, as I mentioned before, the momentum continues, and we will see a strong H2 versus H1.

[Operator]

Your next question comes from the line of Gary Steventon from BNP Paribas Exane.

[Gary Steventon, analyst]

A couple on Life Science, please. So first one, just on Science & Lab. You noted that the customer orders were impacted by the SAP migration back in the second half of last year. So the question is more about what you're now seeing in that customer base, whether you're seeing those customers who needed to go elsewhere, coming straight back to order or whether you think there could be a longer-lasting impact from those lost sales?

And then secondly, actually just on Life Science Services, you made a comment in the slides in the prepared remarks as well about one of your CDMO customers streamlining their supply chain. So could you provide a bit more color here? Is this a customer that's moving away from you as a dual source of supply? Is this something you're generally seeing a bit more of now as supply chain [ pertain ] pressures ease. And then linked to that, is that something that could also potentially impact dynamics in Process Solutions and there are changes to supply chain. So your thoughts around those kind of points would be helpful.

[Matthias Heinzel, executive]

Yes. Thank you. Great questions. So on the first one, SAP, look, the issue is behind us, right? Some of the customers who needed their products within 48 hours, obviously, those sales are gone in that period last year, but we are not seeing an impact anymore. So if you will, the SLS dynamics is independent from the SAP situation we had last year.

Then the other point, and I think it's very specific which you picked up. Let me explain that. And so it was a specific customer situation where during COVID, we help the customer to organize their supply chain essentially to purchase raw materials and we had it like a pass-through. And we kind of phased out that specific situation because it wasn't needed anymore. So it was very specific. We put forward it to be transparent, but it's not if you will, a trend or whatever.

To be clear, in LFS, and we talk especially about the CDMO part and about the testing part. The CDMO part, it's more volatile, right? We are focusing on more the customers in the normal modalities, which are by nature in the early phases, right, depending on the, if you will, win as they go through their development phases and that what's driving a lot of the volatility. We have not lost customers, and that's not driving that volatility. And as such, that has not any, if you will, parallel effect on what we see on the PS side.

[Operator]

Your next question comes from the line of Brian Balchin from Jefferies.

[Unknown Analyst]

[indiscernible] from Jefferies. I'll be asking on behalf of Brian. So just two for me, please. On Electronics, can you help us understand which type of chips you'd expect to lead the early 2H recovery? Is it early pickup in logic? Is it likely to drive a greater rebound alongside memory? So that's the first question.

And then secondly, I understand there's been quite a few questions on reordering and Life Sciences. But perhaps could you give us a percentage on the customers that have begun to restock?

[Kai Beckmann, executive]

Let me take the Electronics question. So the recovery is typically defined by a return of the mainstream technologies, and this is predominantly 3D NAND that defines volume in our industry as well as mainstream logic as well as Analog. These are the three technologies that we need to recover volumes and to set the inflection point. The current early trend is defined by high-end AI-related technologies where we are specifically benefiting from. This is an atypical cycle where one technology is leading the pack early, and this is all related to the current trend towards AI.

[Matthias Heinzel, executive]

Yes. And on your PS question, look, we already have a substantial base of customers who are in the kind of reordering trend. We have others, which are kind of getting there as I mentioned before, by and large, we expect that the majority of the customers, the broad base of customers we have in PS, will have destocking behind them come end of Q2 right? Some of them will still come in Q3. But by and large, I would say we are exactly in that pattern, which we expected. Some are back to normal already and some are kind of in the process there. So I think that's exactly what we have anticipated and also what we communicated in our prior call.

[Operator]

Your next question comes from the line of Rajesh Kumar from HSBC.

[Rajesh Kumar, analyst]

The first question is on Process Solutions guidance. If we look at your guidance, how much of it requires the demand to sequentially improve from the current run rate versus the comps in the second half being softer? You could choose to [ onsite ] at the Life Sciences group level and Process Solutions or if Process Solutions is more helpful also -- please share that.

And then the second question is around margin improvement in Electronics. You clearly have said that the capacity ramp-up and therefore, expect the operational gearing more second half rated. And then can you characterize the nature of the gearing? So would you expect the incremental margins to be similar to previous periods of growth? Or can it be a little higher or lower? I know you've given a full year guidance range, but not just for this year going forward, beyond 2024, how should we think about the incremental margin in Electronics?

[Matthias Heinzel, executive]

Yes. On your first question, indeed, the guidance, if you will, reflects the mix, right? I mean, first of all, indeed, like second half last year, obviously, provides a lower base than first half last year because in Q1, we still had the lack of the effect of the destocking as we discussed a lot. So that's one component.

But indeed, the bigger component, and I think more relevant is the expectation that gradually, we're going back to the more normalized order pattern, several of the topics I mentioned already before. And think about the momentum we are building, which I explained before, with a book-to-bill around 1, with order intake sequentially increasing quarter-over-quarter, some more, some less, that will get us into the range of the guidance.

So I think that's the way I would look at it. That's the math and how it works. But certainly, we're expecting a solid book-to-bill around 1, including order intake to increase and also including that customers are acknowledging our shorter lead time so that the orders we are getting in a quarter are delivered sooner than during COVID times when we had much longer lead times. So that's kind of the -- how if you will, if you look at it holistically.

[Rajesh Kumar, analyst]

Sorry. In that context, can you sort of give us some color on what proportion of that business is driven by order books versus pot business because if we look at one, then we might be tempted to assume the whole business is order book driven, but surely, that's not the case.

[Matthias Heinzel, executive]

Look, I mean, I'm not sure I fully understand your question. Of course, there is a run rate business, right, but still customers place an order. So maybe happy to follow up with you, but I'm not exactly sure I'm clear about the question.

[Kai Beckmann, executive]

On your margin question for Electronics, the midterm guidance of around 30% is intact. So this is what we always communicated on the midterm margin development.

Now talking about short term, what happens in 2024. See on the positive side, a positive mix effect of the simple technology for advanced technologies, advanced nodes. That is a positive mix effect. We see the volume leverage kicking in over the quarters this year, especially after the inflection of the mainstream technologies mid of the year. And then on the more on the more conservative side, we see, of course, additional ramp-up costs coming in as we ramp up new capacity for our semiconductor materials, and that new capacity impacts the margin negatively. So don't extrapolate from Q1 because then you would exclude the ramp-up effects in your calculation.

[Operator]

Your next question comes from the line of Simon Baker from Redburn Atlantic.

[Simon Baker, analyst]

Two if I may, please. Firstly, on Electronics. I'm just trying to triangulate performance and guidance here. So 6.3% organic growth in Q1, guidance for the year, 0.4, guidance also for second half inflection. You did talk about DS&S phasing, but that would suggest that Q2 would be considerably lower growth than we saw in Q1. Is that the case? Is there any other factor at play? Or is this simply prudent guidance at a still relatively early stage of the year?

And then secondly, a quick question on Healthcare. Amongst the drivers you cited strong growth of TEPMETKO. I couldn't see a sales number in any of the releases. I wonder if you could possibly give us the TEPMETKO sales number for Q1.

[Kai Beckmann, executive]

Simon, let me start on Electronics. So first of all, I think you have to take into account a bit the low comps that we had in Q1 2023 in terms of factoring in the growth trajectory for the coming quarters. Second, the market reports, the recent, very recent market report as well as our customers communicating on their quarter, have shown a more cautious outlook into the rest of the year, which we had to take into account looking into our guidance.

Then you already mentioned the DS&S shift of one or the other invoice from one quarter to another or potentially even at the end of the year, into early next year, that could have an impact on our growth. So this defines a bit the lower end of the guidance and the upper end of the guidance is defined, of course, by the current adoption of new technologies and especially our involvement here in AI and highest-end technology that gives us the confidence on the positive side, as you find the full frame of the guidance and depending on what comes when, when we see us landing within those different boundaries.

[Peter Guenter, executive]

Yes, Simon, to your question on TEPMETKO , we have never disclosed it, but I guess you can calculate it by subtracting total oncology minus Erbitux and Bavencio. So it's a little bit shy of EUR 30 million in the first quarter. It's growing strongly. It's our first endeavor in the targeted therapy space, and we have actually very good performance in Japan also picking up seriously in the U.S. and also in the European countries where we have reimbursement.

I've also told you in the past that I think that the potential of the drug is somewhere around EUR 150 million. I can now say that very confidently. And when I see the development, it may even go a little bit above EUR 150 million.

[Operator]

Your next question comes from the line of Florent Cespedes from Bernstein.

[Florent Cespedes, analyst]

Florence Cespedes, Bernstein. Three quick ones. First, for Peter, on the pipeline, Peter, please, could you give us a little bit more color on what we should expect for the 3rd of June call and early oncology? And is it an area where we should to see some in-licensing activity?

And the second question on pharma on fertility. Could you give us please a little bit more color on how we should see the rest of the year? We see quarter-on-quarter, the sales kind of plateauing on the fertility. Do you see more pricing pressure or some volumes are slowing down due to the competitive environment?

And my third question, if I may, is on Life Science Services. It's just a follow-up to make sure that we understand on the CDMO business. You said on your slide that there is an unfavorable batch phasing. So is it a kind of one-off impacting this quarter? And should we -- if we should see some recovery in Q2? Or is it something that should impact also the rest of the quarters? Any clarification on this front would be great.

[Peter Guenter, executive]

Yes. Thank you, Florent. So your first question on the R&D cost. So what you can expect is really early oncology in focus, no focus on xevinapant on this time around. So it's about our very, very nicely advancing ADC technology with [ anti-C 5 ] as a frontrunner as you know. We will talk about the DDR portfolio with Tuvusertib, as you have seen in the R&D catalyst slide moving into Phase II in combination, of course, also updates on the selective PARP1 inhibitor that we licensed from Hungary. And we'll also give you some more color on Pimicotinib. So I think it's going to be really interesting to get that better. And of course, we will also talk there about the future continuation of in-licensing strategy.

Your question on fertility, I think the way you should think about it is that the stock out of the competitors is really fading out relatively quickly now, and that the growth that you have seen in Q1 is largely driven, largely driven, not exclusively, but largely, by the low comparators in Q1 in China.

In other words, moving forward for the rest of the year, I think you should think about a flat to slightly growing fertility business for the year to go. And then we think that as of 2025, we will resume a "normal situation" with competition back, and then we would return in principle to a mid-single-digit growth rate.

[Matthias Heinzel, executive]

Sorry, continuing on the LSS question.

[Constantin Fest, executive]

One more, apologies.

[Matthias Heinzel, executive]

Yes, let me give the chance to explain that, indeed, thanks for your question. So look, in the CDMO business, we are serving -- compared to other businesses, we have a much smaller set of customers. Those are much more in the early phases, right, early biotechs, which are developing those novel modalities. So by definition, we are depending, and I mentioned that before, a bit more on how their development goes through the different phases, right? Will they hit the milestone and that triggers then what we call the batch phasing, right? Do I get some of their batches in this quarter? If they have a delay of 6 months, it will come 2 quarters later.

That's why the way I would look at the LSS business, especially the CDMO portion is much more volatile. It could go up a quarter, right, if we get a batch in, it could go down. And the next quarter the batch is kind of delayed. So you will see that business a little bit more volatile quarter-over-quarter. We're still expecting towards certainly the midterm as the business grows, getting a little bit more stable. But that's kind of the dynamics of that business.

[Constantin Fest, executive]

Thank you for all of your questions. Belen, any closing words from your side?

[Belén Garijo López, executive]

Yes, very briefly. So thank you very much, and thanks, everyone, for your continued interest in Merck. I think we can say very firmly that 2023 has confirmed as indeed as a transition year. And with Q1 2024, we have begun our journey to return to organic sales and EBITDA pre growth now in 2024. So we remain highly committed to continuously execute our strategy and most importantly, to delivering on our commit -- on our commitments for profitable growth and sustainable value maximization.

So we look forward to meeting many of you at the upcoming road shows and conferences, including ASCO 2024. And as Peter mentioned, our R&D update call in early June. Please also note that we will be hosting our Capital Markets Day on October 17, and it will be here at our beautiful headquarters in Darmstadt, as you might have already seen on our web page. So Constantin will then send an invitation with all details, and we would be absolutely delighted to welcome as many of you as possible here in our headquarters.

With this, thank you so much for your attention and support, and goodbye.

[Operator]

Ladies and gentlemen, thank you for your attendance. This call has been concluded. You may disconnect.