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Glaxosmithkline plc (NYSE:GSK)

Q4 2009 Earnings Call

February 4, 2010 9:00 am ET

Executives

Andrew Witty - CEO

Julian Heslop - CFO

Analysts

Andrew Baum - Morgan Stanley

Graham Parry - Banc of America/Merrill Lynch

Jeff Holford - Jefferies

Michael Leacock - RBS

Naresh Chauhan - ICAP

Justin Smith - JPMorgan

Andrew Witty

Good afternoon everybody, thank you very much for joining us today for our 2009 results briefing. Also, welcome to everybody, who is watching this on the webcast as well. What we are going to do today is, all you run through a view of where we are at as a business. And then, Julian Heslop, our Finance Director will come up and take you through the detailed numbers for 2009 and give you some signals to some of the cost flow guidance percentages going forward into 2010. And then, we'll obviously have a Q&A session at the end.

Let me start by saying, I really think that 2009 was a very important year for GSK, more than for any other reason that it really started to demonstrate that the strategy that we've been deploying over the last couple of years has really begun to bite and start to deliver. And that's being true across a number of parts of the business that I'll describe in a few minutes.

I think it's also an important year, psychologically, because it saw the return to sales growth for the first time, since 2007. And it's sometimes interesting, and I did this little analysis on Friday just to look back and during '07, '08, and '09 between U.S. generics and the loss of an Avandia sales, the company actually lost £4.5 billion of turnover in the '07,'08, '09 period, but actually grew by 500 million. So, in that period, where we clearly had tremendous pressure on us from U.S. generics and Avandia to name just a couple of big areas, we've been able to grow the overall business, actually added £5 billion of new sales over those three years.

And of course, in 2009, what you started to see is that reflected in a net growth of sales, as the headwinds have started to diminish and the tailwinds have started to become stronger. And that's because, A, obviously, a change in some of those negatives, but, B, more importantly, coming on stream of a whole series of sources of growth for the business.

In some ways, as I look forward now into 2010, really start to see the company come through what you might have regarded, as its patent cliff in terms of saying goodbye to a whole portfolio of legacy brands in the U.S. marketplace. I am not too humorous this early in the afternoon, I think, to some degree, GSK's patent cliff ended up being a gentle slope.

Let me move on to where we are in terms of strategy. What you've seen across the organization is a real commitment to drive growth on a diversified global basis. That's really been driven through our investments in our emerging markets, our consumer business in Japan, our vaccine business, and of course, ensuring that our new product pipeline is delivered into the marketplace efficiently.

I just want to point out, some of you will notice there's some different numbers on this slide. There's a typing mistake in the slide book you have in front of you, where it says Rx, CX sales in emerging markets. The numbers on here are 21% of GSK sales growth 16% are correct. This is the correct version. I think the books you have in front of you have slightly wrong numbers, in there. We just simply pull that measure together just to try and put our emerging market numbers on the same basis, as many other companies, obviously, everybody measures their emerging markets slightly different ways. What this does is bring together everything we do in the emerging markets, whether it's consumer or Rx into the same place.

What you can see immediately is, it's a substantial part of the business and it's growing very well. The right hand side of the slide, you can see that we are continuing to be successful in diminishing our exposure to white pills western market business, that business which has been most volatile for the industry in the last 10 years due to patent invalidation, for example, and the phenomenon of super rapid genericization at the end of exclusivity. That business has now come down to under 30%, about 29% for 2009, from a level of 40% in 2007.

What you've also seen during the year is a continued effort to really make sure that we are allocating capital and resources in this company in the places, where we can generate the very best returns. You know, we've been running a program to save £1.7 billion out of our cost base, much of it reinvested back into growth businesses of the organization. We're on track with that program, £1 billion of cost savings achieved by the end of 2009, the rest to be achieved by the end of 2011.

And today, we've made an announcement that we intend to increase that number by a further £500 million, new £500 million of savings to be delivered in full by the end of 2012, half of it to come from R&D, half of it from SG&A around the world and 70% of that new £500 million flow to the bottom line.

Working capital is now a focus of the company. It was not a focus of the company up until two years ago. And you can see that we've generated a benefit of £1.5 billion in improved working capital. You won't necessarily see that in the numbers because clearly, what that has allowed us to do is to engage in growth businesses, which, for example, consume more working capital, like emerging markets, et cetera. And it also somewhat allowed us to absorb the huge stock build that was required around H1N1 without increasing the working capital for the company. Julian will talk more about that in a second, but rest assured the fundamental efficiency of the company is working well in terms of working capital, all of that helping contribute to a significant increase of about 12% in free cash flow to just over £5 billion during the year.

R&D continued to perform extremely strong, and I'm going to talk more about R&D in a few minutes, because you will have seen that we've made some announcement today on proposals that we are planning to make changes in parts of R&D. But right from the beginning, let me emphasize, the strategy for GSK R&D is working. Again, in 2009, we achieved more NME and vaccine approvals from FDA than any other company, in fact, we were neck and neck with Novartis, four each.

If you look over the period 2007, '08, '09, we have the highest number, 13% of all new molecular approvals from FDA were GSK's. Real evidence of the performance of the R&D organization, and of course that's helping us diversify even in our core business. So, whereas, in the past we've been hugely dependent on one or two drugs even in our core Western Pharma business you are beginning to see us diversify out of that potential growth, I'll touch on more later.

Looking forward, we've seen six opportunities for new molecular entity launches over the next 18 months, the most exciting of which is likely to be Benlysta, but also among the several new vaccines.

Now, if I just go for a quick summary of 2009, Julian is going to give you a lot more detail of the numbers. But just to pull out some of the highlights, first of all, growth, back to positive sales growth for the company, 3% overall, obviously driven by very strong performance of a number of our newer portfolio brands, particularly in the vaccine area. Obviously, H1N1 was a significant contributor to sales during the year. Delighted by the performance of the company in response to the H1N1 demand from governments around the world, an absolutely excellent example of long-term investment over the last 15 years, putting the company in a position where we have the right technology and capacity to be able to respond in an unprecedented speed to the demands that government has placed on us.

As you will have seen substantial sales in 2009 and as of today, obviously following a whole variety of conversations with governments over the last eight weeks, we currently expect sales in this area of H1N1 to be about the same in 2010, as they were in 2009. But elsewhere in the vaccine business, great start for Synflorix. You can see Synflorix was only launched at the end of Q3 of last year, £73 million, very strong start in, particularly, the emerging markets, now registered in about 50 countries around the world.

Cervarix, good strong growth here, very lumpy in terms of sales because so much of that business is dominated by particularly European tenders. You tend to get quarters with very big sales and then another quarter very low sales. Q4 happened to be a low quarter, I can tell you Q1 is going to be a big quarter.

So, Cervarix is a very lumpy product at the moment, but as we speak, promotion is starting both in the U.S. and in Japan. Those markets are likely to be less tender driven and therefore, I think, you will start to see Cervarix move out over the next couple of years. But for this year, like last year, I would expect to see that European tender phenomenon continue to be present in the patent.

Elsewhere, in terms of growth, I have to mention Advair. Advair, our biggest product, continues to perform very strongly, up 5% for the year, in fact up 7% in Q4, very strong performance across the world, emerging markets, Japan extremely strong and a pickup in our U.S. performance is of course is a key metric for us.

If I look generally across our business, you can see some core, midsize brands performing well, Lovaza, Avodart, Arixtra, and in particular also you see Europe strongly helped by H1N1, and Japan have very strong performance. I'll just mention, just for your information, there are zero sales of H1N1 in 2009 Japan numbers. So that is all new products, core organic business. And Relenza, an unusually, the majority of Relenza in Japan is in the retail sector, not in government orders. So, Japan had an extremely strong year, and shipments of H1N1 vaccine to the Japanese market have started in Q1 of this year.

If I look at R&D, one very important area we wanted to focus on a couple of years ago was to build up our Biopharma area, and you see that really beginning to now deliver, first approval of Arzerra, now we have a positive opinion for Prolia. This is denosumab in partnership obviously with Amgen, where we have essentially PMO marketing rights in Europe, we have PMO in oncology and commercialization rights in the emerging markets. Positive opinion there from the European Union was very encouraging.

Benlysta, you all know the data looks encouraging, we aim to file during the first half, for Benlysta. So, Biopharma is moving forward. We have a series of other molecules in full development, for example, [Trex 4] type I diabetes. And right now, we have 19% of our R&D clinical programs are biopharmaceuticals. So, significant shift forward in making sure that we have a portfolio of large molecules in addition to our vaccines portfolio and alongside the small molecules.

Emerging market, Pharma business had a very strong year, up 20%. You can see Advair, Augmentin and others driving that and our consumer business, I think, frankly had a spectacular year, 7% up in a year of recession in most economies of the world, 7% up in a marketplace which grew around 2%. We grew market share in almost every segment, with the exception of U.K. Nutritionals. And in America, for example, we increased our oral care toothpaste market share by over 3 percentage points.

The launch of alli in Europe, first pan-European deregulation by any company and although, launched in early April of 2009, achieved sales of the third highest selling product in OTC for Europe. So, very, very strong performance from Europe, which has been continued, certainly, into January of this year.

Now, in terms of inorganic growth, we made it very clear that we would be focused on value creating bolt on acquisitions. And during 2009, we in fact executed 11 of those across the business. You can see here a summary of small to medium in all of the key areas we wanted to focus on. So, we make these investments in those businesses we want to drive great growth in, emerging markets. Obviously, on select areas of the pharmaceutical business, vaccines and consumer.

All of these deals put in place last year. We set ourselves disciplined financial metrics, there are lots more deals than this around. We were involved in plenty more, but we walked away from a series, particularly in Q4, there was quite a lot of activity around and our view was that companies were being sold for prices which didn't make economic sense for us.

Just as an aside, all of the deals on this chart, all of these transactions we have a projected internal rate of return which exceed 14% for us. So, it gives you some idea of the kind of return that we anticipate in the future, that these transactions can generate for the company. Very disciplined financially around this and we are not going to get drawn into buying or bidding up at prices on companies. It was important period at the end of last year to signal to a number of putative sellers that they couldn't necessarily count on GSK to be there at the last round of the auction, they can't. We'll be there, if it makes sense for GSK at the right price.

Let me go into a little bit more detail about the biggest of these acquisitions, which is Stiefel. And I just wanted to take a couple of minutes just to describe to you why, in my view, Stiefel is the right kind of acquisition for GSK and you've seen the numbers, you've seen the synergies which we can generate and essentially, we could value, we could generate the value of the acquisition through the synergies, which were achievable for the business.

So, we have a lot of opportunity to take cost out of this business. Why do we do that? Why are we confident? Because, we are bolting on to a pre-existing dermatology organization. In fact, on a pro-forma basis, counting the sales that Stiefel booked before we took control, last year, this business combined, GSK dermatology plus Stiefel dermatology generated sales of over £1 billion, so big business, you bring these two businesses together, great synergies. We are taking cost out of GSK dermatology, and of course, we are taking cost out of Stiefel, as an organization.

We're well on the way to integration and you can see very substantial amounts of cost synergies coming out of this business in the upper right hand box of this slide. G&A coming down dramatically, not surprisingly. You can bolt on these small acquisitions, you really, this is a marginal increase in activity for our finance organization, HR organization in GSK, huge synergy opportunities, very aggressive chance.

The area which is much more unusual and actually was one of the reasons we originally targeted Stiefel was the opportunity to hit the gross margin. And you will see here that five out of the six factories that Stiefel ran are already announced for closure. And you might wonder how we can go so quickly to close those plants. I want to explain that to you very briefly, and I will use a prop for this. This is a pack of Univate, manufactured by Glaxo Dermatology at Barnard Castle, a factory we run in the north of England.

In the last 2.5 years, through a reengineering of the process of that plant, we were able to increase efficiency of that factory by 40%. By increasing the efficiency of the factory by 40%, that factory, without any new investment can absorb 55% of all of Stiefel's volume. So, we were able to eliminate essentially an entire fixed asset base and draw all that volume into spare capacity that we had created in GSK. What that's allowing us to do is not just take synergy from the obvious SG&A line of the Stiefel P&L, but also from the cost of goods line, very unusual to do, very hard to get out so quickly and that's, on that level, why we are so confident, we can generate very rapid improvements in the margin of Stiefel.

Right now, very hard to see because of all of the puts and takes in the acquisition year, but roughly, roughly, the margin when we bought Stiefel that business about 20%. What you can see, it's going to very dramatically improve. What we also believe, unusually with an acquisition like this, is that we have the chance to now globalize the portfolio of products. So, this speaks very much to it's a global footprint company acquiring a business, which for whatever reason, had been resource constrained, had never commercialized. No Stiefel products in Japan, no Stiefel products in China, no Stiefel products in India. That clearly is an agenda for us to move forward.

For our synergies in terms of how we develop our compounds, obviously, GSK had, overtime, not prioritized dermatology development of a series of assets. Now, by retaining an R&D focus from Stiefel on dermatology, we can restart that effort to find new assets.

And the final area is that we intend to create a fourth platform for our Consumer business. Within Stiefel, there is a big chunk of the pharmaceutical business, but there are also a tremendous portfolio of straight consumer dermatology brands, which have never really been commercialized, as a true consumer business through a professional consumer organization. So, in future our intention alongside Nutritionals, Oral Care, OTC is to build up now a consumer dermatology platform for our consumer business.

So, what you have in this acquisition is a multi-pronged approach to extract value from the transaction, which was initially justified simply on the cost synergies that were achievable. That's the kind of acquisition we like to find, they're not easy to find, there aren't many around, but when we can find them, we're prepared to go and win them.

Now, I want to move on now to a more generalized set of comments about how we think about cost and capital allocations and simplifying our business and I'm going to start by focusing on R&D, not least because we've made announcement today on some further changes in terms of where we intend to invest in R&D. Before I go into that detail, I really want to make a couple of comments about our overall strategy in R&D. This slide you've seen before.

Moncef Slaoui presented this slide, it captures exactly the themes on which we focus and how we want to develop our R&D capabilities. We want to focus on the best science, we want to bring, re-personalize R&D, bring individuals, not the process, back into discovery. We want to diversify our effort through greater externalization, and we'll focus on improving the return on investments. None of that has changed. In fact, nothing in the GSK strategy has changed, as a consequence of the announcements made today.

We are extremely, extremely positive about the way things are going. And I'll show you a little bit why. This gives you a sense of the progression of our delivery from R&D, a whole raft of products. This is why we have the highest number of approvals from FDA over the last three years. And if I project forward just another year, what might we have over the next year and a half, another six molecules. And it's interesting, if you look at this tall bright bar, there are actually 21 novel small chemical entities, all biopharmaceuticals, all vaccines, 21.

Remember, this company didn't launch a single novel molecule between 1998 and 2007. So, a huge shift in terms of the delivery of pipeline, of course, what this requires is tremendous changes in commercialization approaches. How do we tackle specialist markets, all of those things? But the flow of products, which is coming through is clearly demonstrating a huge shift in capability.

The performance of the R&D is extremely positive all the way from our discovery performance units, which are all up and running, all the way through development. Can we expect more? I believe we can. So, if I just look at a snapshot of the performance card that I look at for our R&D organization, this shows you what 2009 looks like, how many approvals, how many filings, how many key Phase III starts, how many first time in humans.

Now, you know, I never talked about anything before Phase III; I'm not going to change that commitment today, but I think, it's worthwhile every few years just let you know that actually, beneath the surface, there's a tremendous amount of progression in terms of activity. What's critical is that nowhere are we paying anybody just for numbers. We will pay people for quality. What does quality mean? It means differentiated medicines of value to patients and to payors. That's why the reimbursement system or the payment system of bonuses in our R&D organization has in it a trigger, which is associated with reimbursement.

So, the R&D team cannot get their maximum bonuses simply by churning out files or simply by progressing molecules. They have to deliver molecules which ultimately get reimbursed, which clearly the measure of value for money in today's society. So, great that we've got activity, what's more important is that activity is focused on delivering quality. That's why, during 2009, we terminated at least six programs of drugs which had nothing wrong with them, they were perfectly safe as far as we could see. They had activity in the disease area. We just didn't believe, we could differentiate them and we weren't going to carry on spending money on them simply to generate a product where we failed to get reimbursements. That is evidence of the focus on quality in the business.

How might we drive greater returns inside our R&D organization? Well, we can shift more of the activity to late stage development because that's where value is really created. We've got more going on in the late stage, it means, we are really bringing product to the marketplace, not just spinning our wheels going around hypothesis after hypothesis. And you can see in the first left hand box, a big shift over the last several years of resources from the early phase conceptual research to late phase full development.

We can do more with external partners. And again, you can see this is not something we're talking about for the first time that we might do in the future. It's something that's fundamentally part of our organization and you can see the number of projects in the middle box, which are now executed with external partners. We want to grow biopharmaceuticals because we know that the run out period of returns on those molecules are likely to be higher than small molecules. So, I've said to you already, 19% of our clinical pipeline is now Biopharma excluding vaccines, and you can see here the number of biopharmaceutical molecules which have now been brought through.

I've told you already about how we focus on differentiation and it's clear that we want to drive more efficiency. And I'll give you some examples of that in a second. Before that, just to remind you where our externalization network is at, this is a slide I showed you last year, 34 or so external engines. We now have 47 external engines, you can see here a raft of the deals, we've done during the year, and the company continues to be a very strong believer in the merits of this. It's not just about numbers, it's about diversity of approach, tapping into research teams, which have a fundamentally different thought process than our own gives us more probability of hitching a win.

What this has done is actually replaced quite a bit late stage licensing. So, rather than chasing around after the one or two assets which are out there, we go for them sometimes, but generally those things have not proven to be so productive for us. What this has given us is low cost optionality over a huge amount of potential product flow, most recent one of which came through positively with the Crohn's disease program from ChemoCentryx, which we optioned in just after Christmas.

So, the externalization is really a feature of the way we run this business and there are certain DPUs in GSK, who have elected to spend, or up to, or even, in some cases, more than half of their resources on external collaboration. Very interesting, because what that's telling you is that the researchers are saying, I'll take the money, I have got from GSK, and rather than pay for GSK scientists in GSK labs, I want to use that money with an external partner. It really shows an open mindedness to chase the best science, which is what we are trying to encourage.

Move on now to efficiency. So, from one part of the R&D framework of discovery and invention to the second, which is, now we've got the product, how do we do this at a lower cost? And this is, again, an area where we've made, I believe, very, very strong progress over the last couple of years. And this slide simply lists for you a few examples of how we are trying to change, the way, we spend money in this part of the business. It's obvious to everybody, this consumes enormous amounts of resources.

And you may look at some of these things and think, God, that's very simple. How obvious is that? But you can imagine when you are talking about, as we are, at GSK, having 40,000 patients in clinical trials just in pharmaceuticals excluding vaccines, how you make a performance change across 40 countries, how you get those kind of improvements in performance, they are not trivial operational challenges. What this shows you is, we are making great strides, very obvious stuff.

How many sites only ever recruit zero patients after you've spent all the money to initiate the site? It used to be 29% of the sites, now it's 19%, huge benefit. How many save money by not over supplying clinical trial materials that aren't ultimately used. Yes, in fact, over the last two or three years, we've saved over $100 million. Can we be more focused in where we do our research, yes, by reducing our clinical trials footprint. Can we get things more consolidated and go quicker, yes, you can see from Syncria, who are far ahead of schedule because of the approach we've taken in simplifying and consolidating our research planning.

All of these are just very simple examples, but you can imagine, just by that $120 million price tag in the middle, each one of these apparently minor twitches of the dial generates huge dollars. And that's why we are able to keep the same 30 drugs in full development and deliver the filings and approvals without massively increasing our R&D spend. We spend today, roughly, roughly the same amount we spent three, four years ago, adjusted for inflation. And yet, we are churning out a substantially greater amount of product because of these sorts of disciplines in the organization.

Now, let me move on to what we've announced today, which really speaks to how we can go further in terms of tackling our return on investment in R&D. The strategy, I believe, is the right strategy. It's delivering, but we should never be complacent about driving up returns. Just a couple of facts or a couple of dimensions to think about, first of all, about a third of our R&D cost is in fixed infrastructure. What does that mean? January 1st, the first scientist walks through the door, turns on the light, and a third of the costs are incurred for the entire company, because its building it's all that fixed infrastructure. It's a huge overhang from the 1980s.

Today, if we started again, would we all go around building massive research centers? I don't think we would, because we want to see a more flexible, a more virtual, a more engaged, diversified research collaborative environment, but we have these enormous research centers. That's what's driving our fixed infrastructure, in many instances. So, can we do something about it now?

Secondly, if we look across all of the diseases we are active in, where are we in terms of risk and return? So, in terms of the cost of being successful, versus the probability of success, have we got outliers where, frankly, the right decision is to say, right now this isn't a place for us to be focused. Doesn't mean, we could never win, but the probability is we won't. And that's why today we've made announcements associated with proposals, subject to consultations, to reduce our research activity in the neuroscience area.

So, what this means is, we'll be proposing to cease research in areas such as depression, in pain, anxiety et cetera, because we'll continue in areas such as Alzheimer's, other neurodegenerative conditions. The point here is that we've identified those first set of neuroscience diseases, as ones where we believe, for various reasons, I'm happy to get into if you wish, where we believe the probability of success is relatively low. We think the cost of achieving success is disproportionately high, and it so happens that that research activity underpins the some pretty substantial fixed infrastructure.

By disinvesting from this area, we are able to significantly reduce our exposure to fixed infrastructure costs, about £250 million in total, releasable over the next three years. 70% of that we intend to deploy back to the bottom line. About a third reinvested, you saw today, we announced creation of a rare disease initiative. That's where some of that money is going to go, so the majority of it coming to the bottom line. And what this is about is finding a clear opportunity, where we can target a change in activity without changing the strategy and significantly improve the return of the operation.

Let me go to a general point about returns. I think, I'm probably talking to a room full of people, who are completely convinced that the return rate of the pharmaceutical industry's R&D engines over the last 15 years has been less than optimal. And I don't know what number you would pick, but if you looked at the work that McKenzie did, they basically assessed industry return on investments in pharmaceuticals published last year, and they estimate about 7%, 7% internal rate of return.

We've looked at all of our activities with our current late stage pipeline, so those products we've just launched and those that we are imminently to launch and we basically tried to assess what we believe our current internal rate of return is. And we believe, it sits around 11% across our organization.

Now, of course, this is subject to all those future sales, which will come in over the next 20 years, a very long forecast. And it's subject to a view of how we allocate resources. I think the back of your packs there's a page which gives you a little bit more detail of the methodologies that I'm not going to go through.

Our view today is that our internal rate of return is about 11%. We believe, we can improve that and so we set for ourselves an aspiration to improve that 11% by another 25% to somewhere in the order of 14% over the next few years and that's where we'd like to go, and that's why we're so focused on trying to drive all those things I've just talked to you about in R&D, better quality decisions, focus in areas where we have the best chance of winning, making sure we are efficient and making sure that organization continues on a steady state basis to generate the outputs that we've been seeing. I think, we're well on the way, as this indicates, to that.

Now, let me move on to other areas of where we spend money in the organization. Cost control and thoughtful allocation of resources is really a key dimension of how we're running the business in GSK. I'll go to SG&A, first of all. I thought, it would be interesting just to give you a sense over the last couple of years of how we've been moving our resources around. We've obviously been restructuring the business and we've taken a lot of money away from our legacy businesses, particularly in Western Europe, particularly in America and we've redeployed them into our emerging markets.

And you can see here the amount of resource, which has grown over the last several years in terms of allocation to our emerging markets. Just as an anecdote, nothing more than that, it's interesting that for the very first time in December 2009, we employed more representatives outside of America and Europe than we did inside of America and Europe. It gives you just a sense of the reality of the shift of resources in the organization.

Let me jump to consumer for a second. You see here in the consumers, two parts of this slide, the left hand slide incremental advertising, largely funded by savings from within the consumer business. That's been a key priority for us over the last two years, increased our advertising activity and also, importantly, increased our spend on innovation. Today, we spend about twice as much on consumer R&D, as we did when I took over. I believe that's why we've been able to keep some of our biggest brands so current in a period of recession.

It doesn't matter how much you spend on advertising if you add to rubbish. So, the slide, the picture on the right hand side of this slide simply gives you a sense of how we judge that. So, we test every ad for persuasion, for brand recognition, memorability, typical FMCG tests, and you can see that 83% of our ads score in the upper 20% of all ads. The combination of volume, of activity, quality is what is really underpinning consumer.

That's why, I've been very keen and prepared to continue to invest behind our consumer business, it's why you'll see last year, we saw great sales growth. You didn't see parallel profit growth. Why? Because, we needed to get that consumer business to the right level of investment, the right decision and even as we went through Q4, we continued to spend that level. I'm delighted, we did because we've had a fantastic start in January with our consumer business, even stronger than the performance we saw last year. And I think vindicates the commitment to allocate resources to this part of the business.

Going forward, though, I believe, we've got the right kind of level in the equation for the consumer business. So, going forward, I fully expect to see profit growth come alongside sales growth in this business. If I look at our emerging markets, probably, talk a little bit more about an increase in SG&A.

There you can see again increases. Just to show you where they've come from, you can see the effort, the allocation of resources in China, in Russia, reinvestment behind some legacy products. It's an interesting phenomenon in our emerging markets business that for a few years some of the products like Augmentin and Ventolin haven't been invested in as well as they should have been. It's been a big shift to try and reverse that trend and that's why you are seeing a lot of out performance in the emerging markets.

If we look at, now, G&A, so, moving away from S and focus more on G&A, I just wanted to touch on a couple of areas that we are very focused on. One is how do we reduce the cost of support or administration to the business? We have a goal to take out 20% of our costs in this area by the end of 2011. We're already well on the way to that. What does that look like? A sense of excellence, new systems, we run today something like over 20 back office finance systems across the world. You can imagine how complex that is to make anything happen. There's a lot of standardization, simplification, creation of sense of excellence, a real opportunity to drive that across the business.

And overtime, you'll see us move towards a global business service type environment which will give us over the next four or five years, year-on-year opportunities, I believe, to drive efficiency in this part of the organization.

We also have real opportunity to further reduce our real estate footprint. And you can see from this slide, over the next few years, we expect to exit up to another 11 million square feet, about 13% of our real estate portfolio. That gives us a real chance to reduce our infrastructure costs, at least partially. I've already mentioned some of it, in R&D. What it also does, it simplifies the organization, allows us to really concentrate our activities in a few places and take away what is clearly a lot of cost driver.

One other little example here, we are in the process right now of reducing the people, who supply our sites, these are people who do catering, cleaning, all of those things, from 40 to 3. And you can see, just doing something like that generates almost £100 million of savings. So, across the Board we are very much focused on how to do that.

Finally, on this piece of the commentary, I wanted to touch on manufacturing. I don't often talk in this group about manufacturing, and I think it's something that deserves a little bit of a spotlight because the amount of work that's been going on there over the last several years is quite incredible. Just to give you an orientation, this is our manufacturing network for our consumer and pharmaceutical businesses. It does not include the vaccine business. To give you a sense, vaccines are another 15 factories with another 6000 people. But everything, I'm going to talk about from now on is really about Pharma and consumer.

You see spread across the world, 79 sites, over 1300 brands. We have a massive contract manufacturing network of about 150 suppliers, and this has changed dramatically over the last few years. I think, it's also fair to say this benchmarked extremely well against others. So, for example, we run less consumer factories than Reckitt Benckiser. We run about the same total number of factories, as the new Pfizer/Wyeth. So, if you look across the headlines, they look broadly similar. We continue to look for ways in which we can reduce this footprint. There's been a tremendous number of site exits over the last five or six years. And in the future, there will be a few, but not many.

So, where the real opportunity now sits is really making sure that we are getting process efficiency into our organization and there is a huge effort going on across the business. I wanted to show you some of the results of that because I think sometimes, we haven't necessarily told, as much about this as we should have done. This slide on the left shows you, first of all, what I've just said, number of sites exiting over the last few years. But the second bar chart shows you remarkable improvement in productivity, so an 80% improvement in productivity per head in the manufacturing organization over the last eight years.

And then, we've simply taken one product, probably one you are interested in, in terms of what that actually means for cost of goods on a product like Advair and you can see here very substantial reduction in cost associated with Advair. How do we do that? Very much grinding through the process, you see on the slide, lean Sigma practices, making sure that we've got absolutely the best process in place across all of our lines across the organization, constantly looking to upgrade technologies. That kind of activity is going on across all of our product lines in the business. That's what's allowing us to offset some of this very big margin pressure, you've seen in the past from losing the old generic products in America.

As that loss of generic product goes away, the negative margin pressure is going to ameliorate significantly and you are going to see benefits come through in terms of these sorts of changes. I thought, it might be useful just to show you a little bit what this looks like over a lifecycle of a product, so how we think about manufacturing, because, again, people tend to be a little bit religious about manufacturing. It's either all in house or it's all out of house. And the reality is, it has to be a bit of both. And we want to be clear about where we believe manufacturing makes sense to be held internally versus done externally.

So, the beginning of a product, we truly believe this is where enormous amounts of value, intellectual property and trade secrets are developed. Sometimes those become so important and so pivotal, you are never going to release them. On others, they don't. You generate them, you generate smooth introduction, and then, you are fine to disengage. So, at the beginning, we'll be very engaged around API manufacture. So, for example, in Singapore and Ireland, you will see the company very active around how we develop the manufacturing technologies using a series of technologies we have as a company.

We've driven towards co-location of development and scale up and we focus on making sure that the manufacturing people are engaged with R&D to make sure that the production process actually can work in the factories, quite a novel concept in drug discovery.

As we move forward into the mid and late stage of the life of a product, then we're going to be much more flexible about how we might operate. So, for example, on products where we don't think there is significant IP, that's when we're going to start to bring in outsourcing, we start to externalize our pipelines. On others, like Advair, nobody is coming anywhere near it. So, on that one, completely inside the company, tremendous amount of technology there, we all know how difficult others find it to do what we do. And we focus very much on process improvement. As you get to the end of a product life, then we're looking to essentially externalize the manufacturing supply line and to then consolidate our environment with only just a few exceptions.

Now, to bring this to life, I thought, I'd show you what we're doing with Valtrex. So, Valtrex is our most recent product to go to generic. We launched it in 1999. I've used percentages rather than pounds per kilogram. Nonetheless, you can see what is happening. You start at the beginning, it costs, obviously, 100% of the start price in terms of average costs. By 2006, we had already reduced that cost by 40%, by going through the procedures I just described, and today, we are at 40% of the price we had back at the beginning, in 1999.

So, a very clear example of the effect of being able to deploy the right manufacturing approach to the right phase of the drug. Some of you might wonder, why didn't you give me just the pounds? Why are you making life difficult by having percentages and indexing it? Why not just give you the pounds? The reason, I'm not giving you the pounds is because the generic manufacturers are interested in buying it from us. And I didn't think, we should tell them what our costs were. Interesting notion that the generics would like to buy from us time-to-time.

If we look now, finally, I want to pull together all of this. So, we have an organization, back to sales growth, strategy working, a series of engines firing for the organization, headwinds diminishing, in terms of genericization, and we have an organization focused on appropriate capital deployment and ensuring that we are minimizing our costs. The net of all of that is why I think we are right to be confident about the future prospects of the company. If we look at the overall operating margin of the business, which, if you will, is the final bringing together of all of this, there are clearly questions. Obviously, as you lose Valtrex, you get some pressure on your margins. Obviously, as we grow consumer, we create pressure on the margin, quite rightly, because we know that business shouldn't be run at the same high margin as historic pharmaceuticals. But we are ready to go for that because we want the growth of profits even though it's at a lower margin.

On the counter side, you can see the programs we have in place to reduce costs and to reallocate resources rather than just create new spend is all about how we believe, certainly during 2010, we expect our operating margin to be broadly stable with that of 2009. And Julian will give you a little bit more detail.

So, for me to finish, before I hand over to Julian, really just to summarize where we are at. We are back to growth. We've got very effective cost control in this organization, and we have made very strategically coherent decisions about where to divert resources, spend money and where necessary increase activity. Our R&D modeling in my view is working and against all the benchmarks in this industry, I think, its fair to say that we are succeed in changing R&D.

Notwithstanding that, we are ready to commit to what we believe a reasonable rate of return ought to be and to do what's necessary to deliver it, as you've seen with the proposal today. And all of that is driven around the commitment to delivering shareholder value in terms of performance of the business and of course, in terms of generation of cash and then ultimately dividend increases to our shareholders, which, again, I was delighted, we were able to increase by 7% this time for our shareholders.

So with that, I'll hand over to Julian, who will take you through the detail of 2009.

Julian Heslop

Thank you, Andrew, and good afternoon. I will, as always, talk about performance excluding restructuring costs. And I'll mainly focus on growth at constant exchange rates. This chart here summarizes our overall performance. As you can see, turnover was up 3% and EPS up 2% for the year. Within EPS, we took a gain on the formation of our HIV venture with Pfizer of £296 million, and in the year we absorbed total legal charges of £591 million, as against £611 million in the year before. You will see a strong currency benefit of about 14%. If exchange rates stay roughly where they are now for the rest of this year, which, of course, is always a false prediction. But nonetheless, if they were to, we'd see about a 1% adverse movement in 2010.

Notice the free cash flow, strong performance there. And if you express free cash flow, as a percentage of total earnings after restructuring costs, you come up with a number of 94%, so it's a good performance there. It's just split pharmaceutical turnover, so turnover between pharmaceuticals and consumer. I'm going to cover each in a moment.

This chart simply shows you the geographic spread of our pharmaceutical business, and also includes the Consumer Healthcare business. I'd make a couple of comments. Firstly, generic competition, yet again, in 2009 hit the business, particularly U.S. pharmaceuticals, and that's the driver of that 13% decline. And equally, we benefited, on the other hand, from flu pandemics and vaccine and Relenza sales, particularly in Europe. So that did, both those impacted results. I think, if you look at the chart, an obvious conclusion is the investments that diversified GSK continuing to work. You see great growth in places like emerging markets, up 20%, Japan up 22% and consumer up 7%.

And as Andrew said, consciously, we invested significantly in our consumer business to drive that growth in what couldn't be described as a good market. This is another way of looking at pharmaceutical turnover, along which quite like, Core, I'll come back to in a moment. Influenza pulls together flu pandemic vaccine, it includes Relenza and it actually includes annual flu sales as well. So, you can see there the significant increase in sales in that category.

Avandia has seen a decline each year for the last few years, albeit though that decline rate is now moderating under 16% in 2009. And in products impacted by generics, the impact is clear from this slide, continues to be significant in 2009. Overall, you get a growth of about 2% and included within that, obviously, was the Stiefel acquisition, which contributed sales of £248 million, together with other acquisitions which I think added another £130 million.

If you look at Core plus influenza, that's plus 12%. What the next chart does is summarize where that comes from. Advair growth is up 1% in the U.S., up 5% in Europe, up 23% in the rest of the world. Japan did very well, up 79% to £195 million. If you look at vaccines that's clearly got flu pandemic within it, if you strip it out, growth was about 2%. Good performances from Synflorix, Rotarix, Cervarix, but we lost sales with Infanrix and our hepatitis franchises, particularly in the U.S., where we were under increased competitive pressure.

If you look at that chart, you can see three products, all the sales around £500 million, four products, actually, all growing strongly, including Lovaza, which grew at 31%. Then on the bottom, you see a tranche of products growing about 1%, £8.9 billion of them and that, overall, gives you that 12% growth in Core and Influenza. Here is our new products. You saw the same slide with Andrew's chart going back over three years. You can look at it two ways. You can include everything that's new, in which case new products contributed £2.1 billion and was up over 100%.

You can exclude the H1N1 new vaccine on the premise and that clearly is going to benefit 2010 and 2011, but thereafter is more uncertain. If you do that exclusion, you get a number of £1.26 billion, up 55%. Both are meaningful statistics.

So, our Consumer Healthcare business, another great year for Consumer Healthcare with great brands. If you start on the right and look at OTC medicines, you will see a growth of about 8%. Alli, which was launched in Europe successfully this year, grew by over 100%, Panadol up 10%. Within that category, you can't see it on the chart, but NRT smoking replacement therapy basically declined by about 1% and that's what drives the overall 8% growth for that category.

Looking at Oral Care, another tremendous year for Sensodyne, which seems to grow at a good rate, pretty much year in year out, up another 13% with the category growth basically constrained by Aquafresh, which fell by 1%. Within Aquafresh, it was the white trays at the premium end of the market which suffered, in a clearly more depressed economic environment and that's where gave you an overall return of 7%.

Nutritionals, Lucozade very much an impulse product, a classic product that's going to be impacted by a recession and was down 3%, but Horlicks in India booming along at 17%, dragging overall nutritional healthcare up by 3%.

Now the P&L. Cost of goods went from 23.7% to 25%. And the next chart will track exactly what happened. First of all, when we lose high-margin products to generic competition in both the U.S., mainly, and the EU markets, we see a big impact on our cost of goods. It is unavoidable and you can see that brought the cost of goods margin up 1.2%.

Regional and product mix, with growth in places like emerging markets, vaccines, consumer healthcare, also pushed the cost of goods margin up. But that was pretty much equally offset by operational excellence restructuring savings. And then, within other, it may be 0.1%, but actually that includes currency benefit on the one hand, raw material cost increases on the other.

Interestingly on this chart is, if you take the 23.7% and pretend for a moment, sadly not true, but pretend for a moment that we hadn't got generic competition, you don't actually see much movement in the cost of goods margin. And I think that's an important message for the future. In terms of 2010, clearly in 2010, we are going to be adversely impacted by Valtrex generics, and we're expecting a margin of around, a cost of goods margin of around 26% in 2010.

Looking at SG&A, we've split SG&A, as you know, these charts between Core and Legal. Legal costs for the year were £591 million. If you go back five years and look at legal charges, they range from about £250 million at the lowest to just over £600 million at the highest. If you take the average, it's about £450 million. So, we were at the top end in 2009.

Other Core SG&A costs, as you see from that chart, moved from 27%, sorry, 27.7% of sales, up to about 30.3%. And the next chart, I will track what drove that movement. We reinvested all our restructuring savings into our investment market. One example, we took over 1200 people out of the sales force in the U.S. and Western Europe. We put over 2000 into the sales force in the rest of the world.

One example, a very conscious strategy to diversify and grow the business by reinvesting savings. Stiefel, we acquired Stiefel. It clearly had significant SG&A. We haven't had a chance to synergize the Stiefel SG&A. It had significantly adverse impact on our SG&A margin, as we move to synergize Stiefel that will change. If you recall last year that I told you we benefited from exchange gains, do you remember, I told you that the margins, in fact was 27.7%, but exchange gains have brought it down from 28.5%. In other words, last year, we had a 0.8% benefit to margin. This year, we've had exchange losses. The net impact on the margin year-on-year was a 1.2%.

And finally, I talked to you last year about pension increases driving up SG&A, they have. Looking forward, I anticipate the SG&A margins excluding legal charges of around about 29% for 2010. R&D costs, as you can see, were very similar, slightly better than 2009 in this chart. In 2010, I expect R&D cost as a percent of sales to be around about 14% of sales.

I will come back to other operating income in a moment, operating profit margin, if you look at the operating profit margin for 2009, if you will exclude the ViiV healthcare gain and you will also exclude the legal charges you come out with the margin of around I think 33.7 and if that margin i.e. operating profit margin excluding the ViiV gain and excluding legal charges, there we expect to be broadly similar in 2010 compared to 2009.

Now, other operating income, this chart summarizes and what's in other operating income. We always have a base of around about certainly historically anyway, £300 million of royalty income. And you can see that very clearly in 2009 and in 2008. By the way, our focus on divestments is this, if we can sell assets and reinvest the proceeds and make a better return or divest them and, quite frankly, add shareholder value by divesting them at the right time, we will do so. And in fact, its part of our strategy, I think, any healthy business cuts-off and realizes assets at the end of their life cycle, reinvests that money in growing the business in new brands. We are no different.

So you see, in the green box, the green bar, we did significant sales of products that included Wellbutrin XL, we sold back to Biovail. And we will continue to do that and also some products we sell Aspen. So, we will continue that strategy into 2010 and later. You also see there the gain from the ViiV, from the HIV transaction.

Now, in addition to this, if you look down the P&L there's £115 million profit from the disposal of the shares in Quest, different part of the P&L, still cash, still money, still profit, if you add that in, you get a figure of about £1.25 billion from asset sales plus a solid base of royalty income.

Looking at 2010, and comparing it to that £1.25 billion, I expect us to realize about £800 million to £900 million of profit from a continuation of asset disposals and some clearly continuing to secure royalty income. The chart here shows you interest. Remember, in 2008, we were progressing with the share repurchase program. Remember, in 2009, we have the full year impact in terms of interest on that, and that's one of the reasons the interest charge rising in 2009. The other reason is that, clearly, on a lot of deposits that we have, interest rates have fallen significantly, and that also had an impact. That £710 million is a good base to estimate forecasting such charges for 2010.

This chart, you see the tax rate was actually lower than I anticipated, it came in at 28%. I think that tax rate is going to be good for 2010. Looking down that chart, you'll see minority interest of £138 million, just a reminder to you, remember, we've now done this HIV joint venture with Pfizer. Remember, they have 15% of it. So, minority interest will increase in 2010 to reflect that 15% ownership. Over the bottom here, you see the EPS of £121.2.

On the left, you see the results excluding restructuring. In the middle, you see the restructuring charges for the year of £832 million lower by the £1.1 billion was the number last year. And you see the total results after deducting restructuring charges of £109.1p compared to £88.6p in the previous year.

Free cash flow, I've made a couple of points on this. There is a decrease, increasing working capital of £106 million. We did well in 2009, we got our payables up, we've increased our terms, still very reasonable, but increased our terms. We pay the terms, we generate a lot of cash there. We've done a good job at collecting long outstanding cash and receivables, made good progress there. And we've made limited but started to make progress in inventory, were it not for the very high-level of flu pandemic receivables in December, at the end of December, and higher inventory levels, about 106, would have been certify 500 to 600 benefit.

Now, clearly, as we go through 2010, we'll expect to continue to see flu pandemic sales. As we move towards the second half, based on everything we know today, we would expect those to taper off. And we would see, obviously, a comparable benefit in the cash flow, as that large receivable at the end of December comes back in. Time will tell. And clearly at the bottom, free cash flow of £5.25 billion.

So, what do we do with that £5.25 billion? I think, there's a very simple way to look at this chart, it's certainly the way I look at it. With free cash flow, we did two things, we paid dividends to our shareholders of £3 billion and we funded 80% of our acquisitions. Being the CFO, I would always like to stand here and tell you we funded 100% of our acquisitions, but we found some further good acquisitions to invest our money in, so, I wasn't able to meet that marvelous target. But nonetheless, I think, it's a pretty powerful point that 80% of our acquisitions were funded out of our own cash flow.

Net debt went down, but you can see, if you look at exchange and other movements that was driven by currency exchanges with a lot of our debt denominated in dollars and in euros. This is the restructuring program that Andrew talked to you about. This shows the phasing on the left hand side of the £900 million of restructuring costs, about 70% of those are cash, 30% of those are non-cash. On the right, the phasing of the savings cumulatively making £500 million in 2012. We intend to reinvest 30% of those, let 70% come drop down to the bottom line.

So, in conclusion, we delivered sales growth of 3% in 2009, we saw significant pandemic related sales. But actually, thankfully for the investment that the company put in over the last few years, we were able to meet the emergent need for pandemic and will be able to meet future needs, if we see pandemics obviously in the future.

We've taken additional restructuring, I think, it will make us a more efficient business, and it is very focused and we continue to be a strong cash generator, up 12% year-on-year. We recognize that to our investors, the dividend, a sustainable dividend, continues to be absolutely critical. We are very mindful of that and that is reflected in the £0.04 increase to £0.61 for the year.

And just as a reminder to you, we will be disclosing greater P&L detail from our operating segments in 2010. What I mean by that is we'll take you from sales down to operating profit in the same format that we give you for GSK in aggregate. We'll also be providing, by the way, those segments will also include our HIV business, which will be a separate segment, clearly, in 2010.

And in addition, while they're not part of our operating segments, as defined under international accounting standards, we will be providing you with memorandum information in a slightly similar format in respect of our vaccines business and also our derms business.

With that I will hand you back to Andrew. Thank you very much.

Andrew Witty

Okay, thanks Julian. We'll then open up to Q&A now.

Question-and-Answer Session

Andrew Baum - Morgan Stanley

It's Andrew Baum from Morgan Stanley. Three question please, firstly, now that you have built out, continue to build out your non-small molecule assets, namely consumer health vaccines emerging markets, does that helps you accelerate the process reducing your internal research infrastructures small molecules. So, now you have actually got these additional platforms replace that scale is that make you more comfortable about pushing with accelerating the timeline that which you see some of the infrastructure you referred to?

Second, do you have sufficient [BGNL] teams in order to take full advantage of external opportunities which exist out that or is that something that you are looking to still bulk out? And then finally, could you talk about the broader implications of externalization, passing boxes or something that have been talked about in U.K. and many, many other European countries, to what extent this externalization have any impact on more adverse or less opportunistic tax environment compared to maintaining internal research presence?

Andrew Witty

Okay, thanks Andre. I think, in terms of the first question, not really a huge link there, I think that we are really looking, obviously, we're looking to invest behind where we can drive growth in the business. That's clearly what the emerging market strategy and the like is around. R&D is a closely related but really independent agenda, which is how do we get value out of this organic engine? And so, and how do we drive up the return? And I think what has made us more confident, if I can, usual you know, state your concept, to make those changes is our belief in the progress. We're actually making things like the discovery performance units our ability to work the external network as discovery organization. And it's more what's gone well in R&D, which has revealed what we can afford to pull back on in R&D, rather than, so that was your first answer.

As far as business development licensing, not to endorse any particular bank, but if you were at the JPM conference in San Francisco, you wouldn't have wondered whether we were sure of business development people, I think, we had 50 people at that meeting and we did 300 meetings in the three days. So, we have a lot of people. I don't think, we're short of people, but in my view, this is all about having a handful of brilliant people. So, we're always looking for whether we can augment that. And so, I feel very good that we have the machine. We have some great people in there, but there's no doubt, as we've stepped up both at the corporate level, at the R&D partnering level and even at the VC investment level, we've been looking for and have been securing specific individuals to really strengthen our capacity to get those deals done.

So, it's not a massing, but it's definitely a capability we are focused on building and I'm sure there's more that we will do there. We will have more people like that. As far as the pan box is concerned, I have to say the UK's announcement to implement the pan box here is probably the single biggest change in our investment planning that we've had for 10 or 15 years. Completely changed where we think we would build major new facilities, particularly manufacturing facilities. And I think, what it also drives is, where you think about licensing in intellectual property too. So, which entity is going to become the owner? So, to some degree, the patent box doesn't inhibit what you might do in terms of externalization, but it makes you think very carefully about which entity goes into the agreement with the partners, because you need to think very carefully where you want the patent to be held or the IP to be licensed to, downstream so when the profit flow starts to be generated.

So, the first thing, I'd say is the patent box is enormously positive for GSK. Secondly, it's going to be positive for the U.K. because it's going to drive our investment decisions and thirdly, it just requires us to think, we need to be thoughtful right at the beginning of a partnership about which part of GSK licenses the IP. Next question?

Graham Parry - Banc of America/Merrill Lynch

Thanks, its, Graham Parry from Banc of America/Merrill Lynch. I've got a couple of questions on the R&D and productivity agreements you've talked about. First of all, you talk about, on your 11% calculation the back of the slide that did take a quick pick about using industry standard attrition rate, I was just wondering what those attrition rates are and what is this source, are we using more recent tool, we again have tough universities studies from 2001?

And then, secondly, on the improvements of 14% from 11%, what is it that you see driving that? Is it really lowering your R&D costs, or is it actually that you higher value in the molecule so to coming through in developments, or is it cost surely to part of the equation? And then, secondly, a question on guidance for 2010. Just wondering, a question for Julian, how we should think about the legal going into 2010, so is there anything in the impairment or the adjustments that we saw in the fourth quarter of 2009 that would imply they should continue in 2010, and on the other operating income line of the £800 million to £900 million, how much of that you expect to be divestment gains?

Andrew Witty

Why don't you answer the guidance questions, and I'll address the R&D.

Julian Heslop

In terms, then, of the £800 million to £900 million, I expect about £300 million to be royalties roughly, and so the rest will be divestment gains and may be a certain small offset in terms of impairments where you saw we took some pretty hefty impairments this year. There's not much value left to be impaired. So that's an overall, it's a rather sad comment, really, isn't it? So, I shown is potential for the future. That hopefully answers that question. Sorry; your other one was? In terms of legal, yes, I mean, look, you can't predict legal charges, clearly. We've progressed with our cases, looking to settle them clearly, if we can settle them at a reasonable figure; if not, we go to litigation. All these things take time, I think, all I can guide you to is that we have a historic range of between £250 million and £600 million with an average of about £450 million, I think that's probably the only information I can give you. But you can't predict them.

Andrew Witty

So, in terms of your first couple of questions, Graham, in terms of where we get the attrition rate from, we've calculated what we think the industry attrition rates are. They are very similar to the kind of surveys you describe. The reason we're doing that is we're not building in here some big assumption that we can massively change attrition rate. That's really the point here, that we are not loading the future or the assessment by some belief that we're going to be, and actually, our attrition rates over the last four or five years have been quite similar to industry rates, it's an area to improve, but it's not one that, today, I'm going to stand here and say we've found the magic bullet.

In terms of how we get to 14, it's basically both. So, it's an aspiration to improve from where we are. And clearly, both dimensions are important. So, you've seen today announcements of proposals to reduce our cost of R&D, particularly around fixed infrastructure, clearly, that has an impact on potential returns. But obviously, also, the potential sales forecasts, which will be driven by greater differentiation is the other side of the equation. It's clearly both, and that's what we're focused on at both ends of the equation.

Julian Heslop

So, one other point, I know it's probably obvious, which in case it is in the impairments I was talking about are equity impairments which rely on other operating income. Clearly, if we have any impairments in respect of R&D, assets, in licensed assets, they fall as an R&D charge.

Unidentified Analyst

The first question is, sorry, it's a boring question about FX. But I've been trying to get my head around this. You had a 4% FX benefit on the sales but that 22 that looks like a 10 or probably slightly lower hit on the bottom line. And I understand there has been this wind factor from having exchange losses this quarter and gains in the quarter last year, which about 6% wind factor, can you just run us through the P&L, where the negative effect comes from?

Julian Heslop

Sure. It really does look odd, doesn't it, in the fourth quarter? And it actually looked odd last year. You've got these exchange gains and losses that have a significant, I think, it's about 8% or 9% in terms of the quarter four EPS movement. It doesn't affect sales at all. That's the first point.

The second point is a more complicated one because the fourth quarter is always a cash out. Remember, we use average rates for the whole year, so there is a catch-up in the fourth quarter to average everything out of that final average rate, which does have an effect.

Finally, what I always do, and I do it, myself, at the end of the year, is I look at the full year, see our actual rate differential, and I use that simple ready reckon we gave you, if you use that for the full year, it all works pretty perfectly. Actually, the thing to remember when you do that, when we reckon it for the full year, is you've got to take that exchange gain/loss impact out of the [AR/CR] growth, which brings you down to the level we saw for the full year. So, that's the answer. If you need any more --

Andrew Witty

He's available later, if you want more on that.

Unidentified Analyst

I will have to think that through. Firstly, just on R&D, when I look at the new restructuring program, you telling us £250 million savings, 70% coming through the bottom line, but before that, you had broadly been guiding to, we should think R&D being pretty flat going forward. So does it mean it's now going to decline or is that actually going to be reinvested into non-Pharma R&D as in consumer or vaccine R&D?

And third question is on the divestment gains. You gave us guidance for this year but you also said it's going to continue beyond 2010. And I know you can't predict them going forward, but it is about a 5% or so swing factor on your earnings. So may be you can suggest a similar range which we should use going forward that's what the legal charge may be?

And the final question is just on, you were talking about the internal rate of return in the 2009 acquisition being 14%, you also said that Stiefel has been the largest acquisition, and you have just found, so after the acquisition was done, do you find significance sale synergies from globalizing the sales and from tapping the OTC potential of those brands? So, I'm just wondering what the 14% would have been before you found those sales, those sales synergies, obviously trying to find out what's the real hurdle rate?

Julian Heslop

Well, also in terms of when we look at a transaction before we sell, we are basically looking for transactions where we can get at least the three-year return on invested capital about 8%. And that's actually is quite challenging. And there's a lot of transactions flying around where you can't get to 8% ROIC at year three.

Now, you might argue in some parts of, if we were looking at an emerging economy business, we'd probably be looking at more like, we wanted something like 11% or maybe even more than that, to recognize the increased risks around those businesses. SO, in terms of up-front hurdle rate type analysis, and that would be the kind of numbers we're looking for, in terms Stiefel, we've shown you kind of where were at today, a lot of what I've talked to today is, in terms of where we are going, what I think will drive up the return on that transaction. So, I think that transaction will continue to improve. And what I also said was all the funds on this slide are at least 14%. I didn't say which one each individual one was. And I didn't say they were all 14%. So, don't miss that, either.

Unidentified Analyst

So, let me ask the question another way, then. Finding this sales synergies is at been a key driver about 14%, or is it minus thing?

Julian Heslop

Particularly the consumer synergies is not a key driver of whatever the return is for Stiefel.

Unidentified Analyst

…globalization which could?

Andrew Witty

Globalization and the proximity were always part of the thought of process client Stiefel. Consumerization is something we've really started to focus on since we've made the decision to go forward. So, it enhanced our confidence we can drive great to returns.

Julian Heslop

To answer your question another way, the bulk of the drive or the value in Stiefel was the existing business, combining it with ours, and there were some sales synergies within it. And it was a contributor, but not a material contributor. It was driven by those cost synergies, which are very significant, because of the manufacturing, because of the administration gains combined the two businesses. And naturally, we are always, when we're looking at investments, although, we believe in sale synergies, we are a lot more skeptical about them than we are about cost synergies. So, it was a strong cost synergies that really reinforced our view that from forgetting about strategy, from a financial point of view this was a good deal, clearly from a strategic point of view it was.

Andrew Witty

To mention legal, while you are…

Julian Heslop

It was other operating…

Andrew Witty

Sorry, other operating.

Julian Heslop

Yes, look, you are [experiment to say] really guide you to 2011. Obviously, you'd be right. But it's going to be, what we seem to have had a steady royalty income, of course, it moves around, I can't predict it but 275, 300, 325. It depends on what happens to the products that we get royalties from. But it's a pretty steady earner, pretty steady earner. I can't recall a year, where we haven't sold assets, divested assets, in the sense that shake the tree, dropping the low hanging, the fruit that's delivering low returns, products at the end of their life. Or part with somebody who can do a better job than we can. And I think that will go on, I can't give you a number. But again, I think, if you look back in the past, you will see pretty, we do disclose what this is every year a pretty steady. If you look at the past, I know sort of bad predictor for the future if you look back and take an average.

Andrew Witty

And as far as R&D is concerned, let me make a couple of points. First of all, I've always said we're not a slave to a certain percentage of sales or a certain level of R&D. That's never been part of our thinking. We should be very much, in my view, allocating R&D resource to where we believe we can generate superior returns, the best returns. All else being equal, based on what we see today, the announcement we're making today would lead you directly to believe that R&D spend will come down in the future.

Not by massive amount because obviously this is a portion of the total. However, if there were great opportunities, if we, I don't know, if tomorrow morning we have an opportunity to license in an asset which we have to pay the Phase III program for, then obviously we are going to take the opportunity. But, all else being equal, absolutely right, we'd expect the savings which we're talking about here to drop down to the bottom line. And as a result, you would see a reduction in Pharma R&D activity absolutely. Next question.

Jeff Holford - Jefferies

Hi, it's Jeff Holford from Jefferies. Two questions. Firstly, on H1N1 order in 2010, I wonder what level of visibility you have so far on the similar level versus last year, what percentage you have sort of very good line of or size on being delivered already for this year? Secondly, as you continue to externalize on some of these products coming to maturity as well, what stage and what aspects do you think about in terms of re-internalizing some those assets, given that potentially become less efficient, I should have just play marketing and co promotion deals et cetera?

Andrew Witty

Good question. As far as H1N1 is concerned, we have very good visibility of contractual position. That doesn't mean to say that that will never change. So, there's no certainty that a government isn't going to come back tomorrow morning or in three weeks' time and say, we want to have another conversation. So, I can't, and I'm not going to pretend that these things are absolutely bulletproof because you are talking about working with very few customers on our whole business and their needs change, then we have to work with them on it.

But much of that conversation has already happened and we have very good visibility, and January was a very busy shipping month for vaccines for H1N1. So, we have good visibility, shipments have been very busy. And I'm happy with the steer we've given you in terms of being able to deliver about the same this year as last year. If that changes, we'll let you know, just as we've let you know, I think, we've bent over backwards to try and be pretty real time in terms of giving you a sense of where this was going up. And as it has plateaued, what it's looking like.

In terms of re-internalizing external partnerships that's probably the most elegant way I've heard somebody ask that question for quite a long time. So, it's not intuitively what we want to do, actually. So, if you look at the overall strategy of what we are doing, obviously, partnership is a really big part of what we are about. And it's how we are able to leverage a law of discovery activity without consuming huge P&L resources. So, its given there is a huge potential of diverse research without necessarily having to commit too much, not every partner wants to be [bore], right. And so, it's very important that, philosophically, we don't get ourselves into a position where we kind of eat our partners the minute we feel [packish]. And it's really not the way we are going to go. Could it happen? Yes, it could happen.

But it's not a philosophical approach we want to take. And I have to say that on most of the partnerships we have which have progressed to a point where you might have this thought in your mind, we have a pretty healthy share of the economics and it's not obvious that it's the right thing to do. So, no, I can't be more specific than that, Jeff, but it's not a philosophical direction of travel that we are revved up on. Next question.

Michael Leacock - RBS

It's Michael Leacock from RBS. Andrew, I think awhile ago you said that one of your key objectives was to simplify the organization. But that was causing you some degree of frustration. I just wondered and held being making progress there. And also just for Julian, just in terms of CapEx in the longer-term, you got this mix of out-sourcing and in-sourcing manufacturing in R&D as well as the mix of emerging markets coming in, how did you get it started a little bit to where you expect your overall CapEx to be for the longer-term, not just asking for 2010 number?

Andrew Witty

Okay. So, on the first one, Michael; I don't look stressed today, do I? No. So, I'm actually, I think, we've made a lot of progress in the last six or eight months on the simplification agenda. Particularly around system selection and standardization, particularly around, and in our simplification of our above country operations, so what we want to get done outside of the subsidiary versus what we want to get done inside. There's a lot of work still to go, but I think we have got a very highly agreed, actually, roadmap of where we are going in terms of systems, in terms of global business services, in terms of service levels, in terms of the kind of resources we're going to need or not need going forward. So, I think, a lot of execution to get done and a lot of, obviously, therefore, the benefits to flow. But I think, we've broken the back of the architecture of what we want. And I feel pretty good about that, actually. So no; I'm feeling okay about that.

Julian Heslop

Next two or three years, we've been running at about 5% of sales, 6% of sales. We ran about £1.4 billion, £1.5 billion, putting a lot of money into vaccines in terms of new products. Rough estimate, as we sit here today around that sort of level, maybe a bit more, maybe a bit less, not dramatically for the next two to three years. There will come a point, though, where we reach that position in vaccines where we have established that new manufacturing base. Then, I'd like to think we can bring it down, but as of today, over the next few years, I think, around about the £1.5 billion level is probably as good a steer as I can give you.

Andrew Witty

Okay. Next question.

Naresh Chauhan - ICAP

Naresh Chauhan from ICAP. Just a couple of questions on emerging markets please, what is rent up the investment in SG&A in emerging markets when do you feel you will have sufficient scale that to stop the investment ramp up? And secondly, can you give us some sense of your market share in the BRIC countries and where you think this investment can get you to?

Andrew Witty

Great questions. So, we're continuing to scale up, but it's beginning to differentiate across the world. So in, for example, Middle East, North Africa, we are getting very close to where we need to be. We are continuing to build up in China, although, in a very, not in a north's way, in a pretty gradual way. Keeping control of your operations in China is not a trivial proposition, and so its happening, but in a relatively gradual way. Latina you will see things build up in. So, there will be some patterns around the place, but probably the biggest part of the surge has happened, rather than to come.

In terms of market shares, it varies around the world. So again, MENA, Middle East, North Africa, we are running around 9% to 10% market share. If you go to India, we are the second biggest pharmaceutical company in India, after Ranbaxy Daiichi, probably running there around a 5%, 5.5% share, something like that.

China we're much lower, and Latina, we are much lower. And so, we want to, obviously, grow in all those markets. We definitely need to do some catch-up in Latina, I think, China, we are on the right course, a very strong growth performance in China last year. Latina, for me, is kind of still a little bit needs some attention. Where do we want to go, long run? We want to grow faster than the market in the emerging market region that we described and that's the goal. So, we intend to grow share and obviously we're going to need to do it in places like Latina, China and to some degree, India. But India we are already huge; it's a question of, really, what is a realistic growth rate. Thank you. Yes please.

Unidentified Analyst

UBS. Another question on R&D, this time from the cost side, the data you gave was pretty interesting. To what extent does this reflect out performance for Glaxo or a general trend in the industry in terms of zero recruitment for sites et cetera? And then, secondly, on Advair IP, I noticed that there's been a citizens' petition since the last set of results. To what extent is that beholden to new rules in timing from the FDA versus having some exceptions because there is that device involved here?

Andrew Witty

Okay. As far as the R&D performance, I don't know how well the other companies are doing. Our sense is that the kind of level of focus that we have on really turning those points of efficiency all up and down the activity set of R&D is probably rare, if not unique. So, I can't guarantee that it's not happening on this scale. We have a huge program across R&D, where we are focused on essentially taking a lot of the practices, and this is in development, a lot of the practices which we've test driven and have helped us a lot in manufacturing, and applied it into our R&D development teams. A lot of it is around Lean Sigma and the key with Lean Sigma, as you well know, is not that it's a great idea and it makes sense, the question is, can you get 100 teams to do it in parallel? Or, is it just going to be one or two people do it, and everybody else carries on like they were? So, it's really about how you get that scale of impact.

We have a series of these programs if I sponsor personally the development cost reduction program in the company. So, what that means is we have a team of people led by two of our Senior Vice Presidents, who are looking, working with every single development team in the company. And they worked together, multiple team, individual team, looking at every single piece of their program so how they could do better though compared to other best performers in the company and other best in class.

So, as to my knowledge, there has never been, so far in the last 16 months, a single intervention like that which has not reduced the cost of the program being reviewed. So, even the teams that come in and say, we're bulletproof, there's nothing you can teach us, we know everything, even those teams have, and who are genuinely very good, not just deluded, even those teams found money and the great thing is they then come out of those sessions telling everybody else, you've got to get in this room, because you get in this room, they're going to find money, they're going to find ways to go quicker. And that's what's really about culture change in R&D.

Just as re-personalizing discovery, taking accountability from corporate resource in development is all about culture and changing the culture on those two dimensions is huge in terms of driving performance and efficiency and returns for the organization. So, it's, I think, a very healthy program, very well endorsed by people in the organization, and its making a big difference.

As far as Advair IP is concerned, its report [Six Sigma] petition in there, it wasn't triggered by anything other than we wanted to get a message in, if you will, or a statement that we want people to be judged, we want to be judged with others on a level playing field. And so, what that was all about was simply saying, here's the dimensions on which we think any potential or putative product needs to be judged and there was a lot of those levels. So, there was no special trigger, circumstance, rationale for it, other than we wanted that to be understood and recognized early and that's why we do it.

Unidentified Analyst

In terms of timing for a response?

Andrew Witty

Absolutely no idea. Yeah, please.

Unidentified Analyst

I have two questions. The first one relates to the AdCom on [inaudible] on the 10th of March and have you been asked to present or any specific request by the FDA to run Phase IV programs even on products that are already on the market and if you have or if there is that scope, is that affecting your decision on when you initiate Phase III trials for the horizon program? And the second question is a philosophical one, if you like. But you are exiting large parts of neuroscience.

I assume from your presentation subject to consultation that perhaps one of the sites might close some of your location et cetera, et cetera, can you make or paint a picture here how you aim to do that, will you just be put lock-in and walk away from that? Or are you looking to may be put some of the assets together and spin it out or is this held some of the IP, how do you propose to go about doing that?

Andrew Witty

Two good questions. As far as the AdCom is concerned, the AdCom is focused on what, if any, safety studies ought to be done for marketed products. Whether that's ultimately the full scope of the AdCom, I have to wait and see. As you know, it was only just announced few days ago. We haven't been asked to do anything specific, at this point. Obviously, we have an opinion. It's not an easy question to answer. Remember, we've had a series of AdComs on this class of products. You remember that Advair, I think, was the only product to the last I would count on a unanimous vote of support from the Advisory Board. So, and it's not a trivial question to how do you disprove the possibility of this event, when it's so rare.

So, we'll have to see how that goes. As far as where we are in terms of starting horizon in, we are in the final discussions with the FDA on that. We are ready to go on it. We just need to decide whether we wait for the AdCom or not. We'll make that decision, as we kind of go through the next few weeks. So, no kind of substantive news on that to be honest with you.

In terms of potential scale down of sites or ex set of sites, I'm going to be a little bit reticent here, this is we are only just telling, literally, we're telling our employees, while we've been inside, in this room. So, I'm just going to be a little bit reticent on that, for the benefit of them. But obviously, we're going to be looking forward to working with unions and employee representatives to come up with whatever is the best outcome that we possibly can. But beyond that, I'm just going to leave it there because its important we have those conversations with our employees first.

Justin Smith - JPMorgan

It's Justin Smith from JPMorgan. I've just got two questions. The first question Andrew, about 18 months ago you said getting very interesting anecdotes, on the cost of good lines the pharmaceutical business could learn a lot from the consumer business, so I am just interested to get your thoughts on why with the new £500 million starting program, there are some cost of good synergies in there all this addition on top of the 500?

And then, the second question, with regards to when you slowed down the pace of the share buyback, just wanted to really get your thoughts with regards to ranking the organization's since then are you happy with the deal making that's being done? Could there be room for improvement, I know, the world has changed. But just wanted to get some thoughts there as well.

Andrew Witty

Good question. CGS, actually, the reason why, so you end up with big restructuring charges in CGS when you close factories to release cost. We've kind of done that now. We've got one or two sites which we're winding out, and that's part of the current £1.7 billion restructuring program. But actually, was much more, what I'm talking about now is you are seeing literally product after product be reassessed for process efficiency and so actually we've got some significant efficiencies built into our future five years from manufacturing. But it's not going to require huge amounts of upfront write-offs, which actually is very positive.

So, the agenda for manufacturing, if anything, is more constructive to the profitability of the company, and it's not costing huge amounts of money to access it. And the amount of, and you're right, there's lots of lessons. Just as I've said, there's lessons from R&D to learn from manufacturing, there are certainly lessons from consumer to Pharma. So, to give you an example we are part of what is called the [inaudible] box benchmarking study, which is a McKinsey pan-pharma consumer benchmark is there and we have, I think, 10 of our 11 Pharma or 10 of our Pharma sites are in the top quartile of all, 10 of our consumer sites are in the top quartile of all consumer factories.

So, we've got fabulous efficiencies in consumer. And it's exactly what's going on in those sites, which is being shared into Pharma along with Lean Sigma approaches, along with, frankly, we launched Ventolin in 1969. Surely something has changed since then which could allow us to be even more efficient, I mean, just simple, obvious statements of fact. So, that's the kind of place you are going to see.

And it's why Julian was right when he said, net-net-net, the negative on the margin is all to do with the loss of high-growth margin products in the U.S., because actually there's so much going on in the CGS line that all the other things are being offset by efficiencies which have been delivered. So, as those U.S. losses start to ameliorate, the pressure on the gross margin starts to ameliorate.

Now in terms of, you know, I'm not sure I'm the right person to judge our score card of acquisitions, I think, we have made, I think we did what we said we'd do, we said, we would make bolt on acquisitions that we would be fiscally disciplined and that we would make those acquisitions coherent with our strategy of where we wanted to develop this company, exactly what we have done.

We've done that. And we've walked away where those conditions are met. So, thank goodness, no banker now comes to me with a book, trying to get me to do a massive piece of M&A. Taken a year, eventually they stop. So, nobody is doing that anymore, which is great and we've walked away from some deals which we just didn't believe made economic sense to us. And whether or not, ultimately, we got the best deals or that's for other people to judge in the future. But we did what we said we'd do, and that's exactly the way we are going to carry on.

Listen, I think we're out of time. Thanks so much for all your questions. And obviously, we'll be around at the front if there are any other things you want to pick up. Thanks a lot.

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Source: Glaxosmithkline plc Q4 2009 Earnings Call Transcript
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