Q2 2007 Earnings Call
July 25, 2007 9:00 am ET
Dr. J.P. Garnier - CEO
Julian Heslop - CFO
David Stout - President, Pharmaceutical Operations
John Clarke - President, Consumer Healthcare
Kevin Wilson - Citigroup
Andy Cosen - Analyst
Graham Perry - Merrill Lynch
Steve Scala - Cowen & Company
Andrew Baum - Morgan Stanley
Craig Maxwell - J.P. Morgan
David Adlington - Analyst
Good morning or good afternoon, ladies and gentlemen. Welcome to the GSK Q2 results call (Operator Instructions).
Just to remind you all, this conference call is being recorded. I would now like to hand over to today's chairperson, Dr. J.P. Garnier. Please begin your meeting, sir.
Dr. J.P. Garnier
Thank you very much and welcome. I would like to give you some headlines on the results, and I will be followed by Julian Heslop, our Chief Financial Officer, and David Stout, our President for Pharmaceuticals, and finally, John Clarke, our President for Consumer Healthcare.
First of all, the EPS was a good number, plus 11% at constant foreign exchange rate. Also, our pharma sales performed well. If you exclude generics and Avandia, of course, the rest of the business is very healthy; sales up 10%. But even considering the negative effect of Avandia in the U.S., where sales were down 31%, we are still encouraged because I think that we have seen, again, a lot of evidence recently preparing for Monday's meeting. And the evidence is supportive of Avandia's risk/benefit ratio, and of its effect on cardiovascular safety.
In fact, you will see the submission from the FDA and from GSK to the advisory board members in the very near future; it should be on their Web site or soon thereafter. And I encourage you to look for new data; there is some. In fact, there is a spectacular epidemiology study, spectacular because of its size. This is information on 400,000 patients treated with the usual spectrum of drugs. There's a direct comparison between Avandia, Actos, Metformin, SUs. And I think it's very interesting. So all this will be debated in public Monday, and then the FDA will make a decision. And we look to a resolution of this controversy; the earlier the better.
But Avandia is not the whole story. U.S. sales of Avandia before the controversy started were representing about 5% of GSK revenues. And I have to say, the rest of the business is in very good shape. That is also why we maintained the guidance, because frankly, we are ahead of our own plans for pretty much everything except Avandia.
In that context, consumer did very well this quarter again; sales up 18%. And we'll spend a little bit more time on consumer than we normally do to celebrate their success. John will talk to you about the recent launch of Alli in the U.S.
Pipeline momentum is -- continues the theme at GSK. Our products are advancing. We did receive the all-important Cervarix approval in Europe, and we are working diligently to move all our molecules forward. And then, to build long-term value for shareholders; this is the only way to do it, is to have the best pipeline in the industry, and to launch new products. And talking about shareholders, you have noticed our announcement to increase significantly our share buyback, and to accelerate it, so we will be spending GBP12 billion over the next two years.
On the next slide you can see what I was talking about earlier on. Avandia is important, but it's not the whole story. And the portfolio is doing well. The declining sales of Zofran, Wellbutrin and Flonase, of course, is impacting '08. That was completely expected in our guidance. And as expected, sales in that particular segment are down 53%. But for the rest, all our products are doing well. And David will give you some more specific news on the usual growth drivers that we describe every quarter.
So, consumer is important. It's outpacing pharmaceuticals this year so far. And I want to come back a little bit to why we like to own a consumer healthcare business and run it in an intertwined manner with pharmaceuticals.
Frankly, from a strategic standpoint, there are basically three reasons why pharmaceutical companies should own OTC businesses rather than sell them. First of all, you have to look into the future and see where healthcare is going. And healthcare is becoming far more consumer-centric. Patients no longer want to be passive about how to manage their conditions. They want to have a say. They have access to the net. They have access in some countries to direct-to-consumer advertising. They are much more educated and knowledgeable. And therefore, they want to interfere with the process of healthcare delivery in a positive way. They're looking for more autonomy.
And then of course, OTCs play a very important role, particularly when you add to the equation the fact that consumers now pay for more of healthcare than ever before, not just in the U.S. but also in some countries in Europe. We are seeing copays take -- put in place. So consumers are even motivated from a financial standpoint to look at alternatives, and clearly, the OTC alternative is a very good one to save money, save a trip to the physician. And therefore, there is a drive towards showing more interest for what's available over-the-counter. And of course, countries are also taking advantage of the over-the-counter opportunity. By de-reimbursing and allowing switches, they essentially lower their exposure to the cost of healthcare medications.
And finally, of importance today, as you know, we are completely focused on growing the non-U.S., non-European part of our business. This is where the future is. The new economies are really getting ready now to embrace healthcare systems for their populations. They have the money to do it. And of course, they have extremely large populations that could become instantly customers for GSK and others. And the over-the-counter solution within that framework of developing economies is much more important than in fully developed countries. To give you an example, a OTCs represent roughly 7 to 10% of prescription sales in countries in Europe and in the U.S. In contrast, in China, OTCs represent 40% of the market. And not being present in that market, in my view, is a strategic disadvantage. So we are very happy about being in over-the-counter, and we're going to stay there for the foreseeable future.
I also want to say that, of course, it does make sense for us to own a consumer business, because there are tremendous synergies on multiple directions, not just sales and also costs. But the discovery of innovative, new OTCs has a lot to do with our expertise in formulation, in clinical development to build new claims for our drugs, in our ability to work with regulatory agencies, such as we have seen we have done for Alli on behalf of Roche. So for all those reasons, there is tremendous added value and creation of value. Of course, selling consumer would destroy all this.
And then finally, we have a very good consumer healthcare business. Not only we are in the right market, owned by the right kind of company, but we have a very successful consumer healthcare business; it's been successful for a long time now. You look at the positioning; we are in the right categories. I'm particularly happy about our leadership in causes of preventable deaths, which are going to continue to be important for today's populations everywhere in the world, that is until the last person smokes the last cigarette, we'll be a big factor in helping them quit. And of course, obesity is unfortunately on the rise everywhere. And here, our first entry with Alli is promising, but we are also looking for more.
And then of course, this is important today, is to judge how the business model is compared to the business model for pharmaceuticals. And clearly, in consumer healthcare, our brands have indefinite life, as you can see with the success for instance of Horlicks (ph) and many other products which were introduced more than 100 years ago. And in OTCs, parallel and the like have been there for a very long time, and they are not easily made obsolete, particularly as we continue to invest research money to make those brands better in terms of their delivery characteristics and the like. So we have the opportunity of avoiding the dreaded cliff effect that we see in the prescription business model for all those reasons. We continue to support a strong consumer healthcare business, and we are glad to have it.
Now, in terms of creation of value, I just want to remind you how we're doing this year in terms of new launches. As you can see on the slide, we have already launched five major new pharmaceutical products and, of course, Alli as well. We are off to a good start for all of them, although it's very early days, so we're not going to have too many details. But clearly, the start of Veramyst and the others, Dike (ph) Tykerb and so forth, is good. Cervarix is not, strictly speaking, on the market, except for Australia. So it's early days.
Now, besides those six launches, if you look at the pipeline and the need to constantly have a new wave of new product introductions, and never miss in terms of replacement of existing product lines, the situation at GSK here again is quite healthy. And as you can see, if you look at the all-important late-stage pipeline, and that's all I'm going to say, is just list how many opportunities we have for '07, '08, '09. So for the immediate future, if everything works normally, and we don't experience too many delays with the FDA and so forth, we could be up to launching 25 potential interesting new products, NCEs, vaccines and some important PLEs. So all together, this will generate considerable future revenues, and that's important in today's environment. And that really is the way to do it on the long run.
On the short-term, we increased our share buyback to give an opportunity for shareholders. Frankly, the stock price was doing reasonably well. We were outpacing the FTSE and the pharmaceutical index up to the point of the controversy on Avandia started. That's unfortunate. We had planned to accelerate this share buyback, and we are glad to announce it now. That is a good time, I think, for the shareholders to benefit from our actions.
So on that note, I'm going to pass it on now to Julian Heslop.
Thank you, J.P., and good afternoon. You'll see the turnover in the quarter was up 3%. Pharmaceutical sales were level with last year, with strong performances from a number of our key products, offset by generic competition in the U.S. and a decrease in Avandia sales. Consumer healthcare sales were up 18% and benefited from the successful launch of Alli, the FDA-approved OTC weight loss product.
Cost of goods as a percentage of turnover was 21.4%, which was broadly in line with the 2006 full-year margin. SG&A as a percentage of turnover was in line with last year, and includes significantly higher advertising and promotional spending in support of our key consumer healthcare brands, including Alli. Pharmaceutical SG&A costs, excluding legal and restructuring, were flat compared to last year. R&D expenditure was lower than last year, mainly reflecting lower asset write-offs.
Other operating income of 97 million is twice last year's level, and includes a more than doubling of royalty income to GBP49 million. Operating profit growth was 9%. EPS growth of 11% was 2 percentage points above operating profit growth, reflecting the benefit from the lower tax rate and the share buyback program, partly offset by higher interest charges.
You can see that the quarter was again adversely impacted by currency with a hit of 8%, and this reflects the continued strength of sterling against most major currencies, but in particular the dollar, which was $1.98 for the quarter compared with $1.83 last year.
Free cash flow for the quarter was 903 million, slightly higher than last year, as a result of lower tax payments. You may recall that last year the quarter was hit with a withholding tax payment that was repaid in the fourth quarter. You can see that cash returns to shareholders comprising dividends and share buybacks amounted to over 1.4 billion, a GBP330 million increase over the previous year. Net debt was 3.3 billion at the end of the period.
Finally, the Company continues to drive to increase cash returns to shareholders, firstly and most importantly through a progressive policy of dividend increases, and secondly through share repurchases. In 2006 we doubled the annual share repurchase program. We have now chosen to increase the absolute level of debt and have decided to do this through a GBP12 billion share repurchase program, which we expect to complete over a two-year period. This will take the place of the previous share repurchase program. The slide summarizes the expected phasing of the 12 billion share repurchase program compared to the previous program, which it replaces.
In conclusion, we have in the quarter delivered sales growth despite significant generic competition, continued to control our costs, and as a result, generated good earnings growth.
I'll now hand over to David.
Thank you very much, Julian. If you'll please turn to the page that's headed 2Q '07 pharma sales.
As you can see, sales for the second quarter were GBP4.8 billion and were even with last year. Our key growth products are continuing to do very well, and just about offset both the anticipated hits that we took with the generic competition to Zofran and Wellbutrin XL, along with the unanticipated loss in sales to Avandia, which I'll talk about a little bit later in the presentation.
For now, let me just give you a little more detail on the performance of our growth products. So, if you'll turn to slide two.
And as you can see here, despite removing Avandia, at least for the time being, this group of growth products still represents almost 50% of our portfolio. And of course, we hope to add Avandia, which represents less than 5% of our U.S. pharmaceutical sales, back to this list in the future. I'll have more to say on Advair, vaccines and Coreg during the rest of the presentation, so let me just say a few words around the rest of the portfolio.
Valtrex and Lamictal continued to deliver very solid double-digit growth. It doesn't seem that long ago that we were passing the $1 billion threshold, and now, despite the weakness in the dollar and generic competition in Europe, we're headed towards GBP1 billion in annual sales for both products.
Requip is being driven by the Restless Leg Syndrome. And for the non-believers out there, I hope you have the chance to see the article in the New England Journal of Medicine last week, which really laid out the case for the disease.
Avodart is continuing to expand its use in BPH, and Boniva continues to grow share with GBP36 million that you see on this slide, which represents half of the total sales from our joint marketing effort with Roche.
Now let me just take a few minutes to talk about the Avandia situation. If you look at the next slide, I think, the immediate impression that you will get from looking at this slide is that the impact has mostly been on the U.S. market, with some impact and international markets that are closely tied to the U.S., yet with very little impact in Europe. We, of course, believe very strongly in Avandia, based on the extensive review of all the available data that we'll be presenting to the Advisory Committee and the FDA on July 30th. It's our understanding that the material sent to the Advisory Committee will be posted on the FDA Web site either today or tomorrow, and I'm sure you'll look through it. And just as J.P. mentioned earlier, I would direct your attention to GSK's comprehensive submission of all of our knowledge and data, including the large epidemiology study of 400,000 patients.
In the U.S., the media has done more -- has had more of an impact on physician and patient impressions than the data itself, however, so now they're waiting to hear more definitively from the FDA and the Advisory Committee. We're of course very helpful that shortly after the meeting with the FDA, that we'll be able to renew physicians' confidence to prescribe Avandia for new patients.
You can see in more detail the impact on prescribing in the next slide. And as you see, since the publication of the meta-analysis that the total volumes are down about 37%, while new scripts are down almost 46%. While the drop-offs appear to have plateaued, I think that we need to wait for the outcome of the Advisory Committee and the FDA before we can draw any conclusions for the longer-term. What we are hearing is that most physicians still believe very strongly in Avandia and they want to keep patients on the product. But it's often hard for them to continue a patient who's been scared off or to start new patients. Let me just finish with Avandia by recapping our position.
Apart from the well-known risks for CHF that's inherent in all TZDs, the totality of the evidence shows that from a safety perspective, Avandia is comparable to other oral anti-diabetic medicines. Equally important is the well-established efficacy of Avandia. We can't lose sight of this. Through ADOPT, Avandia has been shown to be proven more effective in the long-term control of blood sugar than either Metformin or Glyburide. And finally, we should all remember that Avandia is the most studied diabetes drug ever, with three outcomes trials reporting out so far and three more ongoing. These, along with the multiple epidemiological studies, which look at the real-world experience, and other multiple clinical trials, continues to support the strong benefit versus the risk profile.
So, enough about Avandia for now. Let's look at the next slide and talk a little bit about Advair and Seretide.
This was a very good quarter for Advair and Seretide, and was capped off with the exciting news of the approval and launch, finally, in Japan. All markets show really good growth, and international in particular, which was aided by the stocking in Japan leading the way with 25% growth. The U.S. and Europe have been steadily growing and recapturing the momentum of two years ago. As of this month also, Europe now has the TORCH data included in their label, along with an expanded indication, which will help to continue their growth.
At the same time, we had a very positive Advisory Committee in the U.S. in May to review the TORCH data, and we're now awaiting the outcome of the FDA's decision on the label, which could further accelerate our growth in COPD.
We also had a surprising late cold winter spell in the U.S., which if you turn to the next slide, you can see had a positive upward push for Advair through March and into the second quarter. We now have had 20 consecutive weeks of volume growth for new prescriptions versus last year. This also should put us into a much better position as we go into next fall's seasonal upswing. Again, this is all before any potential positive changes to the label in COPD.
Next slide. At the beginning of the year, as was previously mentioned, we said that we had five major new launches in the pharma side coming in 2007 that you can see here. We are right on track with all these launches. Let me just take a minute to give you an update.
Two of the products that you see on this slide have already launched in the U.S. -- that's Tykerb and Veramyst -- along with one other product which was not on the list; that's Altabax. It didn't make our majors list, but it is nonetheless a very nice product, and it's off to a very good start as the very first new topical antibacterial approved by the FDA in almost two decades.
More importantly, though, are the good starts with Tykerb and Veramyst. Tykerb is quickly gaining ground in the metastatic breast cancer market and has almost 50% of patients receiving HER2 targeted therapy in the third line or later setting. And another positive sign is that about 16% of Tykerb's use is in second line or earlier. Our extensive clinical trial program in breast cancer and other cancers is ongoing, and the profile of Tykerb remains excellent.
Veramyst has just launched, so it is a little early to say much other than we are getting good feedback from physicians on the importance of Veramyst's ability to attack not just the nasal symptoms, but also the ocular symptoms of allergic rhinitis. And we also have the advantage of launching before the upcoming allergy season. And I guess with -- after six weeks of 3% market share, if you'll pardon the pun, that's nothing to sneeze at.
Turning now to Coreg and Coreg CR, let me just give you a quick update. Coreg CR was launched at the end of March and began very nicely, as you see in the graph. Unfortunately, as you can also see in the graph, is the momentum was lost when our sales forces, which are the same ones that are responsible for Avandia, had their attention turned to defend the Avandia franchise. We've now made adjustments in our field force coverage, and have about 2000 reps with Coreg CR in a first position, which should give it the intensity it will need as we move out of the summer. I think equally important, two of the big three commercial plans have now moved Coreg CR into a tier 2 coverage. All of our market research indicates that specialists and generalists that have tried Coreg CR intend to increase their future use.
Moving to Cervarix, we received our first approval in a major market when Australia granted a license last month. The label was also very broad, with coverage for females up to 45 years of age -- that's very unique -- along with data on efficacy against persistent infections caused by antigens beyond just the 16 and the 18. And our launch is now just beginning this month.
In Europe, we received the positive opinion from the CHMP last week, and we're now moving towards a final approval with the EMEA before the end of the year. Of course we need to work now on the pricing within each country, and we will be ready to launch upon final approval. In the U.S. our file is under review, with a first quarter PDUFA date.
While Cervarix certainly is the biggest individual vaccine opportunity, we are expecting exponential growth in our entire vaccine business over the next several years. I think you can see here the many opportunities in addition to Cervarix for 2007 and beyond, and this is the broadest portfolio in the industry, which I won't go into today. But let me just remind you that we have now filed for Rotarix in the U.S. market, which is a key market for rotavirus vaccines, and we have a key differentiator versus other vaccines with just a two-dose schedule. And on the flu front, in addition to our regular seasonal shipments that will begin in the fall, we also will have our first shipments of a pre-pandemic vaccine, which will be the start, we hope, of a major opportunity.
Let me just close with a final slide, and I have attempted to summarize here several of the important milestones that we'll be approaching in the second half of the year. I've already mentioned the Avandia AdCom meeting on the 30th and it's obvious importance.
Approval for Trexima, our new advance in the treatment of migraine headaches, should come next week. We've received excellent clinical data on Trexima in previous meetings -- we've talked about the clinical data in the previous meetings, and we're now hoping for the final approval after working closely with the FDA over the last year. And we will be ready to launch this quarter, if approved.
I've also touched on Cervarix, so let me go on to the last three products, where all the pipeline opportunities with potential near-term contributions.
Gepirone ER has potential to be the first of a new class of antidepressants with no risk of sexual side effects or weight issues that many of the other antidepressants have. The FDA has accepted the file for review, and we'll know something by around November 2nd. While I don't think this is in many of the forecast models, this would be a nice upside if it's approved.
Synflorix will compete with Prevnar in Europe once we get approval on a file that we're planning to make by the end of this year. And finally, Promacta is also a very high priority for us. We presented the excellent Phase III results at our oncology seminar in June, and we could potentially file before year-end, or at latest early 2008.
Let me finish by just adding that although Avandia is casting a shadow on the day, we are extremely excited around the performance of the rest of the portfolio, and by the opportunities we have in our new product launches, and it's keeping us all very busy.
So now let me pass the baton to John Clarke, who is going to review our consumer healthcare business performance.
Thank you, David. Hello, everybody. John Clarke, President, Consumer Healthcare. As this is my first presentation to you, I thought it would be valuable before getting into the results to take a few moments to share the key points of strategic direction in the consumer business.
Long-term value creation in consumer healthcare is generated through growth and strength of the brands. And so it's all about growing the top-line, and we think this maximizes the bottom-line in the short and the long run. And it also, of course, strengthens the business market share and strategic positions.
Top-line growth for us has been driven through a significantly strengthened new product pipeline. We've introduced a range of new products recently and plan to continue to do so into the future. Our top-line is also being driven by a significant increase in marketing expenditure, and a determined focus on producing competitively superior communications and advertising, and we're achieving that.
Key initiatives driving the strategy are a reorganized innovation model, including both our research and development and marketing teams, who now work together as one unit, and importantly, a very aggressive program to continue to drive down costs to maximize the investment behind our brands as we maintain margins.
We're also heavily engaged, as J.P. mentioned, in driving our brands in the world's fast-growing economies. We have a strong global infrastructure, and we're leveraging it to optimize our global brands and the innovation pipeline.
Strategically adjacent acquisitions have a clear role in our strategy, too, as evidenced by the acquisition of the CNS business, which brought the FiberChoice and BreatheRight brands into our company in 2006. This gives us the opportunity to drive double-digit growth on that business in the U.S., and expand our acquired brands, the newly acquired brands, around the world, again, leveraging infrastructure.
So, on the very first slide here, you will see that the innovation growth strategy, supported by the drive for marketing excellence and global expansion and the relevant acquisitions, is showing through. The quarter sales were up 18, as earlier mentioned. And this result has been driven by new product innovation pretty much across the business in Europe and in the U.S., but it's been particularly strong in the international markets. In addition, as also noted, Alli, the weight loss product, has been successfully launched. I'll return to that subject in a few moments.
The next slide will show that the underlying momentum in the business, in the base business, which is now up 8% at the half-year, which is building on the 6% achieved in 2006, is a good momentum. The addition of Alli builds that growth to the half-year point to 14%. And as I indicated, this underlying growth is being influenced strongly by new products.
By way of example, I'll refer to a superior in-home whitening treatment previously only available from dentists has been launched under the Aquafresh brand-name, and that's been very successful. We have launched the first product formulated and positioned for the rapidly developing and serious condition of tooth erosion. This product is marketed under our Sensodyne brand and has also been very successful.
The next chart shows the performance of the brands in the quarter. This is the Q2 analysis. Total sales up 18. We see Lucozade still doing very well up 17%. Aquafresh up 20. Alli contributes GBP76 million to the sales. Sensodyne is up 13, Panadol up 14, and Horlicks up 14%. So overall, the result in the quarter was a good one. We've established a good momentum, with growth based on the innovation led strategy. And I believe this is established as a good platform for the future growth.
I would now like to move to a briefing on the very early performance of Alli. The challenge in this category, where we see the consumer need for an effective product continuing to grow quite relentlessly -- the challenge is to create a long-term sustainable business. And to do that, we have built our marketing strategy around a concept we call a program, not a pill. The reason for that is that the market is characterized by consumers who are looking for a quick fix, or looking for a miracle cure. And there are many products that are not FDA approved that overpromise. Overpromise and underdelivery has led to consumer disillusionment and short-term success cycles for other products.
Against this, Alli is effective, and can deliver weight loss 50% greater than dieting alone. However, it's very important to achieving weight loss benefit that consumers manage their diet when they're taking the product. Our marketing plan is an extensive one, and it is very deliberately focused strongly on education and behavioral support, to allow the consumer to make the appropriate changes to their lifestyle and diet.
Our many years experience in designing programs to successfully assist smokers change their behavior to quit, a very difficult process, have actually informed our process here. So, the marketing program sets out expectations, again, under a principle we call straight talk. All aspects of the marketing plan communicate that Alli is effective when taken in conjunction with a reduced calorie, low-fat diet; that you should expect gradual, modest weight loss; not a miracle result. And importantly, you may experience what we call treatment effects.
To illustrate this, this is an example of one of our press advertisements, where the headline immediately asks -- the question isn't can this weight loss program change your life, but can you? And the very first piece of copy says, on the next slide, that it is a combination of a pill and a plan to help you lose weight in a healthy, gradual way when you commit to a reduced calorie, low-fat diet. And then on the very next slide, which comes from the advertisement, very deliberately we describe the potential treatment effects. The copy says it prevents the absorption of some of the fat in the foods you eat. If you eat too much fat, you may experience treatment effects, including loose or more frequent stools, an urgent need to go to the bathroom, or gas with an oily discharge.
In this market of over-claim, over-expectation, our straight-talk approach to help consumers avoid the treatment effects, to benefit from genuine weight loss, we believe, is an imperative to building a sustainable business.
Additionally -- and on the next slide you will see a picture from our Web site -- our program is not a one-way communication. The Web site not only offers the conventional information and personalized behavioral programs, but it enables an honest dialogue around what to expect and how to manage between individual consumers, as they share their experiences with each other, and also, if they wish, our advisors online.
I will illustrate the range of experiences with two online postings by consumers, and here is the first one. This is a genuine consumer report on the myalli.com Web site.
"During the two months I have been taking Alli, I have experienced none of the treatment effects that the press likes to latch onto when discussing Alli. I did have to change my lifestyle a bit."
Now, that's at the moderate end of experiences. Moving to the other end of the range, on the next slide.
"Since partnering with Alli, I have lost 16 pounds. I experienced some of the treatment effects in the beginning, but only when I wasn't informed about the foods I was eating. Get your starter pack and read it thoroughly before starting the program. Follow the guidelines and I wish you success. I have been very satisfied with my Alli experience."
That is, as I say, a range of experiences. We are getting positive results from consumers talking to each other as they go through their experiences.
The Web site has been successful. We show on the next slide that there has been some 4.5 million visitors. That's an average of 10 minutes per visit, and this site is now the number-three site in over 1000 OTC and pharmaceutical sites.
The next slide will show that we've received extensive publicity for Alli. This results in 2.4 billion media impressions. That's nearly -- that's 10 per adult in the U.S., and a rate that exceeds any OTC launch that we've been able to measure. At this early point we do not have repeat data. And clearly, as I mentioned before, that's critical. But we do have data from our pre-selected user experience group, whose experience has been used to model and refine out our approach to our launch. These people are not typical, but the repeat standard 84%, somewhat higher than we would expect for a product like this. So we can say that the early results for establishing a long-term business with Alli are very positive.
So to conclude the consumer section, I would say that Alli is off to a pleasing start, the result for the quarter was a good one, and we have established a good momentum with our growth based on the innovation-led strategy. This, I believe, has established a good platform for sustained growth.
I will now hand back to J.P.
Dr. J.P. Garnier
Thank you, John. We are ready for Q&A.
(Operator Instructions) Our first question comes from Kevin Wilson. Please state your question then announce your company name and location please.
Kevin Wilson - Citigroup
Yeah, thank you its Kevin Wilson from Citigroup in London. Three questions, if I may, J.P. Firstly, in the U.S., the 2% decline in sales in the quarter. Could you break out the volume and any price element you saw, and perhaps also comment on the fading effect of Part D (inaudible) as well? Secondly, for Julian, what's driven the change in what you consider to be acceptable interest cover, if you're now happy to have a higher level of debt on the balance sheet than in the past? And thirdly, could you also refresh us on your flu capacity for the coming season and next year, as well as perhaps give us some sense of what you think the pre-pandemic might do? Thanks.
Dr. J.P. Garnier
Thank you, Kevin. Why don't we start with Julian, and then David will take on the other two questions.
Thanks. We've always believed in having a conservative balance sheet, as you know. Even if you take the 2006 actual results and take the current debt of just over 3 billion and add on the incremental 8, you're still going to have an interest cover which is well beyond 10. So I think the answer to your question is, I think, that's still very satisfactory and still very conservative. But it reflects an increased level of debt in the business which I think is now appropriate.
In terms of the U.S., the 2% growth -- I'm sorry -- decline represents, of course, a combination of factors. Especially dragging down are all the generic impacts of Wellbutrin and Zofran, of course including the 30-some% decline in the Avandia sales. Price had minimal impact. We took no price increases during the second quarter; it was just the spillover of the last price increase that we took in the last part of last year. So it's overall, I think, very good results, given especially the rebound in the performance of Advair in the quarter.
Relative to the flu, we had announced previously doubling of our capacity in Dresden, Germany and in our Laval facilities for seasonal flu. We now expect by 2010 that we would be able to produce over 150 million seasonal flu doses. Of course, this is multiplied for our pre-pandemic by an infinite number. We've not been specific, but it is in the hundreds of millions of doses that we can produce on an annual basis, starting in 2008. We're still negotiating with the governments, and the only order that we've announced publicly so far is the Swiss government, along with some antigen that was bought by the U.S. Thank you, next question please.
And our next comes from Andy Cosen (ph), please state your question then announce your company name and location please.
Andy Cosen - Analyst
Yes, It's Andy Cosen at Revben (ph) in London. The first question is going back to the big increase in the buyback, maybe if we ask the question differently, not in terms of interest cover but in terms of the balance sheet. You previously talked about how industry risks were quite great, and also that your shareholders didn't particularly want the move that you've done today. So in terms of your balance sheet structure, could you give us a bit of an idea of what's changed? And then the second question is just in terms of Alli. Do you think the 76 million represents stocking, or is it in any way representative of underlying demand. Thanks?
Dr. J.P. Garnier
On the change, I think, to be fair, we have a dialogue with our investors on a continuous basis. And I think lately the consensus of our investors was clearly that we were too conservative. And even though there is some justification in having a pristine balance sheet, there is -- it's a matter of how much. And we looked more carefully at the leverage we could take on which would not diminish our flexibility to do deals, or for that matter to pick up a large tab for, let's say, an unexpected legal liability. Even though we don't expect that to be certainly the case today, you never know what's around the corner. So based on that analysis, we came to the conclusion that we could do this without really changing the fundamentals, changing our flexibility to do deals and to borrow large amounts of money. If you look at all the ratios, this is still, by all comparisons to other industries, a reasonable leverage. Julian, you want to add something to this?
No. I think you said it, J.P. I think we, at the end of the day, still end up with reasonable leverage levels, reasonable interest cover capacity, and we're well-positioned to face whatever the future has for us.
Dr. J.P. Garnier
John, can you speculate on what part of the 70 we -- is out of the…
Certainly. By all means. Let me stress initially that what we're doing at the moment is looking to build a very long-term business, so the early numbers are not particularly indicative of that. That said, of the GBP76 million that has been sold today to the retail trade, around about 60% has gone through to the consumer. That's what we would expect. But it's very early to make a prediction on what that means as far as the long-term brand sale is concerned. Thank you.
And our next question comes from Graham Perry, please state your question and then announce your company name and location please.
Graham Perry - Merrill Lynch
Thanks for taking my question. It’s Graham Perry from Merrill Lynch. Just to start off on the gearing again, it looks (inaudible) net debt to equity you would be looking at, if you complete the buyback by around mid-'09, would be north of 100%. Just wondering, is that a ceiling for you? Is that a comfort level? Could we see you go higher? And does that ratio really matter to you? So in short, what I'm trying to get to is could we actually see you issue more debt over and above this beyond that period?
Also, could you detail any UK tax benefits of the current buyback, and whether there's an annual restriction on the buyback level that you could get to this year or next year? And thirdly, a question on the upcoming Advisory Committee meeting panel on Avandia. I was just wondering whether you're concerned in any way that Takeda has not been asked to present at the AdCom at all; they're only there to answer questions, and whether we can read into that that there is no option here of a class label change, and any label changes that could come out of that recommendation would only apply to Avandia. Thanks.
Dr. J.P. Garnier
I'll take the last one, if you don't mind, and then pass it on to Julian. We are not concerned about the choice of who speaks and who doesn't speak at the Advisory Committee. I think you are reading consequences which I am not reading. I know for a fact that there is a conversation going on between all the companies, including Actos sponsors with the FDA. I think there's a lot of data that is in the file concerning Actos. I think you should read some of the excerpts from the FDA submission and, for that matter, ours, that will confirm to you that there will be discussion of TZDs as a class. And therefore, I think you cannot rule anything, and I think you cannot draw any conclusion from what we have heard so far about the Advisory Committee. And therefore, I think, all options are on the table, including having TZD class labeling later on, or not. Certainly for CHF, that will be the case. But excluding CHF, which by the way is not part of the discussion on next Monday, if you look at ischemic events, I think that all the alternatives are still on the table. And we cannot deduct from anything that has been said or done where the FDA is leaning, or whether the Committee is going to rule one way or the other. I think it's too early to tell. We'll find out Monday. Julian?
In terms of your gearing point, it's a very fair question actually. I think in most businesses, the answer is it's a pretty relevant measure. But in pharmaceuticals, as you know, we take our most valuable asset, which is our pipeline, and completely write it off. So for that reason, it's not a measure that actually influences our actions. So the real key for me has always been interest cover, so that's really what I look at in terms of determining the appropriate level of gearing, rather than its relationship to the sort of net assets of the balance sheet.
And in terms of tax, as we're doing it with a sort of phased share buyback program, yes, we do get full tax relief. If we were to do it in an absolute one-off, we wouldn't. So a large portion of it would be without tax relief. So it is a relevant factor, yes.
Dr. J.P. Garnier
And, I think, to be fair, the 12 billion wasn't picked out of the air. We wanted to maximize our return, and there is a point of diminishing returns. If you don't get tax coverage, what's the point of increasing further the buyback? But we could have done it from purely a structure standpoint, which could have gone beyond 12, but we would not have the same kind of overall tax benefit. So 12 is the right number as far as we are concerned.
Graham Perry - Merrill Lynch
To follow up on that point, the 2.5 that you've outlined for the second half of this year, though, to go over that would likely breach that level. So we wouldn't expect to see you buy back more than the 2.5 for this year than you've currently outlined.
I think 2.5 is a very good call for the rest of this year.
Dr. J.P. Garnier
Dr. J.P. Garnier
And our next question comes from Steve Scala, please state your question, then announce your company name and location please.
Steve Scala - Cowen & Company
Thank you. Cowen & Company in Boston. I have three questions. What does your EPS guidance for 2007 assume for Avandia in the second half of the year? Does it assume a continued decline, and if so, at the existing rate or moderation? Does it assume a flattening or a rebound? Secondly, on Synflorix, has there been any progress on figuring out the U.S. clinical trial requirements, or will Glaxo simply not participate in the U.S. opportunity? And then lastly, I'm just curious as to whether the 400,000-patient epidemiologic study to be revealed on Monday includes any data on Januvia and its side-effect profile relative to the other agents, and if it does, if you'd like to share with us the findings.
Dr. J.P. Garnier
Thank you very much, Steve. I always look forward to your questions because they are to the point. Starting with the EPS and the speculation on Avandia, whether we expect it to come back or get worse over the second part of the year, I'd rather pass on this. Because frankly, again, Avandia U.S. sales constitute 5% of our business. There are lots of other moving parts which we look at carefully when we talk about guidance. As I have said before, pretty much everything is ahead of our own internal plan, except for Avandia, which allows us to maintain the guidance. Otherwise -- clearly, we didn't expect Avandia to lose 40% of its sales, in effect, in the U.S. So we're going to just maintain the guidance. If some things go much better or much worse than expected, which is very unlikely, on Monday and, more importantly, beyond, because what really matters is when the FDA speaks, then we will modify our guidance accordingly. But short of that, we're going to leave it the way it is. And we don't detail all the moving parts, and I have no reason, therefore, to do it this time. Sorry. On the Synflorix, David, you want to --?
Steve, again, for competitive reasons, we're still not commenting on our U.S. strategy. But again, remind you that our biggest market opportunity, we think still, is in the EU, where the market is way underdeveloped. And we intend to file Synflorix at the end of this year.
Dr. J.P. Garnier
And then Januvia is not included in the large epidemiology study.
And our next question comes from Andrew Baum, please state your question, then announce your company name and location please.
Andrew Baum - Morgan Stanley
Three questions, if I may. Firstly, just going back to the dialogue that J.P. referred to with investors, obviously, the industry and Glaxo is under pressure to create value for shareholders. You obviously doubled your share buyback. You have now geared your balance sheet, or will gear your balance sheet. Your payout ratio is already fairly high, moving up. Having done all this, are there any additional levers left to pull, having excluded the divestments of over-the-counter, particularly in regards to additional cost savings on top of your operational excellence programs? That's the first question.
Second question is for the consumer health business. Obviously, there are a number of smaller assets which potentially could be acquired, and I'm talking companies rather than products. Should we anticipate any move by GSK in that direction, given your comments on the strategic fit within the Company? The final question, perhaps a little bit more color on the Coreg CR/Avandia sales force dynamic. Perhaps you could outline for us what percentage of the Coreg CR sales force effort was actively involved in promoting Avandia as well?
Dr. J.P. Garnier
Andrew, first of all, other measures to increase shareholders value -- well, first of all, we continue to have a policy of increasing our dividends every year. And even though we have a very good yield right now, we expect that to continue. And we'll have to wait and see what happens at the end of the year. But that's traditional at the time when we make announcements about our dividends.
As far as the business is concerned, I think we have lots of opportunities to once again beat the analyst forecasts. We have done that pretty much for seven years in a row. I have some -- we have some big plans to help out '08, and of course '09 and '10 should be very good years because we have fewer generic losses. And beyond, I continue to say that the way Advair will come to its sunset is affecting the analyst consensus on the sales line, because many of them are predicting that there will be a cliff effect in Advair. I remind you the regulation in the U.S. market on the inhaled medicines is unlikely to -- well, highly unlikely to produce an AB rated generic. There'll be generics, but they won't be AB rated, which means that we will have a far softer landing, and that changes dramatically the projection of our sales growth over the next five years. It's here and there.
In terms of smaller assets, we look at our business all the time, and we look at smaller assets as well as big assets. We have said why consumer healthcare makes sense strategically for the long run, and I'll keep those comments to that. And then finally, on CHF sales force --
Because of the overlap in the target audience, it was the exact same sales forces that were selling Coreg CR as selling Avandia. So you can't just change that overnight. But I think, again, it shows the flexibility we have in our sales forces that within a four-week, five-week period, we've been able to bring on board 2000 reps now that will be able to promote Coreg CR in a first position.
Andrew Baum - Morgan Stanley
Just one follow-up to Julian from J.P.'s answer. I was specifically trying to address the cost element in terms of improving the operating margin structure, either by outsourcing some of your maturing products ahead of patent expiration to improve gross margin, or a number of parts within the P&L. How much more is there to come (inaudible) the big plans that J.P. mentioned to you just a second ago?
Dr. J.P. Garnier
Julian can answer, but it's the same answer, Andrew. We will talk about our plans when it's time to talk about the guidance for 2008. We have said all along that we continue to believe there are opportunities to operate a large pharma business on a lower cost basis -- and we continue to strive in that direction -- without depriving the key engines of the business, which is drug development, and also marketing and sales. We don't want to cut our nose despite our face and reduce our sales growth. If you look at our schedule of new product launches within the next years, '07, '08, '09, we're talking about up to 25 launches. Clearly, we need to have the resources to do that effectively. We are growing our pipeline. Our late-stage pipeline has 33 assets. That costs money, but we have made significant progress. We're able to do more with less, frankly, and it's not surprising. If you -- we're outsourcing up to 40% of our clinical trials. Every trial we outsource is -- the cost is reduced by roughly 80%. This is huge money saving for the Company. So we're very comfortable that we will be able to continue in the future. Whether there will be an above and beyond restructuring plan, we'll discuss that when our plan is ready. We are considering all options.
And our next question comes from Craig Maxwell, please state your question, then announce your company name and location please.
Craig Maxwell - J.P. Morgan
Hi it’s Craig Maxwell from J. P. Morgan in London. Just A couple of (inaudible) questions. On Synflorix, is that Europe only, or is it maybe some other countries outside of Europe and the rest of the world? I know it's not U.S. But just how broad do we define Europe? And how does that stack up against the current Prevnar product, and then potentially against the 13 (inaudible) Prevnar product that's coming along in a couple years' time? And if possible, what are some of the strategic issues of breaking into a European vaccine market where there's already one major player? Obviously, it was different from small molecules, those different buying points and so on. How do you just in essence go about doing that? And possibly if you could extend how you could possibly do that for maybe Cervarix against Gardasil as well. And then lastly on consumer, some of the retail brands -- Lucozade, (inaudible), Horlicks, oral care -- how do they fit into the OTC strategy?
Let me first take the Synflorix question. It's primarily Europe, but there are several international markets we'll be filing as well. But the real bulk of the opportunity is in Europe. There are some very fine differences in the antigen mix between Synflorix and Prevnar. We think there's a couple key antigens, however, that are the key drivers of hospitalization that will be a key differentiator for us. So that's a very important element of the Synflorix file and the Synflorix marketing plan. So that's very important.
Relative to how do you break into a market, whether it's Europe, Cervarix, U.S., Synflorix, unfortunately we have way too much experience coming second in the markets with vaccines, and we've continued to do very well. So often in the vaccine marketplace, this isn't like statins, where you may be the fifth or sixth one in; there are typically one, two and, in some rare cases, three competitors. And it's often very straight. There's a lot of tendering as well. But we have a lot of experience doing that and we'll continue to draw on that experience.
Dr. J.P. Garnier
Just to add to what David said, the big difference is, being first in vaccine, it has the advantage of generating revenues earlier. Not to be underestimated, but you don't build a marketing anchor as with a drug for chronic use. Because drug for chronic use, while you capture patients who stay on the drug and renew their pact with you over the years -- so you have guaranteed book of business, so to speak, when number two comes on the market. And he has to steal it from you, which is always hard.
Well, in the case of vaccine, that's not the case, because your customer you only get once. It's, sadly, like the funeral home parlor business; the customer only shows up once. And once you have had that sale, you're not going to get it again. So everybody, the clock starts to zero every 1st of January, and the whole market is for grabs -- is up for grabs. But again, I want to stress that in the case of Cervarix, all this really doesn't matter, because the size of the opportunity is what is important in the marketing thrust. It's not whether consumers are going to use Gardasil or Cervarix; that's a secondary question. The primary question is how many women are going to realize that they need to do this, that this is a must, and this simple intervention will avoid for them the risk of a deadly disease? That's what is of interest. Because I agree that Gardasil is doing well. But they're just scratching the surface in terms of market penetration. We're talking a single-digit percentage of the opportunity has been captured. We have a long way to go. So I think it's in everybody's interest, Gardasil and Cervarix, to really clinch that catalyst that all OB/GYNs advise their patients to go and get the shots. And that's going to play a big role.
In terms of consumer, I think we have said it all. We have a very intertwined business between over-the-counter, oral care and pharmaceuticals. So it's very hard to separate those things. They use the same backbone, the same infrastructure, and the same distribution channels. And they benefit from each other and they help each other, and there is tremendous advantage to not separate the two. In fact, the sales force is going to physicians promote both sometimes, oral care solutions in the case of dentists, and antibiotics and so forth. So it's all mix and match.
That's not the case for drinks. Drinks is a stand-alone separate business. It's true that it is strategically less related to the core. What has kept us faithful and loyal to the drink business, frankly, is their outstanding performance. They have outperformed every other division in the Company systematically with double-digit growth in revenues, and this quarter is no different. So as long as we continue to be very successful -- you realize that three years ago some people advised us to sell our drink business. And it's true that we would have made a onetime gain. But I tell you, it's much more valuable today to have kept it than to have sold it three years ago. So we're going to be very careful and we're not going to sell anything that has a bigger long-term value if it stays in our hands.
So on top of that, to separate the drink business from the rest of the consumer business would create some negative synergies on the cost side that should not be misunderstood and should not be underestimated. But thank you for the question, and now we're going to go to the last question of the conference, please.
Our last question comes from David Adlington (ph), please state your question then announce your company name and location please.
David Adlington - Analyst
Hi James, thanks for taking the question. Just going back to the share buyback, just wondered if you'd give a little bit more insight into how you got to that 12 billion figure. And particularly, in terms of what headroom it does give you for acquisitions and licensing. Presumably you'll be retaining your investment-grade status and that sort of level of gearing as well.
Dr. J.P. Garnier
Let me just repeat that this changed nothing to our ability to in-license significant assets or buy significant companies. We can raise a significant amount of money even with this kind of leverage on our balance sheet. I think it's -- we have many banks that are knocking on our door. And if we needed to raise a substantial amount of money for a transaction, we would be able to do so. So we haven't lost any flexibility. Now, back to the gearing and so forth. Julian, you want to comment?
One more thing to add. You're absolutely right; we retained, clearly, our investment-grade. S&P have reviewed the credit rating and left it unchanged at AA. Obviously, we're waiting to hear from Moody's as to what their assessment is. But, no; we still have financial capacity for something with added value to the shareholders.
Dr. J.P. Garnier
On that note, I want to thank you all for being with us today. We look forward to talk to you very soon, I suppose. Bye bye.
Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.
THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.
If you have any additional questions about our online transcripts, please contact us at: email@example.com. Thank you!