J.P. Garnier - CEO
Julian Heslop - CFO
David Stout - President, Pharmaceutical Operations
Tim Anderson - Stanford Bernstein
Kevin Wilson - Citigroup
John Murphy - Goldman Sachs
Brian Walcoff - Deutsche Bank
Andrew Baum - Morgan Stanley
Louisa Hector - Lehman Brothers
Michael Leacock - ABN Amro
GlaxoSmithKline plc (GSK) Q3 2007 Earnings Call October 24, 2007 9:00 AM ET
Good morning or good afternoon, ladies and gentlemen and welcome to the GSK Q3 Results Call. At this time all participants are in a listen-only mode. Later we will conduct the question-and-answer session and instructions will follow at that time. (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 meeting, sir, and I will be standing by.
Thank you very much. Hello everyone. I am here with Julian Heslop, our CFO; and David Stout, our President, Pharmaceuticals, and we will give a brief presentation followed by Q&A as usual.
So, let me start by talking much more about '08 and beyond. Then '07 I think that the situation is clear for '07. If we look at the plus and minuses for '08, you'll see that generic erosion definitely will continue, although '07 is not exactly an easy year for us with Zofran and Coreg and Wellbutrin XL. But, clearly the weight of generic erosion was slowdown as we go forward.
Avandia is a question mark. It all depends on how we come out of the FDA and what physicians feel about the drug. Right now they're very supportive of Avandia, but clearly there will a change in the label. It's just the matter of what kind of a change. If the FDA decides to mimic Europe, I think we'll be in good shape. If you recall Europe has come out with a change in label that reconfirms the value of TZDs in the treatment of diabetes and then has a descriptive on Avandia which we feel is balanced. So, it's more unknown than anything else. A big swing factor for us for '08 particularly.
But then we have growth drivers, which of course help explain why despite a significant loss in Avandia, we were able to hold the sales line pretty much even with last year. So, despite the generic, despite Avandia in '07, the rest is performing quite well and some of those growth factors like vaccines are really booming. Vaccines were up 50% this quarter. That's probably above the average kind of growth rate, but remember that doesn't even include Cervarix and Cervarix is a tremendous opportunity.
I was looking at penetration rate in the target audience and even though Gardasil was probably going to break a billion, all that has been done is 9% penetration. So, the potential out there is absolutely huge, and I am not just talking US. On top of that, we expect new products. Now, there is a bit of a slowdown at the FDA. I was looking at stats on NDAs going through the FDA and I think four out of five get an approvable letter now. So, our average for '07 is a little better, we got two out of four. So, there will be delays no doubt about it, we have a very full pipeline and we will make some very brief comments on that. Because, I think the news coming from the pipeline in this quarter were all good.
And then finally, to rebalance a little bit the future, we are now in a position to basically accelerate what we've been doing all along. And you are very familiar with our efforts to reduce our infrastructure and become more efficient as a company. Well, now, we have a chance to expand a little bit beyond the classic G&A and manufacturing to also include R&D and selling. And the reason we are able to do this is, because we have worked very hard in those topics to extract additional efficiencies and synergies. And let me make a few comments about the first one, the sales force minute. In the meantime I will remind you of our culture at GSK.
Basically, we are good at standardizing and outsourcing when it's not a core activity that we want to manage ourselves. The arbitrage that is now available through the global world in which we live is a phenomenal opportunity and we are taking full advantage. And it is just an illustration of all the programs that we have completed between 2001 and 2007 and all of them have paid off in terms of savings to the company.
This is an example of those savings. Even in the years where we didn't have significant growth in revenues, for instance, a year we lost Paxil and Augmentin, every time we were able improve the SG&A ratio, I expect this to continue in the future. And this is really what's it's all about in terms of this expansion of the Operational Excellence program. We're going to have an impact on selling, on manufacturing, on R&D and also, and I won't talk about it, but it's the one we have been pursing all long on reducing bureaucracy, improving our processes and just being more efficient in everything we do.
In terms of selling model, the key takeaway is that actually it's not just the cost saving program, it's a redistribution program. We are expanding specialty teams, oncology and vaccines, and if you look at our schedule of new products, that's not hard to understand.
We are investing and expanding our sales force in some of the new economies such as China, and of course, we started to test alternative selling models way back, but more intensely in the last year. And this test was pretty extensive. We had 15 separate pilots in 13 countries. This involved over a 1,000 of our sales representatives and we had plenty of time to see the effect of whatever changes we made in those various sales and to draw, in some cases, very clear cut conclusion. And that's just an example in two cases at Advair and Avandia where, as you can see there is no difference really between the traditional or the way we are selling today, and a new pilot that is a more cost effective using fewer people and yet you see that we are able to basically stay the course and generate about the same volume of business. So, this is just an example to show you that this was done quite scientifically.
Now, in terms of manufacturing, we are all going to be able to reduce our network and simplify it. Here the strategy is basically simple in terms of the concept. What we want is protect our new products. We don't want anybody to have control over our new products, for commercial reasons, but also for ethical reasons. We don't want people to make our oncology products, because if they go wrong and there is an out of stock, we are killing people. So, for practical reason we tend to want to have control of our manufacturing on all the new products until they become multi-sourced. At the time they become multi-sourced, it's less important to us whether we make the product or whether we buy it. And if we can buy it cheaper than we make it then of course that's what we going to do.
We think that over the next three years we will be able to make significant inroads. Which means that first of all the percentage of our primary cost is going to be different in three years in terms of outsourcing, we have an internal target. But, the point is that outsourcing is going to grow, particularly, when you look at the share of the multi-sourced business we are still manufacturing and we have a number of products going generic, which are now fair game for potential outsourcing. So, that's what it's all about with manufacturing, more efficient network at the end of the day.
In terms of R&D efficiencies, we have to talk first about where we going to super invest. Of course, we are maintaining many things in place, but we want to accelerate our investments in a number of directions. First is of course the late stage pipelines particularly oncology which is an expensive area, but also the neurosciences and alike.
Then we will continue to invest in vaccines as we have a really first class pipeline. And as you have seen we are building biologicals, first of all with some in-licensing but also with our own molecules. We just announced the in-licensing of an anti-CD-3 agent. And I want to remind you that Domantis is a potential game changing technology. It could absolutely reinvent the monoclonal antibodies field. That's a great opportunity we want to accelerate the effort and continue to invest, so that this promise becomes a reality.
Of course we will accelerate also our establishment of R&D in China, this is going very fast. So those areas require money and of course we have to do less of certain things. For instance, because we have new technologies such as prices in place we are probably able to rationalize some of those activities.
We are also looking for faster and better quality decision making everywhere particularly in development and we still have very complex organizational networks, that's understandable because the process itself is very complex. But we think we have found ways to simplify and reduce some unnecessary complexities and facilitate decision making, making sure it's speedy and high quality at the same time. And we'll have some savings coming out of support functions as well.
This is just a reminder that there's a lot of activity on the pipeline. We have started to make some good launches in '07. We've filed a number of products, David will give you a little more on this, but the bottom line is this is a very time in terms of new products. Remember we are looking at potentially 25 launches over the next three years. We have launched already five NCEs, but we have more coming and we need to be very focused on delivering this flow of new products. That will come right on time frankly to replace what we are losing to the generics.
We are announcing a neurosciences R&D seminar. If you look at the spectrum of diseases in CNS, it's quite remarkable because we haven't talked to you about this for quite a few years now, but we have been very busy and today I think we are the only company with at least a clinical candidate. A candidate in clinical trials in every single disease that is listed on this slide and for eight of them our clinical candidate is already in Phase II or III.
So we have a number of bets and some of them are very exciting, you'll see some first-in-class in terms of science going after approaches and demonstrating proof of concept with an entirely new approach. And you'll see also some best-in-class molecules like in schizophrenia that seem to have a very competitive profile. So this is going to be a good day to showcase what our two sides have realized over the last few years.
Then just one word on consumer, John is not with us today but I will give him all kudos for another exciting quarter with sales up 16%, everything is booming. I am particularly happy with the acquisition we made of Breathe Right and FiberChoice this is turning into a very good bet that we placed a few months ago. This business is small but growing very quickly, 24% and we have not even started to expand it throughout the world, we're just getting started. So, there is more to come here.
Then of course, we have new launches of line extension and new variations, which have helped all our business, we're gaining share, with Sensodyne, Aquafresh, Lucozade Horlicks. Not bad for the less core items that are part of Consumer Healthcare, but overall an excellent performance.
Then, in terms of the future I think it's fair to say the news of this quarter has been very good on the global portfolio. It shows that we have products ready to take over from the generics and from the Avandia loss. We have an extensive pipeline, the reload is very good, the flow of products is going from proof of concept to Phase II to Phase III is very satisfactory to us. We are launching an extension of our operational excellence program, which I think will help and we will make the company even more fit for the future and we need to be.
Last but certainly not least, we have now designated Andrew Witty as our new CEO and you will get to know Andrew in the near future. We are going through the transition together and I think you will be very excited by the quality of leadership. I also want to pay tribute to David Stout and Chris Viehbacher. They have shown class and character during this very tough process and it shows that there is a great quality of management at GSK, at the top and also throughout the ranks. So, on that note I am going to now pass on to our CFO, Julian Heslop.
JP, thank you. You will see if you look at the first slide, the turnover in the quarter was up 1%. Pharmaceuticals was down 2%, adversely impacted by generic competition in the U.S. and lower Avandia sales.
Consumer Healthcare as JP has just shown you was up 16%, reflecting the strong performance from the core business including alli and further growth in the CNS products acquired last year. The cost of goods margin of 22.5% was not distorted by one-off items and reflects the reduction in relatively high gross margin U.S. sales of products such as Avandia, Zofran and Coreg. It also reflects faster growth in the relatively lower gross margin Consumer Healthcare business.
SG&A costs were 3% higher than last year and within this figure, Pharmaceutical costs excluding legal and restructuring charges were some 5% lower. And Consumer Healthcare costs were 18% higher primarily reflecting higher advertising.
R&D expenditure was 9% lower than the previous year due to low restructuring costs in the quarter and excluding these expenditures was 1% lower than last year.
Other operating income includes £57 million of royalty income and £22 million of asset sale profits, partly offset by £32 million charge on the Quest collar. Last year, other operating income benefited from higher asset sale profits of £63 million and a profit on the mark-to-market at the Quest collar of £22 million.
If you move to the next slide, you can see that earnings per share grew 1% compared with a 1% decline in operating profit, which reflected 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 adversely impacted by currency with a hit of 5% and this reflected the strength of Sterling against the Dollar. The dollar being $2.03 for this quarter compared to $1.88 last year.
Moving on to the cash flow slide; you can see free cash flow £1.4 billion, and you may recall that last year's free cash flow was adversely impacted by payments made to the IRS under the U.S. tax settlement. You can see the cash returns to shareholders in the quarter comprising dividends and share buybacks amounted to nearly £1.8 billion, an £850 million increase over the previous year. We concluded the quarter with net debt of £3.7 billion.
Turning now to the Operational Excellence restructuring; the new £1.5 billion Operational Excellence program would take approximately three years to implement. Approximately 30% of these charges relate to non-cash write-offs.
As you can see some 60% of the one-off costs relate to manufacturing, 20% to SG&A, with a balance of 20% to research and development.
The next slide shows the phasing of the cost savings, and you can see that over three years we moved to deliver £700 million by the end of the three-year period in 2010.
Moving on to look at the accounting for this; with effect from the fourth quarter of this year, we will introduce a 3-column approach to the income statement. The first column will show the business performance results, excluding the one-off costs from the restructuring program of £1.5 billion. We will include in the middle column the one-off restructuring costs. Finally, in the last column, we will show the total statutory results for the company, including the one-off restructuring costs as required under International Accounting Standards.
The company will provide earnings guidance in future on a business performance basis, which excludes the one-off costs of the new restructuring program.
In conclusion, we expect 2007 EPS growth of 8% to 10% at constant exchange rates, excluding charges relating to the new £1.5 billion restructuring program. We remain on track to complete our £12 billion share buyback program over two-year period and since the beginning in August to repurchase £1.7 billion worth of shares.
Lastly, we've announced today that we expect to pay a 2007 dividend of 53 pence a share, which represents just over a 10% increase over last year.
I'd now like to hand over to David.
Thanks very much, Julian. If you move to the first slide, you'll see sales of pharmaceuticals in the third quarter were £4.6 billion and 2% below last year. Pulling sales down in the quarter was really a combination of the anticipated losses due to the generics Zofran, Wellbutrin XL and Coreg, along with the unanticipated declines in Avandia which combined totaled about £460 million.
Now to give you an update on what's happening with Avandia sales if you move to the next slide, you'll see here that since the publication of the NEJM article, shares for new Rxs and total Rxs have declined by slightly more than half, with some leveling in the last two months.
And if you want to see the impact on sales moving to the next slide, you'll see here the 48% decline in U.S. sales corresponds to the share loss that we just saw. We are now waiting of course for the final decision on any labeling changes from the FDA.
Conversely though outside of U.S., the impact hasn't been as dramatic. In fact, the 11% decline that you see here in Europe is really more impacted by a sales callback by one of the EU countries. If you actually remove the impact of this accounting adjustment, sales in Europe grew by 4%, which is consistent with prescription trends and our stable market share.
In the international markets, you really have an average of the groups of countries that are more like the U.S. and experiencing a similar situation and those that are more like the European situation.
Now, of course, offsetting all of the generic Zofran, Wellbutrin XL and Coreg impact, and a part of the Avandia decline, is the growth in our key assets.
So if you move to the next slide, you can see that we've picked up just under £400 million in the quarter from some of our other key assets.
If you move on, you'll see some of this in more detail. I have removed Avandia from the slide for obvious reasons and I've also taken Coreg off the list as the initial loss of the IRR sales to generics will be greater than the Coreg CR growth. Although I expected Coreg CR will be added back to the list as we get it more established in the hypertension market. The remaining group of products still contributed over £2 billion pounds and grew 21%.
I'll cover Advair and Vaccine in some detail in a moment. Just let me say a few words about some of the others. First, Lamictal growth continues to be driven by the bipolar indications in U.S. despite generics in Europe, and for Valtrex, growth is coming from our indication for reducing the risk of transmitting genital herpes. And of course not all surprises are bad ones I continue to be very personally surprised by Requip's growth, which is being driven by the restless legs syndrome indication.
Moving down to Avodart; sales are growing very strong as is the market growth in the U.S. which was up 17% in the quarter. Our DTC campaign has been very effective with patients and physicians who identify with this shrinking the prostate message. We are also making headway with physicians, based on the results of the CombAT study, and if you recall, this is a head-to-head study versus Flomax, which was published in August, and demonstrated superior symptom relief over the long-term.
Boniva continues to show very strong growth in the U.S. data showing the impact on bone mineral density with once-a-month Boniva is equivalent to the once-weekly Fosamax, which, as you know, itself show to be better than the bone mineral density impacts over Actonel, and this is helping to drive the growth.
And I of course also now added Tykerb to the list, which is just getting started, but will be a big contributor for many years to come, and on an annualized basis, is now running above a $100 million a year, despite this fairly narrow initial indication which will expand overtime.
Now, if we turn to Advair which of course is our largest product, with third quarter sales were £835 million with a reported growth of 7%. The U.S. sales reported growth of 5%, but this is below our estimate of the real world growth, which was 8%. And if you remember at last year's third quarter, we've reported 17% growth in the U.S., but we noted that the growth benefited from the stocking patterns and from a reverse adjustment in the Tricare business. So this year, there is a reverse impact on the growth rate.
Europe meanwhile continued its trend of high single-digit growth for the brand, and international growth with strong 15% growth is starting to benefit from the launch in Japan.
Key driver for Advair's growth has been the use in the treatment of COPD. We know there is still a lot of growth opportunity in this market and we are continuing to work with the regulators in the U.S. to further expand the Advair label around the COPD indication.
Now in U.S., Advair's growth in the asthma hasn't been as strong as the COPD, but there are new NIH guidelines for the treatment of asthma that were just issued and they are positive for Advair and we hope to get a boost from this.
Let me give you a little bit more detail there, and just to give you a little background. The NIH guidelines for asthma were first issued in 1991, and there have only been two full updates since then. Now, these guidelines carry a lot weight in the medical community. In fact, it was the second full update that led to inhaled corticosteroids becoming the preferred treatment for asthma in the late 1990s. Now, at the end of just this past August, we received the third full update of the guidelines based on the complete review of the scientific information available. And after reviewing all of the evidence the guidelines have reaffirmed that the combined use of a low-dose inhaled corticosteroid and our LABA, which is basically Advair, is a preferred initial therapy in the treatment of moderate or severe patients.
The guidelines are also emphasizing the importance of patients maintaining control of their asthma. They have also recommended using tools such as the asthma control test that we've talked about before and the GSK developed in collaboration with the American Lung Association, just to make sure that the patient's asthma is under control. You can see examples in this slide of how the new guidelines have already been incorporated in our aids.
And if you are wondering just how much weight physicians put on these guidelines, you can see here some of our own market research completed this past June, asking just that question. You can see that more than half of all physicians indicated that they referred to the guidelines to determine what's an appropriate treatment for their patients. And of course, our sales organization is doing their part to disseminate the guidelines. And here again is another sales aid, pointing out that the asthma control test which we featured in our DTC campaigns and our reps have been preaching to the physicians, is directly aligned with the NIH guidelines for determining if patients have their asthma under control.
The initial feedback from our sales force has been very good. They've been very positive. They feel like the guideline lines have given them some credibility in the eyes of the physicians.
We would move on now to the Vaccine business. In the second quarter, if you recall, we pointed out that growth of this business was significantly improved during the second half of the year, because of the timing around our tender business and our flu shipments. And of course, you can see that that is now been proven true by the 49% sales growth that you see in the third quarter and sales of almost £600 million.
You can also see at the very bottom that the year-to-date growth is 21% and much more in line with the recent history and our expectations. Also remember moving forward, we will now start to see sales from Cervarix, as we roll out our launches in Europe and in several other international markets.
You can see from the slide that the growth, though, was strong across all parts of the portfolio, our hepatitis business grew 29%, helped in large part by US, where Merck had manufacturing problems with their hepatitis A vaccine. The Infanrix business had a really strong quarter, especially in the US, where it grew 40% in the quarter and year-to-date growth is now 34%.
Moving down the list, I am going to come back to flu sales in a moment. But, Boostrix performance this quarter was helped by some shipments that were delayed in the first half and the year-to-date growth now for the product is 33%. Next year we are expecting to file in the US to expand the indicated age group for Boostrix to include adults.
Rotarix with sales of £23 million for the quarter is building momentum. We expect some new very compelling data for Rotarix to be published before the year-end. And in the third quarter, of course, the FDA accepted the company's file for Rotarix, so next year we will be looking forward to a late end of year launch.
And of course our portfolio of other vaccines benefited from the completion of many of our tender orders.
Now, let me give you a little more detail on the flu franchise. Our seasonal flu vaccines, Fluarix and FluLaval had sales of £120 million this quarter, versus only £55 million last year. Now, big part of this increase is due to our ability to ship earlier this year than we did last. If you recall, last year sales were delayed in to the fourth quarter, because of difficulty producing one of the strains and because we didn't get FluLaval approved until October.
So this year we are getting a much earlier start. Now that being said, we are also getting better pricing on the flu vaccine this year, because we are shipping earlier, and we have also increased our production so that we still have the majority of our doses to ship in the fourth quarter.
In the third quarter, we also recorded our first significant sales for the pandemic flu, where we had £21 million of sales. Most of this was from selling the first tranche of the H5N1 vaccine to the U.S. Health and Human Services. In the fourth quarter, we expect to ship more to HHS. We should also ship our pre-pandemic vaccine to the Swiss before the year-end. Of course, in the third quarter we also announced an advanced purchase agreement with U.K. government.
And I mentioned Cervarix a minute ago, so let me just give you an update for the quarter where Cervarix achieved several major milestones, including most importantly final European approval, followed by very rapid launches during the first week of October in the U.K., Belgium and Germany.
Outside of the EU we also received approvals in Norway, Mexico and Philippines. And we shouldn't overlook that we filed Cervarix in Japan in September. This was not only the first cervical cancer vaccine filed in Japan, but was also the first vaccine for GSK to be filed in Japan and hopefully that's the start of a new trend.
Following the EU market authorization, we have also submitted Cervarix to the WHO for pre-qualification. If you are now familiar with this, this is the first step of our process that was put in place by the WHO which allows the approval from a recognized National Regulatory Authority such as EMEA to speed the delivery of new vaccines to developing countries. So, group such as the GAVI Alliance and various UN agencies will use this status for their vaccination programs in the developing world.
Finally we'll be presenting some new analysis on cost protection tomorrow at the ACIP. And well I'd love to give you the data ahead of the meeting, I can't, but the bottom line is we are very confident in our vaccine. It maintains the antibody responses over time and we believe this will be a significant advantage for Cervarix. We believe that the healthcare professionals will understand this especially as it relates to the HPV 18 antigen and its related HPV types.
So for my last slide as JP indicated earlier I have included a recap of the significant regulatory activities for this year. We've launched already four new products in the U.S. along with Advair in Japan and now also I just mentioned more recently Cervarix in Europe. These of course will be very important for 2008 and beyond.
We also have nine additional new near-term opportunities currently in the hands of the regulators and the final word from the regulators and several of these is until next year, but it's certainly nice to know that we have a lot of shots on goal. I am not going to go into each of these now as you've seen the press releases before and I am sure you are very aware of them.
During the third quarter we also received three approvable letters and we are working on filing responses to each of these. But most importantly there are two very critical filings that we expect to make before the year end.
First as promised Promacta, which is oral drug for patients with low blood platelets will be filed in the U.S. before year end and second Synflorix which is our pneumococcal vaccine designed to protect against the ten most pneumococcal serotypes worldwide will be filed in the EU and international markets. And remember because of Synflorix's unique design it also provides protection from acute otitis media caused by non-encapsulated H flu. So, these are two very important products and will be big contributors to the future of GSK.
So, with that I am going to turn the call back over to JP.
Thank David, thank you, Julian. And we're going to now open for Q&A.
Our first question comes from Tim Anderson. Please state your questions sir, announce the company name and location please.
Tim Anderson - Stanford Bernstein
Thank you, Tim Anderson at Stanford Bernstein in New York. Couple of questions. On Cervarix, can you update us on how you plan to position through Cervarix versus Gardasil. If prescribes or purchasers were to as you, why they should use your product versus Merck. I am wondering what your answer would be. And the second question refers to your reference to new selling models. I am wondering, if you can give us specifics on what exactly you are doing with your pilot projects in primary care areas and develop major markets like the U.S., Western Europe. In terms of what you see as working and not working in the future. I think a lot of companies are trying to figure this out and change is probably immediate here. So, again my question is specific to the big primarily care areas?
Tim, I will take the second question and let David, talk about Cervarix. We do not wish to share the details of the conclusions and pilots. Suffice to say that, we tested a number of alternative variations on the theme of face-to-face selling and suffice to say that what works best varies per geographic area. There is no universal answer here, not that we expected one and then it also is important to relate this to your product line. Certain product lines, we could still increase sales force and get some incremental benefits.
Some product lines have passed a point where intense effort is no longer required, even in the high noise level environments. So there is a lot of complexity I think what works well for GSK, may not actually be transferable to directly towards the companies. But we are not going to give lectures on this, because a lot of it we consider is propriety. We have done very good quality testing to get to those answers. So that's where we are going to stay.
So, David on Cervarix please.
If you remember Tim, from the beginning, we have said we designed Cervarix to be a cancer vaccine and we think that’s the most critical particular. As you develop any kind of vaccine, you recognize the more antigens you put into a product, the more chance you develop for problems with interference among the different antigen types. We think based on our unique [agilent] system, along with the fact that we focused on these two antigens, the data will continue to play out that we have better cross protection as we get to the related serotypes and the 16 and the 18. And that we'll have a longer duration of protection and we can build economic models that will show that if you can get even a 5% better cancer protection covering greater serotypes types. That this more offsets any cost advantage which is basically a cosmetic issue with [Genetovas].
Tim Anderson - Stanford Bernstein
Our next question comes from Kevin Wilson. Please state your question and also announce your company and location please.
Kevin Wilson - Citigroup
Hi, thank you, guys. Kevin Wilson from Citi in London. Three questions if I may on Advair. David, you talked in the past about COPD the larger driver or the key driver. So the question there is what will happen with the 250/50 CRP data that I think you published recently? And how do you relate you comments today on the guideline change for asthma, so that goes patent for Advair. So my first question is, is that growth and are the new guidelines going to change?
Secondly, on Avandia in Japan, where are you with that process. In the past, you've talked about its importance given what's happened this year. Could you update us on that?
And finally for Julian, what level of charges for this new Operational Excellence program do you expect in the fourth quarter?
Okay. I will take the first two and then pass it over to Julian. So the Advair on the 250/50, this was the study that was just presented in an abstract this week. It was a post-marketing study that we had done in the U.S. as a part of the regulatory requirement. And again, it supported the idea that it's a broader label. It would indicate a broader label as appropriate for Advair around the COPD indication, where again we showed a significant reduction in exacerbations.
Now if you contrast this to the TORCH study, TORCH was really a very different study that looked at mortality as a primary endpoint. Of course, we picked a higher dose because we wanted to give the patients a greater opportunity for that.
So in terms of the COPD, we think it's still going to continue to be a big driver for us. There is a lot of opportunity there and now with on top of it, we have the asthma guidelines, which will give us more fire on the asthma side of the equation. So we don’t give specific guidance about how Advair is going to grow, but we do firmly believe that it still has a lot of growth in it.
In terms of Avandia in Japan, we continued the development. We've done a lot of the work that the Japanese regulators have asked. We expect to file sometime in 2008-2009 timeframe I believe. And of course the Japanese regulators -- it's a little bit slower over there so we don't expect approval. There were some additional studies that we had to do and that will be sometime probably in the 2010 timeframe.
And Kevin, in terms of what charges in 2007 quarter four, this is all subject to consultation, any number I give you will be wrong, so I won't. I think it will be significant, but I don't want to give you a number now which will mislead you.
Kevin Wilson - Citigroup
Our next question comes from Graham Perry. Please state your questions sir and announce the company name and location please.
All Right, thanks for taking my questions. Firstly a question on the margin outlook for 2008 given the restructuring program. If we look at around to £250 million that's about a 150 basis points on operating margins that you have to offset some of the off patent exposure. Do you expect any of that to emerge as incremental on your margin over 2007, or is this just all going to offset the operational de-leveraging from patent loss and Avandia declines?
And second question on the timing of your restructuring announcements, and just with this coming ahead of the Avandia label, and to what extent, does this reflect your pessimism over the labeling outcome and the inability to stabilize market share once it's issued?
And thirdly on TYKERB, it's annualizing not only GBR64 million, this imply still limited penetration even to the approved indications second-line is that tumor refractory patients. And so what do you see as your penetration now and what are you doing about enhancing it further?
Okay, on the margin, clearly there will be significant improvement in terms of the cost saving program, if you look at the manufacturing cost savings. Now they come not at the beginning of the three years and that's what I think you have to pay attention to. There is a timing element. There are site closures and some of the elements of the cost saving come toward the end of the cycle. But I would say that the picture is that change in mix which is a change in a product mix and also in geographic mix, after all this quarter U.S. is not growing as fast as Europe and internationals. So therefore we also suffer a negative effect there. But overall that kind of effect will be compensated by some of the moves we are making and also the introduction of new products, which are typically high profit products. So you have to look at beyond '07 and even into '08 where gross margin will be a negative, a slight negative and then making a come back as we go forward.
On Avandia label, no we were going to do this program simply because we were looking for the programs to be executed, particularly in manufacturing and selling. So we were a little bit dependent on when the pilots would end and where we could draw the conclusion that has all happened, and in fact if you wanted to get an outlook on Avandia. I mean the European label is a positive. It restores the value of those medicines in diabetes, it profiles Avandia in a way that is I think fair and make the product still competitive.
So if I had to pick, I would say well that's should be an optimistic fact, but the FDA is very unpredictable, and frankly I'm not going to try to guess, but regardless we were going to do this Operational Excellence. And then whatever label we get then we'll make an assessment of whether we can really get Avandia going again and that's why I presented earlier a question mark on Avandia for '08, because I think nobody could guess whether it's going to go the way CRESTOR did which is they've made a turn after six, nine months and were able to in fact grow back to where they came from after a pretty significant safety scare, or whether its going to be a product which really stays where it is and becomes a bit of a slow erosion type product. We don't know that. We will not know for a while. And then on the last point, TYKERB, I will let David answer.
Yeah. I am actually surprised the negative comment on it. I think right now at £64 million, remember this is only the second full quarter on the market and that £64 million were actually running ahead of consensus and were most people thought that this was a very narrow indication that we wouldn't even do a $100 million a year with it, and already we are in the second quarter, we are ahead of that run rate. So, I remind you that, when Herceptin first launched, its sales were quite slow at the beginning. In fact, we are not running too far behind where Herceptin was, despite the fact that they had a full pool of patients sitting there and waiting. It wasn't until they had adjuvant indication. And adjuvant data that really the sales took off. So, we're very pleased.
Yeah, I agree David, I think the TYKERB, you can't really multiply two quarters and get the year. It's in full growth and we're getting more importantly very good quality feedback from oncologist and we can't wait for Europe to be fully labeled and fully ready to go, because there is a great appetite. I mean in very restricted territory, in Europe we are already generating £5 million and we don't even have a formal approval, it's just that the product is available. There is a real demand in Europe, because the system is different. They don't have infusion chairs in very private practice, oncology office in Europe and they are much more likely to send the patients to the hospital. So, I expect a good pickup there, but future will tell. But, Graham, I think you are a little bit of pessimistic here. We hope to prove it to you more clearly next quarter.
And just one quick follow-up on the comments on the Avandia labeling, you previously talked about an expectation as class labeling for both Avandia and Actos. Has anything changed during your discussions with the FDA relating to that expectation?
Well we don't have any expectation, because we really don't know and we can't really influence the FDA beyond what happened at the Advisory Committee. I think its fair to say that if you read the Advisory Committee proceedings, you can see that the bottom-line is there is an enormous pool of data on Avandia and very little on Actos. We have 90% of the data generated, they have 10%. So, we can see a lot more in a picture, it was 90 pieces of the puzzle that are magnified, then in a tiny puzzle where not very much has been done in long-term clinical trials.
So, I cannot predict what the FDA will say on Actos and whether there will be class labeling. That was the wise thing to do to give a class labeling on congestive heart failure and future will tell again, I can't make any predictions. Nobody can do it, no, not even the Wall Street Journal.
Thanks very much.
Our next question comes from John Murphy. Please state you question then announce the company name and city location please.
John Murphy - Goldman Sachs
Yes, good afternoon. It's John Murphy, Goldman Sachs. Jean-Pierre, can you just pick up on the last question linked in to margins. And I mean, you talked about the tough quarter you had, but in pharma you had a fantastic margin of 37%, for many companies growing very, very fast they can't get close to that level. So, just wondering again whether the cost savings program announced is going to allow further expansion from that level or just to offset some of the pressures that you foresee over the next couple years or so?
Well, I think for '08, as I said, I would not give an indication that gross margin is going to improve. Simply because you get the full impact of some of the generics, you get the full impact of -- it depends on Avandia. If we make a bit of a comeback let's say in the second part of '08 with Avandia then all the bets are off on margin, because that has a big impact. But I am just taking the more conservative route that let's say we stay where we are on Avandia, so there is still a net loss '08 versus '07. I am taking in to account the generics, but I am taking into account the fact that in '08 you won't have the bulk of the manufacturing savings.
So, that's for '08, and then in '09 everything turns around the right way for us. So, I think you have to look it as a sort of cyclical effect on the gross margin. We have always been able to improve the gross margin. When I look at the products that are going to be introduced, some of them are pretty high margin some of them are more middle of the road like Cervarix. But all in all I think '08 I would be conservative and '09 more bullish.
John Murphy - Goldman Sachs
Thanks, just had two quick product questions as well maybe for David. Can you give us any update at all on where things are with gepirone at the moment? And any anecdotal comments perhaps around Coreg CR and the sort of feedback you are getting from docs on that?
On the gepirone we are still waiting for the FDA, so it's in their hands, we have heard nothing. So, I can't tell you one way or the other on that one. In terms of Coreg CR, there's a few dynamics with Coreg that are different than some of the other switches. This is a market where the incident number of patients is much more than the prevalence. So, we are having to wait for the new patients to come in, but again the feedback is very positive from the physicians. We just have to be a little more patient than say we were with Wellbutrin XL, where you have very rapid patient switching, where patients go on to different antidepressants very quickly. So, I am not concerned at all with Coreg CR over the long-term.
John Murphy - Goldman Sachs
Thanks a lot.
Okay. Thank you, John. Next question please
Our next question comes from Michael Costa. Please state your question sir and announce your company name and city location please. Mr. Michael Costa your line is open. Once again, Michael Costa your line is open.
Are you able to hear me now?
Yes, we can hear you.
Okay good, thanks, sorry about that. Two questions first on the HIV franchise. Can you talk about what's happened with the pricing since the generic introduction of AVT and what will happen with subsequent generics and also whether the royalty burden that you currently bear on 3TC will continue after '09? And also I am wondering if you can comment -- I have heard some other companies [in your absence] software companies and consumer product companies were quite slightly weaker sales in the third quarter and to the extent that you've got mature consumer products in Europe. Have you see any change in pattern to say that would suggest any impact on the European economy?
Okay, thank you. On the European Consumer Healthcare front, no we are having a very dynamic quarter. So we can't say we would confirm that. It varies but oral care and OTCs are strong, so that's the answer to your second question Mike on the.
On the first one on the HIV pricing we have seen no difference in the pricing just because of the introduction of generics. This is no different than when we see generics being introduced in to other therapeutic classes. So things are going well and in terms of royalties beyond 2009 on 3TC I really don't know I'll have to get back to you.
Okay Thank you next question please.
And our next question comes from [Steve Scudal]. Please state your questions and announce your company name and location please.
I think while you said about Avandia and the [CRESTOR] analogy, the release clearly says lower Avandia sales in 2008 and I am confused as to why you would say that now particularly ahead of the label? I mean your comments really do suggest that the company has no new studies or initiatives to turn things around anytime soon so I am really perplexed as to why you would come now ahead of the label?
Secondly on Lamictal when we should we anticipate generics s in 2008 and will you launch an authorized generic? And then lastly on HFA albuterol, the company has claimed overtime that it would increase its efforts but it's not at all evident has Glaxo abandoned that effort? Thank you.
Okay on the Avandia remember we were full blown sales the first five months of the year, that's the only reason that if you look at the future and you said okay let's say the label is not a case of theirs it's whatever it is and we start to go back to the marketplace. By the time the sales go up even in a fairly realistic scenario mimicking other examples that have happened in the past you have to build yourself a back to where you were in the first place that is the May high point level. And then exceed it possibly while if you do that trust me to on this the simulation shows you that even in this fairly positive scenario you can't quite compensate for the fact that for five months we are going to look at sales, which are double of what they are today. So that's the only reason, but listen we've been wrong before on forecasting product sales so I hope you are right I hope it -- we can execute a even more optimistic scenario but I can't take that as a main planning hypothesis and therefore Lamictal and so forth.
Lamictal, in the release, we stated that in mid 2008 you should see generics and Lamictal and we don't comment on our authorized generic strategies. In terms of the HFA albuterol, we had manufacturing issues. So, we have been planning catch up, but this is still a very important opportunity for us and we haven't given up on it.
And we haven't given up and in fact, if you look at our share, it is from a small base granted but it is growing. So, we're definitely going to be back in this market.
All right, the next question please.
And our next question comes from [Brian Walcoff]. Please state your question sir, announce company name and city location please.
Brian Walcoff - Deutsche Bank
Deutsche Bank, calling from London. A question on the operational excellence program please. You told us that you expect to deliver total annual pre-tax savings about GBR700 million by 210 in different parts of the business. I just would like to ask, is that all cash or are there some accrual elements, some cash outlines that would normally have been expensed that might be capitalized and the state of my thinking is related to the move to manufacturing changes and a move to multi sourcing? Any thoughts there please, thank you.
Yeah, the non cash element of the 700 is under 10%. So, it's a very small proportion of it.
Brian Walcoff - Deutsche Bank
And this is basically an extension of a program but much larger and because of site closing and the like there was need for a provision.
Next question please.
Our next question comes from Andrew Baum, please state your question sir, and announce the company name and location please.
Andrew Baum - Morgan Stanley
Hello, it's Andrew Baum from Morgan Stanley. Just one question and answered. Perhaps Julian you might like to have the guess, as to the outlook for legal costs, anticipating a rash of Avandia (inaudible) as we work into 2008. What do you think is reasonable for us to include within our forecast?
I never predict legal costs, Andrew, because I would always be wrong. They will be what they will be. We believe in Avandia, and we will certainly contest in illegal actions on it. So, we don't see that as a particular issue at this point in time. But it's impossible to predict what it will be. As you know, it's been coming down over the years, but I can't predict. No reason to think it will go up, but who knows.
The good news is, our book of outstanding litigation is getting thinner, it's still thick, but it's getting thinner after years of efforts and many cases which were settled. If you look at all the patent litigations on Paxil and Augmentin and so forth, which contributed to some of those costs. But on the other hand, again, we will take it as it comes, and even though we have no particular concerns, we don't want to make a specific forecast at this point.
Next question please.
Our next question comes from [Louisa Hector]. Please go ahead with your question ma'am and answer your company name and your location please.
Louisa Hector - Lehman Brothers
Hi, good afternoon. It's Louisa Hector at Lehman Brothers. Two questions please. I just wonder if you could comment on Advair and whether you are seeing any impact from the Symbicor in the US. And then, really going back to JP's earlier comments about the FDA with four out of five drugs getting an approval letter at the moment, I just wonder if you could give us an update on your views, the late dilatory environment, clearly seems to be getting tougher. Would you expect that to remain the case for sometime in the future? Thank you.
Okay, thank you. I think Symbicor is just getting started because right now they are not making much of an impact. If you add all the Symbicor prescriptions to the Advair business this quarter, Advair would go up one additional point. So, it's not very much.
In terms of the regulatory environment, well, you know as much as I do, but in our contacts with the FDA, in the tone of the letters we received there is clearly a super agenda item called safety and I think it plays differently in different divisions. After all if you are approving life saving drugs for people who are in very bad shape, the safety risk and the safety concern might not be of the same intensity as if you are on the verge of approving a drug that's going to be used for chronic disease, which are not life threatening.
So we are going to see that the hurdle has been raised. There is no question about it. What is unclear is exactly how should we modify our drug development plans to meet this higher hurdle and we hope that there will be clarifications. And this is more of the FDA than any of the other regulatory agencies. And we find that the regulatory agencies throughout the world most of them use science and clinical data to make decisions and there the lobbying and the political around the agencies is minimum.
And in the US the difference is obvious to everyone who read the paper everyday. So we hope that the FDA will be left alone to do their job and if they do we will be fine. But I would say from a practical pragmatic standpoint what does it mean for us today as we speak? It means that as we are working on 25 launches over the next three years some of them will be delayed that probably wouldn't have been delayed if we had those 25 products even two years ago. But such is life and as far as raising the bar we are absolutely ready for it and particularly in surveillance.
I think it's very important now in every file to have a very descriptive risk management program. I think that's a good thing personally and I think that companies such as GSK are very ready for this challenge and have been working at this for quite a bit. So on that note, I am going to ask I’m going to ask one more question and take it as a last.
Our last question comes from Michael Leacock. Please state your question and answer your company name and city location please.
Michael Leacock - ABN Amro
Thanks. Thanks a lot for taking my question. It's Michael Leacock here at ABN Amro in London. Two questions really if I may firstly on the, JP, and I think you said in the past you are looking towards R&D as a percentage of sales in the long-term rising I think up to 25% was the figure that you hinted at. And as we have seen the R&D costs stable minus 4% down for the nine months, I just wondered whether you are not tempted to put some of your operational expense savings back into R&D and whether your view on that has changed at all.
And secondly for Julian, in the past you have taken restructuring charges they have been running I think it about a 140 million, 200 million I think last year on an ongoing basis. Are all of those charges now going into the clearly delineated operational expense charges or will there still be an underlying background and change going on?
Very good question, Mike. On the R&D again the aspiration is that we should be more R&D intensive. Now there are several ways to get there. The first way is to reduce SG&A and reinvest in R&D and that's what we've been doing all along and even though right now and in the immediate past R&D as a percentage of sales has not gone up, that is, we are doing far more with R&D than before. We are placing more bets. We are driving more products through the pipeline.
If you think about it we nearly doubled the pipeline size and we certainly haven't doubled R&D since the merger eight years ago. The reason this has been possible is because we have made significant efficiency improvements within the process of R&D. So, we are doing more for less. Remember the first company to export clinical trials in a big way, first company to do data capture. I mean all those programs have saved remarkable large amounts of money. If you look at next year by the way, even though we are saving money in R&D and we are saying so that we are doing this program of eliminating duplications and so forth.
That's going to raise some money for us. We are also investing in some parts of the R&D at a faster clip than sales growth. For instance the R&D China, the biological space, oncology programs and so forth. So it's a mix of the two and I would say flat-flat, average I would say flat on sales for a little while but I think that the environment is going to force pharmaceutical companies to raise their [game] in R&D and if we have a productive R&D and we are still working at improving that why not invest more. So, it will be at some point if we are successful in shrinking a little bit our resources used for selling and reinvesting them in R&D will be in a very good shape.
Clearly an inspirational statement, but one that I hope will become a reality in the future and there is very good science out there that we would like to buy and if you look at the extension of our balance sheet, into those kinds of deals what you see in terms of R&D expenses is understatement of the effort. We are actually having access to more program than simply the R&D line seems to indicate. On the other hand, in terms of your second question?
Michael, you are right. The operational excellence of existing programs have averaged between 100 million and 200 million every year and I expect to take further charges against business performance earnings that's the first column in quarter four in respect to the existing programs that are still running. They will carry on and being charged into that first column. However, the new program is so significant, hence the introduction of the middle column that's the ration for it. It would distort our performance if we weren't to do it.
And as a consequence of focusing all our efforts going forward on this new program, I would expect that it will be negligible challenges in the first column. We will focus our efforts delivering this new program and it will take all those efforts. But certainly as far as the fourth quarter of this year is concerned, there will further challenges in the first column in respect to programs still running. They would decide on it before this new program was implemented. Does that answer the question?
Michael Leacock - ABN Amro
Thank you very much.
Yes, and Mike just to complement and that [tale] of costs, related to existing programs, will go over next year as well.
Michael Leacock - ABN Amro
Thank you very much for attending this conference and we will talk to you in a few months.
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