GlaxoSmithKline's (GSK) CEO Andrew Witty on Q2 2016 Results - Earnings Call Transcript

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GlaxoSmithKline Plc (NYSE:GSK)

Q2 2016 Earnings Conference Call

July 27, 2016 09:00 AM ET

Executives

Sir Andrew Witty - CEO

Simon Dingemans - CFO

Analysts

Graham Parry - Bank of America

James Gordon - JP Morgan

Richard Parkes - Deutsche Bank

Tim Anderson - Bernstein

Andrew Baum - Citi

Jo Walton - Credit Suisse

Keyur Parekh - Goldman Sachs

Seamus Fernandez - Leerink

Kerry Holford - BNP

Sir Andrew Witty

Thank you very much. Good afternoon and welcome to this Q2 call. With me is our CFO, Simon Dingemans as usual. As you can see from the results we have just published, we delivered a strong second quarter, with group sales up 4% CER to £6.5 billion. Sales growth was generated across all three businesses in the company, and was particularly driven by new pharmaceutical and vaccine products, which for the first time, had sales of £1 billion in the quarter. In the same quarter last year, this portfolio had sales of £446 million, so clearly a doubling over the year. The growth delivered and demand for these new products is one of the reasons why we have today announced £275 million worth of capital investments to increase our manufacturing capacity in the U.K.

I am also very pleased with the continued progress we are making on cost control, and the delivery of integration and restructuring benefits, which are tracking ahead of schedule. Taking together for the quarter, we have delivered core earnings per share of £0.245, up 16% on constant currency basis. For the half year, core EPS growth was 12% CER.

Given the momentum we have seen so far this year, we now expect to deliver core EPS of the upper end of the guidance we gave to investors in the first quarter. With 2016 core EPS percentage growth now expected to be 11% to 12% in constant currency terms. Clearly, currency has had a significant impact on our results for the quarter, both in total and core reporting, and Simon will talk you through these in more detail in a second.

Moving to cash flow, net cash inflow from operating activities for the first half of the year was £1.7 billion, that compares to half from 2015 of £587 million. This significant improvement reflects growth in operating profits across all three businesses, as well as a currency benefit of approximately £340 million. For Q2, the board has set a dividend of £0.19 a share and expect to pay £0.80 a share for 2016 and 2017.

Turning to the sales line, new pharmaceutical products now account for 23% of total pharma sales. Sales of new HIV products, Tivicay and Triumeq continue to be the major contributor to this growth. Overall in the quarter, sales of these HIV products were £865 million, up 44%.

In respiratory, sales growth of our new respiratory portfolio, Relvar/Breo, Incruse, Anoro, Arnuity and Nucala more than offset declines in Advair/Seretide for the first time.

In the quarter, we announced that we will accelerate the filing for a close triple therapy for COPD in the U.S., to the end of the year, two years earlier than schedule. In addition, as we said previously, we also expect to file the same medicine in Europe this year.

We continue to strengthen our respiratory pipeline, with recent new data supporting the progression of danirixin into phase 2b development and with the in-license announced today of a novel monoclonal antibody for severe asthma from Janssen.

Our vaccine business had another good quarter, with sales up 11%, driven by strong demand from new meningitis vaccine, Bexsero. We are very pleased with the continuing progress in this business, although clearly, vaccine sales are subject to some quarter-to-quarter volatility.

Consumer healthcare sales grew 7% in the quarter, this was driven by Flonase OTC in America continue to perform well, and new innovations such as Sensodyne True White and a [indiscernible] TAF formulation for Excedrin.

Turning to R&D; I was delighted to see approval in Europe for Strimvelis, our first-in-class gene therapy treatment for the rare disease, ADA-SCID. In oncology, our pipeline is progressing very well. We have been granted FDA breakthrough therapy designation for our T-cell therapy, targeted NY-ESO in synovial sarcoma. Yesterday, this asset also received orphan drug status from European authorities. We have also received preliminary phase 1-2 data to support continued development of our BET inhibitor in NUT midline carcinoma, and other tumor types.

During the quarter, our ICOS agonist antibody became the first asset in its class to enter human clinical trials. And altogether, we now have 10 oncology assets in phase 1-2 trials.

Looking ahead to the end of the year, we have up to six significant phase 3 trials, including three in HIV, which are dolutegravir plus lamivudine, a two drug regimen; cabotegravir for treatment and the same assay for prevention of a disease.

Finally, we expect to make several key filings by the end of the year. In addition to the closed triple I have mentioned already, this includes our shingles vaccine Shingrix, Benlysta subcutaneous for lupus; and sirukumab for rheumatoid arthritis. So as you can see, we have a lot of momentum across the group, driving our current performance and setting us up well for the second half of the year.

And with that, I will now have Simon to take you through the financials.

Simon Dingemans

Thank you, Andrew. The Group has had a strong first half with another quarter of good performance across all three businesses, driven by sustained focus on execution, and our trading performance reflects the continued momentum on our new products, held by the investments we are making to support the launches, as well as tight cost control and consistent delivery of benefits from the transaction and restructuring savings.

In line with our financial architecture, we grew earnings ahead of our sales growth, and excluding the investments that we have said we are funding with divestment proceeds, we have also started to see a meaningful improvement in the Group's free cash flow.

After the strong start to the year, we now expect growth for the two halves to the year to be more evenly balanced than we previously thought, and with the additional visibility we now have, we have tightened up the range for our guidance to the higher end of the range previously provided. And so, while there is still a lot to do, we now expect core EPS growth for the full year, in the 11% to 12% range on a constant currency basis. Our earnings release provides an extensive amount of detail about our performance and you can find further detail on the slides that we have posted today on our web site.

As normal, many of the comments today will be focused on CER growth and core results, but as currency has had such a significant impact on our results for the quarter, both total and core, I want to take a bit of time to explain whether the greatest impact has been.

Sterling was relatively stable last year, with an average rate of 1.53 to the dollar; and while concerns about the Brexit referendum were an issue in Q1, rates didn't really move significantly until the second quarter and more sharply in obviously post June 23rd, with the U.S. dollar finishing the quarter at 1.33. We have seen similar declines against most of our major trading currencies. This has resulted in a tailwind over the quarter of 7% of sales and 26% to core EPS. Although, this also reflects the benefit to the quarter of no exchange losses on intercompany transactions, which in Q2 last year, cost us £61 million. This is about 7% of the EPS tailwind. Free cash flows also benefitted from the weaker pound by about £340 million in the first half.

If exchange rates hold at the June month end rates for the remainder of the year, we'd expect a positive full year impact on turnover of about 9%, and we estimate a positive benefit to core EPS of approximately 19%. Free cash flow would also see additional benefit.

A weaker pound benefits our core earnings, not just through a stronger topline, but also in the operating leverage across the businesses. We continue to have a higher proportion of our costs in the U.K. than revenues. And so while this hurts us, while sterling is stronger, it helps us when it declines, and you can see in the quarter, that currency contributed approximately 2.6% in operating margin uplift in the quarter, on top of the 2.5% improvement we delivered operationally at constant exchange rates.

These currency tailwinds apply to all of our businesses to varying degrees, but importantly, also to our majority owned consumer and HIV businesses, the decline is sterling has substantially increased the value of those businesses to GSK, given the larger sterling earnings and cash flows we would expect to receive from both, if FX rates remain at current levels. However, as well as increasing the overall value of the businesses to us; what the decline in sterling has also done, is increase the liability we have for the potential exercise and the put Novartis has for its share of the consumer business and the liability for the puts and associated preference shares Shionogi and Pfizer have in relation to their equity interests in our HIV business.

The increase in the sterling value of ViiV also drives an increase in the value of the future, contingent consideration payable to Shionogi, given that all of the puts, preference shares and the contingent consideration are valued and would be settled in sterling.

With the significant shift in exchange rates we have seen this quarter being clearly more than a short term disruption, we have updated the currency assumptions we use to value these various liabilities to rates consistent with current market. This has given rise to a charge in the quarter of £1.8 billion, reflecting the increase in the value of the puts and contingent consideration, as well as the unwind of the discount applied, given that these are future liabilities. The unwind element was approximately £200 million of that total in the quarter, similar to Q1.

The charges from these valuation adjustments have impacted our total results for the quarter materially and push our total results to a loss for the quarter of £0.09 in EPS terms. However, as the adjustments do not relate to the Group's trading performance and are primarily driven by currency movements, and their impact on estimates of future transaction consideration, that may be payable to our minority partners, we exclude them from core results.

Moving to our trading performance for the quarter, in constant currency terms, Group sales up 4%, core EPS grew 16%, good momentum across all three businesses. And pharmaceuticals, including HIV, up 2%, strong growth from new products more than offsetting lower sales of Seretid/Advair. HIV sales were up 44%, Triumeq and Tivicay growing strongly in all regions, and we continue to expect strong momentum from both products during the second half. Remember however, Epzicom also goes generic in the U.S. in Q3, and we continue to expect to see some generic activity in Europe in the second half.

U.S. pharma sales down 1% in the quarter, as generic pressure on Avodart continues, but newer products in the U.S. grew total respiratory sales 6%, as they more than offset a 7% reported decline for Advair, which did benefit from an increase in wholesaler and retailer inventory levels in the quarter, compared to a decreased we saw at this time last year, and there was this small favorable payor rate of rebate adjustment.

As we said in the past, the various pricing dynamics we are now seeing in the category are likely to lead to a bit more volatility in RAR adjustments quarter-to-quarter. The underlying decline for Advair was more in line with what we saw in the first quarter, around 15% to 20% and we continue to expect U.S. Advair sales to be down, around 20% for the full year, in part because of a tougher comparison we have with Q4 last year. Also in the U.S., BENLYSTA grew 29% to £71 million and Tanzeum, more than doubled to £28 million.

In Europe, pharma sales were down 7%, reflecting a 25% reduction in Seretide due to the impact of generics, but also the ongoing transition to our new ELLIPTA products. For the full year, partly as a result of accelerating the pace of our transition to the ELLIPTA portfolio, continue to expect Seretide to be down a little more than 20%.

Within international, sales in emerging markets were down 9%, with further declines in our China business, as we continue the reshaping of that business. Outside of China, emerging market sales declined 8%, but this is primarily due to the sale of Prolia back to Amgen, and the winding down of the trading in Venezuela.

In Japan, sales were down 3%, primarily due to a five percentage point price cut, and on the positive side, respiratory sales grew 6%, led by particularly strong growth of Relvar ELLIPTA.

For vaccines, the business reported 11% growth, reflecting a strong performance from our new meningitis portfolio, and growing shares for several products in the U.S. and Europe, as well as the benefits in phasing of international tenders for SYNFLORIX and ROTARIX, and some improvements in Bexera supply in the U.S., which came through somewhat earlier than expected.

Consumer healthcare sales were up 7% in Q2, with double digit growth for Sensodyne in every region. The U.S. saw continued strong performance in oral care, new innovations helped Flonase to grow despite increasing competition from private label.

The consumer business in Europe was up 1%, this was expected with many integration activities proceeding during the quarter, and some phasing impact as a result. But many power brands also continue to grow share. International grew 9%, with Sensodyne, Voltaren and Otrivin, all delivering strong growth.

Moving to operating profit, excluding currency, the operating margin improved 250 basis points. We have delivered margin improvements in all three businesses on funding new product launches and investments. The improved margins reflects leverage from the sales growth and mix, including the benefit of the continued momentum we are seeing in HIV, and the substantial incremental benefits delivered from our restructuring and integration programs, as well as ongoing cost controls, which more than offset the continued pricing pressures we are seeing.

Restructuring and integration continue to progress well in all three businesses, with incremental savings in the quarter of approximately £300 million, and a total of around £700 million for the first half. Our plans across the business are on track or ahead. But remember, while there are still many initiatives underway, as we move towards the later stages of the integration and restructuring programs, the pace of incremental savings should be expected to slow, particularly, when compared against the significant step-ups we saw in the second half of last year.

In the bottom half of the P&L, core financing costs were down £50 million to £163 million, reflecting the maturing of [indiscernible] with higher interest costs last year. I continue to expect a modest increase in interest costs for the year as a whole, at constant exchange rates.

The core effective tax rate was 21.3% in the quarter versus 20% last year, with the increase due in part to the higher level of profits being made in the U.S., and for the full year, continue to expect the tax rate between 20% and 21%. Though the mix of trading and currency may create some upward pressure towards the top end of that range.

On cash flow for the first half of the year, excluding legal settlements of £104 million and adjusting for the tax payments on the Novartis transaction, restructuring and the costs of the BMS acquisition, all of which are being funded from retained disposal proceeds, the underlying free cash flow nearly doubled to £1.1 billion. This significant improvement reflects the growth in operating profits across all three businesses, as well as a currency benefit of approximately £340 million, and this is despite higher working capital needs in the first half, as we invested behind new launches and seasonal products.

Net debt at the end of June was £14.9 billion compared to £10.7 billion at the year end. We are moving through the peak period of net debt this year, as I have described to you before. And excluding the impact of translation, net debt is in line with our expectations. The increase mainly reflects the £3 billion of cash we have returned to shareholders in the first half through dividend payments, including a special dividend of £1 billion and roughly £1.3 billion of translation effects.

So in summary, we are pleased with the progress and momentum of all three businesses. We have tightened up our guidance to 11% to 12% on a comparable exchange rate basis, and the Board has approved the dividend at £0.19 for the quarter, and we continue to expect £0.80 for the full year.

And with that, I will hand it back to Andrew.

Sir Andrew Witty

Thanks very much Simon. And we will open up the call to Q&A please. So operator, maybe if you could take everybody through the protocol and we will start.

Question-and-Answer Session

Operator

[Operator Instructions]. The first question is coming from the line of Graham Parry from Bank of America. Please go ahead. You are live on the call.

Graham Parry

Hey. Thank you for taking the question. So the first one is on vaccine sales, you had a very strong first half in vaccines and first half running at around 12% constant exchange rate. You are guiding for these around mid-single digit. So could you help us understand, how you expecting phasing to run through in the second half of the year, particularly, how the Bexera outlook is likely to progress, given you have got better manufacturing there? And also on the margin there, at 28%, how sustainable is that, or is that just related to the amounts of phasing benefit you are going to have there?

Second point is on the FX guidance, the 19% benefit for the full year, you had a 26% benefit in the second quarter, before most of the Brexit FX benefit happened. So I am just wondering, why that may not even be more, as you go through the rest of the year? And then thirdly, question on Gilead's preclinical data on GS-9883 which came after the ASM meeting in June in Boston. They had some resistance profile data there, I just wondered if you'd have time to look at that and had any kind of view on the possible advantages for that products over Tivicay, Trimeq from a resistance perspective? Thank you.

Sir Andrew Witty

Great. Thanks very much Graham. Let me take the first question, and then I will ask Simon to address the currency effect, and I will come back to HIV. So vaccine, a very good quarter. Good shipments of Bexera. We got quite a bit of Bexera way in the last few weeks of the quarter. I would expect the rest of the year to be pretty robust for the vaccine business. But as we keep reminding you, there is some volatility around quarter-to-quarter. So for example in this quarter, we got a tender away to Mexico, which we originally expected to be in Q3, as we came in Q2; happens all the time. Sometimes, those things, net-net, well for a quarter, sometimes they net-net less well per quarter.

Year-end is also always a bit strange, because of a number of governments manage their financial year across literally the end of the calendar year. But having given you that caveat, we feel pretty robust around the next six months positioned for us. Bexera growth continues very strongly across the world. We have seen a more rapid growth -- we are at the kind of front edge of the timing of expansion of our supplies than we anticipated, when we first talked to you at the beginning of the year, which is very good.

We have already, as you may have seen last week, had released for flu [indiscernible] in America. We are the first company to get released by Ciba, and we are about six weeks earlier than we normally are in the flu cycle. That should bode well for us in the flu season. Obviously, that's just beginning, but if that goes well, then we would continue to expect a solid performance for vaccines the rest of the year.

As far as margin is concerned, I think -- we said we would get this business back up and to close to 30% margin over the next several years. We are up in the high 20s, very close to 30. I think we are going to bounce around that. I don't see this dramatically changing. It is quite sensitive to the sales level, so if you have a quarter, where a couple of big tenders slip out, then you can see the margin affected that way and vice versa. But broadly speaking, on a multi-quarter basis, I think we are now going up into the territory we'd expect to be, with the inevitable quarter-to-quarter volatility. And I hand back to Simon on the exchange rate point.

Simon Dingemans

Yeah. I think just on vaccines, to add, remember also, we have got quite a lot of investments going through to make sure, we can deliver against the top line opportunity that you can see opening up for us, and that obviously factors into the margin. On currency, Q1, we obviously had a lot less tailwind. So as you look at the year as a whole, you have to factor that in. We have also assumed, in that calculation, that we ended up with the year, having the same level of exchange gains and losses as we had in 2015, as we have to make an assumption around that. Clearly, we are working hard to make sure that isn't the case.

And then when you look at the mix of costs over the balance of the year, that does also pull the amount of currency leverage, if you like, coming into the P&L over the second half, given the mix that you have got going on there. So that's the three main reasons why it’s a bit lower than what we saw in Q2.

Sir Andrew Witty

Thanks Simon. And on the HIV, I think it's way too early for us to try and draw any conclusion based on the tiny amount of data we have seen. I think there were four patients in each arm of the study, that we saw the post on -- structurally, the medicine looks very similar to dolutegravir. I think really, realistically we need to see more clinical data to really understand, what if any, differences there might be there.

I think more importantly, by the time it comes along, when you look at what's handling in terms of share, particularly in the United States and elsewhere, you are seeing a lot of dynamism within the Gilead population of drugs. So intra-switching within Gilead but the dolutegravir share take in naïve is rock solid, post the recent introductions in Gilead. With another couple of years of that performance, GSK and dolutegravir based regimens are going to be in a very-very strong position. It's not clear to me, that this molecule, if it has any benefit, whether it's likely to be materially, seems relatively unlikely, and we will be well advanced, at least, if all goes according to plan, on our dual regimen. And it's quite interesting, when you look at Europe already, about 20% of patients in Europe are on dual regimen.

So I think that that -- I think the game is beginning to move on again. And clearly, our agenda is very much around, first and foremost, fully established dolutegravir based regimens. We are doing that. We are well on with that, and we have got more time to do it, which is excellent. Secondly, to the next, dual strategy, and thirdly, to develop the long acting, and then to go into future mechanisms with the BMS products.

So I think, that's really what we are focused on Graham. Obviously, we are going to keep a close eye, as more data gets produced on this potential product. But I think as of today, it's just too early to be definitive. Frankly, if I owned it, I wouldn't be being very definitive, and if I am going to compete against, I am certainly not going to be definitive about it.

Next question?

Operator

Thank you. Your next question comes from the line of James Gordon from JP Morgan. Please go ahead, you are live on the call.

James Gordon

Hello. Thanks for taking my questions. A couple more on HIV and one on the triple. On HIV, also on [indiscernible], actually not asking about the efficacy profile, but just in terms of the mixes that it would be with, and whether Gilead might be able to have a cleaner convo, by avoiding Abacavir, which your triple contains. Whether that could be a significant differentiator? Are you finding feedback from doctors that Abacavir is a deterrent to using the triple therapy?

The second HIV question would be about -- I know you are working at doubler with [indiscernible]. With that doubler [ph], I think the ingredient is J&J's ingredient. Does that mean that you'd only have half the economics per patient, that you do have for Trimeq?

And then the third one would be just Epzicom generics, does that put any pricing pressure on Trimeq, as two of the three ingredients go generic?

Sir Andrew Witty

Thanks very much.

James Gordon

And then one question; and so just a quick one on triple, which was just -- are there a lot of patients that are really using triple therapy, how widespread is that as a free combo?

Sir Andrew Witty

Great. Thanks very much. So in terms of the HIV questions, let me try and do it in reverse order; so when you look at the risk to price and there is some risk-to-pricing, but generally speaking, at least up until now, that has been more talked about than the reality, and so I don't think we should be overly anxious about that. There'd be many-many genericizations of molecules within the HIV market, which are themselves within more modern combinations, and we haven't seen a dramatic impact. At the margin perhaps, but not a very dramatic impact. So I wouldn't necessarily anticipate a huge effect there.

I think as far as Abacavir is concerned, I mean, this has been for years and years has been the debate around the safety of Abacavir. The FDA came out almost 10 years ago now, and it must be, with their review. And since then, I'd say, that in reality, it hasn't been an issue in the marketplace. It certainly hasn't held back the performance of dolutegravir in any way, whatsoever. And I think equally, when you look at the alternatives, you took at the TAF contained in regimens, as people live to much longer age on these medicines. Some of the potential risk of those medicines become more relevant.

So I think in all of these situations, there are some puts and takes. I don't think there is anything particularly important here, in terms of a dynamic for dolutegravir. It has had absolutely no inhibition, and as you saw in the launch of dolutegravir, it has been by far and away the most successful launch in many-many years, in terms of really shaking up the market and moving share, and I think that is really reflected in people's confidence, not just to the monotherapy, but of the combination as well, and as you saw in this quarter, Trimeq, is really taking up the charge in terms of the growth of the dolutegravir based regimen.

In terms of the double, I mean really, the focus from where we are, and you are quite right, we are looking at the combination with [indiscernible]. It would be a shared set of economics, but obviously our core focus is on the dolutegravir lamivudine program, which is a different situation altogether.

As far as triple is concerned, about a third of the patients are already on an open triple regimen, James, as far as we can tell. Next question?

Operator

The next question comes from the line of Richard Parkes from Deutsche Bank. Please go ahead. You are live on the call.

Richard Parkes

Yeah. Thanks for taking my questions. I have just got a couple on pricing and respiratory, just looking into 2017, with possible Advair generics, I just wondered if you could update us on how contracting is going for Advair in terms of pricing. And then, with the planning for the filing of the triple being brought forward; I am wondering, what you are thinking about, how pricing might play out there? I think you have -- in the past you have said that, in that price Breo has been lower than Advair and obviously, and that's to ensure full reimbursement access. So I am wondering if for clinical benefits, if the triple can outbreak that cycle, or if it is really going to be a volume gained, and sort of defending/gaining your current position there?

Then third question is just on the pharma margin, going into 2017, you have obviously seen benefits from the cost savings programs coming through. But pharma margins are also seeing an improvement this year, helped by ViiV. I am just wondering if those positives can continue to offset maybe the possible impact of Advair generics, and mix effects from your lower margin respiratory portfolio into 2017, or what perhaps should we think about pharma margins into 2017?

Sir Andrew Witty

Okay. Thanks a lot Richard. So, I think, like everybody else, nobody knows when there is going to be and if there is going to be a generic, and if there is a generic, what shape is the generic and how complete or not the supply is going to be. So we have to wait and see what happens. We have given guidance through to 2020, assuming a pretty fundamental generic competition some time, between now and 2020. But I don't think any of us really know when it could happen. There is obviously a front edge to the window, based on the potential fastest possible approvals, and there is an open ended close to the window, in terms of how wrong things might really take, and of course, exactly how much supply is out there, and whether or not all of the generics make it, and whether they are all substituted, huge questions.

That's just a preamble to say to you that we are in a good position for contracting for 2017, and while not everything is finished yet, it feels as if we are going to have just as good, if not slightly better access for all of our respiratory products in the U.S. in 2017, than we currently have in 2016. And roughly, we haven't had to give too much more price, which -- partly, because we have given a lot in the last three years, and we certainly wouldn't want to be giving a lot more price at this point in time.

Overall, we feel good. Of course, whenever a generic comes along, that is bound to create a kind of disturbance in the system, but it all depends exactly what it is. And I remain, this is probably -- this is definitely going to happen, after I finish the CEO of GSK, and I will therefore spend my entire career as CEO of GSK saying the same thing, which is the genericization of Advair is not going to be normal. It hasn't been normal so far, and it won't be normal, when and if it actually gets into the marketplace. And I think, we are going to have to take a little bit step-by-step, to see exactly what comes to market, and how it compares, in terms of substitutability. And exactly, how much Advair is left by that point; because obviously, our goal is to try and generate a very substantial alternate new respiratory business. We are now growing our respiratory products faster than we are losing Seretide, which is a key step. The triple gives us another key step.

In terms of triple price, I don't want to front-run that conversation; not least; because, we are going to be talking about that pricing situation, middle, end of next year in the U.S., depending on the regulatory timeline. An awful lot can happen in the next 12 months. I don't think it's wise for us to really front-run that conversation. I do believe, that triple is a really exciting opportunity for GSK, and I think that when -- as we look at more of the data, we have seen some very-very exciting exacerbation data from the triple program now. I think this is potentially a product, which could really bring together our entire portfolio in the U.S., and as we have built up this ELLIPTA device based portfolio, we are gradually building greater and greater momentum in all the categories that we operate in, and I think the triple really brings all that together, and I think can give us a tremendous opportunity.

Let me ask Simon to comment on the pharma margin for next year.

Simon Dingemans

Yeah. I mean, clearly given the profitability of Advair and at this stage in its lifecycle, there are relatively few support costs that we have around the product like that [ph], and we have also optimized the cost of goods that contribute some very significant margin. If it goes quickly, then we are going to cushion the downside. But we are obviously not going to be able to offset it. If its spread over a long period of time, then we stand a better chance, and I think, depending on what your scenario is for 2017, you should expect a downdraft on the margin, as Advair goes generic as and when it does. But every quarter that goes by, in terms of the new products, their momentum, their development and also, their improving margin, as we mature those products, and we get to optimize again in the same way as we did with Advair, a decade ago, then the net-net effect is going to reduce. But I think short-term, there is still going to be a significant impact.

Sir Andrew Witty

Next question?

Operator

Thank you. Next question comes from the line of Tim Anderson from Bernstein. Please go ahead. You are live on the call.

Tim Anderson

Thank you. I have some questions on emerging markets, so performance still struggling. When would we expect to see your overall emerging market business return to positive growth territory? In China, I think you had talked about returning to growth in second half, is that still on track? And does your emerging market business now, between the contraction of sales and the remitting of certain problems, is that a profitable business for you at the moment?

And then second question is, just high level on Brexit. Not a near term impact on things like foreign exchange, but really looking for what structural disruption might occur over the intermediate term, whether supply or hiring or anything else to do with it, that you could comment on, that would be helpful?

Sir Andrew Witty

Thanks a lot Tim. So EMs actually are improving underline, but we have had a number of disposals this year and the Venezuela situation and continued reshaping of China. So I'd expect, as we come through this year, you are going to start to see much better underline, getting us into the mid-single digit type territory as we move into next year.

China, likewise. So as we continue to expect China to move back into growth, as we come through the second half of this year, we have just seen Cervarix approved in China. We have just had [indiscernible] put on to the pricing list. We are seeing some very significant positives, as a result of that, and we were already seeing some stabilization.

You got to remember, a number of businesses -- we decided to divest ourselves with a number of products in China in the last six months or so. So an awful lot of the suppression that you see in the structural reshaping of the company rather than anything else.

So as you think, most of that is on course, absolutely still a profitable business for us, is a very good business for us, and I think we are coming through back into something, where it will be a reported contributed to growth, in a way that it hasn't been in the last year or so, because of the China issue, and because of the restructuring or the divestment of various businesses, plus of course, Venezuela.

As far as Brexit is concerned, I mean, I think the things to keep an eye on that, and their all global level, they are all slightly at the margin. But probably, worth having at least on page 14 of your radar. Whether or not U.K. stays in the European Medicine Agency, is going to be a big deal. Why? Because if U.K. leaves, you could articulate a whole bunch of negatives, but you could articulate that the reason why Britain leaved to create its own agency, is to create the best agency in the world, with the fastest most innovative way to assess value for money. I am making it up, but just imagine, that that were the scenario, that could create a very interesting competitive dynamic, in the way in which innovation is assessed globally, and would create a new voice in that system. There are clearly lots of downside risks of separating the U.K. out, but there are possible upsides.

So I think where U.K. regulatory decisions go, will be a very important issue, number one. Number two, parallel trade, so will there continue to be a free movement of goods, between the U.K. and continental Europe? About a third of GSK products sold in Britain is products which was originally sold in continental Europe and then reimported to the U.K. -- sold at lower prices in Europe and reimported and then sold in the U.K., that's a net benefit to GSK, if there were no parallel trade. The changing currency has already helped a bit there. But nonetheless, is still an opportunity there for companies like GSK, if parallel trade were to, for whatever reason, to disappear.

There is the potential for increased complexity in the supply chain, if Britain were to separate from the European regulator, and there is the potential in the long run, and again, now I am painting a downside scenario of a regulator separation. You could paint a picture, which says, in the long run, a standalone British regulator doesn't have as much influence globally, and you do less clinical research in the U.K., and that over time, starts to have an influence on where you might want to do your long term research, which is a very long term question, but is clearly a possibility.

I think the reality on everything I see and feel here, is as much as it might frustrate everybody, I don't think we'd have any clarity on any of these questions for possibly two or three more years from now. I don't think we should be anticipating all of these answers get issued quickly. I think that this is going to take much longer than people think, and it probably should, because it's much better that we get the right answer than we get a quick answer. But we are going to have to live with some uncertainty during this period. Next question?

Operator

Thank you. Your next question comes from the line of Andrew Baum from Citi. Please go ahead. You are live on the call.

Andrew Baum

Thank you. Two questions please; number one, Abbas highlighted a pending decision that would be made to accelerate some of the high probability, high commercial potential compounds in your portfolio. I am interested on the timing of that, have those decisions been made when we should expect [indiscernible] some of the clinical trials, for example, for your OX40 or ICOS or some of the potentially more promising compounds and conversely, a culling of some of the low priority compounds?

Number two, I noted that you described the bictegravir, the Gilead molecule integrated inhibitor structurally similar. Do you believe there is any infringement of your dolutegravir intellectual property and related compounds that you have? And then finally on China, just picking up from the last question, taking out the reshaping that you have referenced; in terms of the underlying growth of the Chinese business that you have, could you give us some sense of how that is progressing? Are the declines ameliorating and bottoming out, and also if you could give us a sense, as a percentage, what fraction of the Chinese business have you divested as part of that reshaping process? Thank you.

Sir Andrew Witty

Great. And thanks very much. So I think on the last point, yes, our underlying growth is improving quite quickly, and we have probably divested around about 25%, a third of where we were beforehand, in terms of -- divested or reshaped about a third of what we had before. As far as the dolutegravir, Gilead competitor concern, I don't know whether or not there is an issue there. But clearly, this is a class where you can see there are some similarities.

As far as the prioritization is concerned, I mean, just to be clear Andrew, we do prioritization all the time. So as soon as we see a program, as you saw, where ICOS is in the clinic. OX40 is now in several trials, collaborative trials with other companies with PD1 partners. So I just want to disabuse of the notion that nothing happens until some committee meets and makes a decision and then everything happens. Everything has moved as fast as it can move, once it achieves its evidence points, whatever they are, whether they are safety or efficacy or quality.

And similarly, as the programs that start to move, start to move, then we would start to rein back on the programs which we have less interest in. And we run a very -- I think a very comprehensive and very thoughtful analysis of every single asset with every single experiment in R&D, force ranked against each other, in terms of its potential economic value to the company. Of course, with the risk rating attached to it, in the way that you do that, and that's what, if you will, drives our decision making. Now of course, it has to be alive to the fact, that on Monday, you will get some amazing news on the drugs you weren't sure about, that suddenly moves it up the schedule. I mean, you have to be able to react to that very quickly.

A real example of that, is the triple for America. I mean, we were on a schedule to file the triple two years from now. We have got some information which gave us confidence that we could potentially move much more quickly, and we reprioritized everything in the company to take two years out of the filing timeline, and we told you, we could file it before the end of this year, as a real example and exactly the way the company operates.

What Abbas was referring to is our -- we do have an annual snapshot review, which is a good chance for everybody in the company to see everything that's going on, gone on to kind of stay. And if they are at that point, kind of collections of products, which look like they are really going to fly, then you might make a decision to say, okay, we are now going to take a choice on the following three or four or five assets, in a much later part of the development portfolio, and we do that every year.

So every September time, we have those reviews, and if you went back six or seven years, that's when we surfaced Breo, Anoro, dolutegravir, all of the products which are driving our sales today. We essentially identify through that process. We then swung behind and then we moved it forward. And we do that every single forward, and every year. So last year, triple, really surfaced through that at the end. Two years before that, Shingrix surfaced, that's really exactly how we do it.

Now, if I am looking at this year's review, the ones that I am watching to see how well we are doing are, the dual in HIV, Shingrix, the triple obviously, it's late stage, danirixin, cabotegravir, the PHI program, the RIP Kinase program, OX40, ICOS, BET inhibitor. Those are the programs which are now all receiving absolutely daily kind of updates on priority and being flushed through the system as quickly as possible, and when we look at the whole portfolio, we will be simply doing a double check to make sure absolutely everything that can be done, is being done.

I would disabuse of the notion that we don't do that on a regular basis. It is absolutely what we do all the time.

Next question?

Operator

Thank you. Your next question comes from the line of Jo Walton from Credit Suisse. Please go ahead. You are live on the call.

Jo Walton

Thank you. Three quick questions please; one, just to help us with our modeling, you have told that your assumption of a 19% improvement from FX for the full year, includes an EGOL situation, the same as last year, that was a minus 54 for last year. Is it likely, given the volatility of currencies going forward, that that EGOL could develop and be more substantial by the end of this year? And when we are looking at where to put this currency gain? Should we model it effectively, mainly in cost of goods, because that seems to be where we soar to the second quarter.

Could you also give us some more help please on the minorities, with the consumer business growing, with ViiV growing, naturally you would have thought that minority would be getting higher. Maybe there were some funnies [ph] in there, but if you can help us with that, that would be very helpful?

And finally, pushing on Advair for next year, are there any opportunities for you to do long term contracting, so that you can at least retain volume, even if there is an issue of price? And can you give us any insights as to how that might be progressing? So what might be realistic for us to assume, in terms of your volume retention in the U.S.?

Sir Andrew Witty

So let me take the last question Jo, and then Simon will obviously address the other ones. Clearly, we are going to explore and are actively exploring all the possible scenarios for continued business retention of a proportion, hopefully substantial proportion of Advair post any generic entry. And there are, definitely to your precise point, yes, there are ways in which we can contract, or we can compete in different ways to keep volume in the U.S.

One I'd remind you of, is that there is no generic file for the MDI, and so, that business alone, you would not anticipate being genericized. The key to all of this is, when does the generic begin and it may or may not begin. So again, I would -- clearly there is a risk of it being in 2017, and it may very well be in 2017, but it may not be. And so, we need to be, first of all, alive to that, and we also need to be alive to what really is the shape of the generic competition, is it one company, is it multiple products, is it substitutable, are they all substitutable, all of that plays to what kind of deal we can do frankly, and clearly, the later it is, the fewer there are and the less substitutable they are, the better for us, I mean, just to be obvious.

I think, in a way, it's unlikely -- it won't be for me to do, but it's unlikely that the company will be giving you very precise guidance to answer your question, other than to frame it in a way that I just have. So that you can do your own assessment of, if there is only one and it doesn't come until the end of 2017, and it's not substitutable, then that's a certain scenario, versus if three came in March of 2017, that's a different scenario.

I think, there is still an awful lot to play for here, and when you look at our share acquisition overall, we have grown our share of ICS LABA over the last 12 months, with Advair obviously declining, but with the strong growth of Breo. I think though, we are in a decent position to continue to build a very strong ongoing revenue base there, and we are certainly on track to what we have said to you before, which is that by 2020, we expect our respiratory business to be as big as ever. And I think, this transition looks very much doable, in terms of where we stand today.

With that though, I will ask Simon to comment on the other questions.

Simon Dingemans

Thanks Jo. So on the currency tailwinds, we have made an assumption in the 19%, as I said earlier, that we will have exactly the same EGOL this year, as we had last year. T his is an area that we have got a huge amount of focus on, and you are absolutely right, that when currencies are volatile, it's even more difficult to control. So we are pleased to have come through the second quarter with none. But over the year, I think we have to expect continued currency volatility, and that's why we made the assumption we have. They typically show up in SG&A, rather than cost of goods. Cost of goods benefit in the quarter is really more about where our costs are, i.e. in Sterling, relative to other currencies. So if you are modeling, I would assume they come in SG&A.

On the minorities, there is definitely some phasing between Q1 and Q2, and I think if you look at the half as a whole, then you will see the trend more in line with what you were probably previously expecting. In Q2, we saw a number of bad debt provisions in some of the other minority interests we have around the group, and not the big two ones we just talked about, and obviously, those credit and minority interest, that's a bit lower than you would otherwise expect. But just look at the half as a whole, and you will be in a more sensible place.

Sir Andrew Witty

Great. Thank you. Next question?

Operator

Thank you for your question. The next question comes from the line of Keyur Parekh from Goldman Sachs. Please go ahead. You are live on the call.

Keyur Parekh

Good afternoon and thank you for taking my questions. Andrew, two for you please; one is, as you think about the Glaxo business over the next five, 10 years, how do you think the challenges and the opportunities that face the new CEO will be different to the ones that you faced when you took over? And consequently, what would your suggestions be for the new CEO? And secondly, as we think about the progress you have made on the integration, we think about the benefits to the cash flow from the Sterling being what it is, is there an opportunity for Glaxo to think about increasing the dividend kind of in 2017, rather than it being flat in 2017 and then growing post 2017? Thank you.

Sir Andrew Witty

Great. Thanks very much for the question. I think -- the last thing a new CEO wants is a kind of instruction manual from their predecessor, they want the complete opposite, they want a freedom to do what they want to do, and that's exactly how it should be here at GSK.

I think that though, when we look at the business, where we are today, versus perhaps where we were a few years ago, as we look forward, one of the really big differences is Advair is coming down quite quickly, its relative importance to the Group is dropping very quickly. And while Simon is quite right, if there were to a sharp genericization, it would hurt in the year, it's no longer strategic in the sense that it once was.

And actually when you look beyond Advair, you really have no material genericizations until the second half of the 2020, that is a massive difference to the last seven or eight years, where we have had a constant stream of expiration of product. It doesn't mean there won't be other issues and other threats, but I think the new CEO has the platform to be able to build growth and focus on how to drive those elements of growth in the vaccine consumer and the pharmaceutical businesses, without having to always be taking two steps back before they take one step forward, because of the losses of the older products, and I think for the next 10 years, that's a very-very attractive place to be as a company, and I would argue and you know my view on this very strongly, I would argue that we built extremely competitive positions now in vaccine consumer and in the key therapy areas in which we compete in pharmaceuticals, and that the mix of those areas give us a very-very strong sustainable position against the likely ongoing pricing pressure in pharmaceuticals, especially in specialty pharmaceuticals, which I think is coming. And we need to make sure we are ready for that.

Now, I am not saying there is a great opportunity there and we want to play in that marketplace, but I don't believe we want to be totally exposed to that. And so, I think for the new CEO, they have that as a foundation to start with, and then they will make good decisions about how to further develop, enhance and change the focus of the company.

I think in terms of the dividend, the board had made it very clear, they expect to pay £0.80 a share for 2016 and 2017, and then I am sure, the board will take a view on what its ongoing dividend approach will be for 2018 and beyond. And of course, what they will inform that, is the position of ongoing cash flows, and as you rightly say, the underlying performance and the currency all help, but I don't think anybody needs to or would necessarily be well advised to make a premature decision.

I mean, there is some water that has to flow under the bridge, and I think then they will make a sensible decision going forward. I think one thing you know from GSK board, is that they value their shareholders very highly, and I think we have had a long history of ensuring a good balance of return of cash to shareholders. And I think in my tenure, I have paid out something like £40 billion, which is almost 100% of the market cap on the day I took over back to shareholders. Next question?

Operator

Thank you. Your next question comes from the line of Seamus Fernandez from Leerink. Please go ahead. You are live on the call.

Seamus Fernandez

Great. Thanks very much. So just a couple of quick questions in the overall respiratory franchise; can you talk a little bit about how you feel the progress of Nucala is going and how you expect that franchise to continue to evolve going forward, as competition emerges in that market? The second question is, on the close triple, can you just help me understand a little bit of where do you really see the incremental value add of the close triple, obviously, superiority to Symbicort is a good and attractive start. But we have seen good performances in superiority versus Advair, with just a two ageing combination from some of the other competitors. So just trying to get a better understanding of how you see that evolving on a going forward basis, and how the close triple -- and how you see the success of the close triple and how you will metric it? Thanks.

Sir Andrew Witty

Great. Thanks very much for the question. So Nucala is off to a good start actually. So we are ahead of our expectations in the U.S. and Europe on Nucala. We are seeing a very -- I think we have something like 3,100 patients on drug in the U.S. These are, as you probably know from other companies, I know Novartis went through exactly this when they launched XOLAIR, very complex to get patients on these kinds of drugs. It's not particularly a clinical issue, it’s a reimbursement issue, and it takes a few months to set up a process and on average it takes us about six weeks to get the patient from a point where a physician says I want to prescribe to actually being able to administer the drug, because it takes so long to go through all the various reimbursement insurance triggers, there is a real issue there in terms of complexity of the U.S. system.

But it takes a few months to set something which works efficiently. Efficient means six weeks unfortunately, but we are in that rhythm and we are seeing actually a nice continued ramp-up, no impact at all from the competition that we have seen so far in the U.S., and I think the subcut [ph] administration and all of the other benefits of the label for Nucala really stands as well there. Looks very promising, I think, it feels very good.

Ex-U.S., we are seeing very good performance, very strong start in Germany in particular, but across the board, we are seeing good reports and we just launched in Japan, and I just came off the phone with our general manager in Japan, and they have had a phenomenal first couple of weeks.

So far so good on Nucala, as far as the triple is concerned, I mean, I just made a couple of points. I said earlier, about a third of the market was in an open triple, more or less. You got to remember though, GSK might only be playing in about half of those prescriptions, so let's assume that Symbicort has about half the base steroid combination, we have about half. And of course, we don't play in hardly any of the SPIRIVA element. So when you break down that third of the current market, we are playing in a relatively small fraction of the total value of that marketplace. So the first thing of course, is to try and capture more of that.

And I have a funny feeling, I was thinking the other day about triple, and it reminds me a lot of when we launched 20 years ago, fluticasone and salmeterol, both of which were highly effective medicines, competed like crazy with Symbicort -- sorry with Budesonide from AstraZeneca, and it was only when we brought Advair out, that it really drove the dominance of GSK in that space, took Astra then another five or six years to try and catch up, and they have never really been able to, in terms of share.

I think this may be somewhat similar, that you have a scenario where we have introduced a series of new medicines. This time, they have been doubles, rather than monos, but actually the thing that really clinches the market is the triple. And I think that that, once you -- if you can establish yourself as the triple of choice, it’s a bit like the Brexit negotiation, right? Once you decided what the answer is, you know what your negotiating strategy is. I think if you decide that your triple of choice is the GSK triple, then why wouldn't you start with a double of GSK? Why on earth would you start with somebody else's double?

Now remember, in America as well, there is never going to be another once a day double product in the marketplace. So we started -- I think we started to create an extremely persuasive pathway, because the reality is, in COPD, everybody knows the patients are going to progress, and patients are not going to stop at any particular level over time, unfortunately, their disease is going to progress, and they are going to need to move on to different regiments, and therefore the physician will need to establish for themselves a pathway. If we lock in the endpoint, then I don't think it becomes obvious where the start points are.

So I think for us, there is an obvious share-take opportunity within the established open space, and I think there is potential for this to be the absolute clincher of the whole respiratory strategy for GSK, and I have to say, with the way we see ELLIPTA devices now being used and welcome, that's why we are building yet another set of production lines announced today to keep up with demand. And the way in which the feedback on the individual molecules and doubles that we have got. I think we are simply building up a tremendous amount of energy and goodwill around these new products. I mean, I look at what could come from the competition, its either late or its twice a day, in the key market of the U.S., and I think we have got a tremendous chance to really drive this market forward in the way that I have just described.

Next question? Last question I think actually.

Operator

Thank you. Your next question comes from the line of Kerry Holford from BNP. Please go ahead. You are live on the call.

Kerry Holford

Thank you. A couple of financial questions, and then a product question please; so firstly, on cost savings, your target for the year remains £2.4 billion, and yet you have essentially built much of that in the first half of the year. So I wonder, why you are not raising that guidance, and why that run rate is low so dramatically into the second half? And if indeed that is the case, how is an incremental £6 million then achievable for next year? If you could just talk about phasing that?

And then on the operating margin, that was up around 250 basis points year-on-year, could you give us a broad guidance to the components there, split between the underlying performance of the business, restructuring benefits and one-off such as the Advair reversal? And then, on the triple, could you just confirm whether you would expect that product to receive a 10 month or a 12 month review in the U.S.? Thank you.

Sir Andrew Witty

Go ahead Simon please, on the first --

Simon Dingemans

So on the cost saves; clearly as we have said in the remarks at the beginning of the call. We are well on track, and in many of the programs we are a bit ahead. There is still quite a lot to do in the second half of the year, so let's get a bit further before we recall where we are going to eventually end up. We do, as I highlighted, the second half of the year is up against significantly tougher comps in that sense, and then we started to ramp up in Q3 and particularly Q4 of last year. So the incremental amounts, usually expect those to be significantly smaller, as we head into the second half of the year. So I think direction and travel pretty clear, but a bit early to call that.

I think on the operating margin, there are no particular one-offs that I would call out, I mean, the Advair adjustments that we referred to are pretty small, and not a material driver of margin, it's much more about operating performance and the leverage from the top line. The leverage from the top line is probably delivering about 40% of the total, and the rest is coming from ongoing cost savings, as well as the integration and restructuring benefits that combine in the 2.5% that we delivered in the quarter.

Sir Andrew Witty

Thanks Simon. And then just finally, Kerry, on the triple, it’s a 10 month review.

With that, thank you very much for your attention and your questions. The IR team at GSK is obviously here to handle any other questions for you. Thank you for your attention today.

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