Source: Seeking Alpha
GlaxoSmithKline (NYSE:GSK)
Q2 2014 Earnings Conference Call
July 23, 2014 09:00 AM ET
Executives
Andrew Witty – CEO
Simon Dingemans – CFO
Analysts
Graham Parry – Bank of America Merrill Lynch
Tim Anderson – Sanford Bernstein
Alexandra Hauber – UBS
Andrew Baum – Citigroup
Mark Clark – Deutsche Bank
James Gordon – JPMorgan
Steve Scala – Cowen
Nicolas Guyon – Morgan Stanley
Seamus Fernandez – Leerink Swann LLC
Andrew Witty
Good afternoon, welcome to today’s call to everybody. GSK’s performance in the second quarter provides evidence of the very significant changes are taking place in the Group’s portfolio. As you know our strategy over the last six years has been to fundamentally reshape the Group and our R&D operations in particular, so that we can replace the significant sales we lost to generics and ensure that the Company can succeed in an environment where our biggest product Advair faces increasing competition.
It’s clear we are now in that period of transition and this is a critical moment to ensure we made the right strategic choices particularly around investment for the long-term health of GSK in the new products and this is reflected in some of the decisions we have taken during the quarter.
Group sales for the quarter declined 4% to £5.6 billion, largely driven by lower sales in the U.S. where we are seeing earlier and more significant generic competition to Lovaza than expected and continued pricing and contracting pressure in the respiratory market including for Advair. However, while Advair sales are now likely to continue to decline, we expect new respiratory products Breo, Anoro and Incruse to generate new sales growth. Already we are seeing some recovery in our overall respiratory volume share as new launches progress albeit at lower price points. These assets together with the six other respiratory products in development will diversify and strengthen our respiratory portfolio and we remain confident we can maintain our leadership position in this therapy area well into the next decade.
Outside the U.S. performance is more positive with emerging market sales up 11%, driven by a very strong vaccine performance in the quarter, up 26%. Europe with flat sales also performed strongly in a tough trading environment with continued negative price pressure. Japan was down 7% in the quarter, reflecting destocking following a consumption tax increase and sales for the year-to-date are up 5%.
I was particularly pleased by the performance of our HIV business, the healthcare where sales grew 13%. This has been driven by the extremely strong launch of Tivicay, our new integrase inhibitor which is on course to be one of our best launches so far.
As flagged in the last quarter, our consumer healthcare business has been affected by some supply interruptions to several brands particularly in the U.S. and Europe. This led to sales decline of 4% in the quarter. The supply situation is beginning to improve and for the year we expect total consumer sales to be broadly flat. Strategically we have decided to maintain support foreign investment in our substantial portfolio of new product launches as this is essential for the future health of the company. Ongoing investment behind these launches combined with lower sales led to earnings per share down 12% in CER terms. Taking all factors into account, it is unlikely we will now deliver sales growth for the year and we now expect full year core EPS on a constant exchange rate basis to be broadly similar to last year. The dividend is up 6% this quarter to £0.19. So we are clearly in the part of our long-term investment cycle where we are seeing the delivery of significant new product flow from R&D. What’s critical is for us to continue to stay focused on ensuring the launches of the first six products are successful.
Looking ahead I believe this existing strength will be supplemented both by further delivery from the pharmaceutical pipeline and the anticipated completion in the first half of 2015 of the three part transaction with Novartis that we announced in April.
Opportunities in the pipeline for our core therapy areas remain extensive. In respiratory, we filed Breo for asthma this quarter and expect to file our first respiratory biologic the anti-IL-5 monoclonal mepolizumab in the second half of the year. We expect to be first in class in that particular case. We also began phase III studies for the first triple combination product for COPD in the quarter. In HIV, we received a positive CHMP opinion for our combination HIV product Triumeq and we expect an FDA decision on this asset in the second half of the year. Overall, we have over 40 new molecular entities in late stage development and across the R&D pipeline we believe there are total of 30 drugs with the potential to be first in class in areas such as immuno-inflammation, epigenetics and cardiovascular disease.
This should lead to a regular flow of new product introduction over the next few years. The three part transaction with Novartis provides the opportunity to reshape the group and strengthen our positions in the long-term growth businesses of vaccine and consumer healthcare. Post completion these businesses will represent around half of group revenues over the coming years and should be capable of generating mid-single-digit sales growth on a consistent basis.
To give you more details on the quarter, now I would now like to handover to Simon Dingemans, the CFO.
Simon Dingemans
Thanks, Andrew. This has clearly been a challenging quarter, one that has made us even more convinced that our strategy to build a more balanced set of growth drivers across the group is both the right one but also one that is showing visible progress despite the significant headwinds we are currently facing. Clearly the most significant step forward in the quarter was the agreement with Novartis of a major three part transaction which we believe accelerates our strategy significantly and strengthens the long-term durability of our key franchises. We continue to expect the transaction to complete in the first half of 2015 subject to regulatory and shareholder approval.
More immediately, our core results in the second quarter are particularly impacted by the shift in U.S. pricing and contracting that we have been discussing with you for some time. This is a specially effected Advair which has now seen a step change in its outlook exacerbated net out of the transition to our new respiratory portfolio is underway.
Reported sales for the quarter were also impacted by a number of other factors included supply interruptions impacting several parts of our consumer business which we now believe will take somewhat longer to fully resolve than we originally anticipated and earlier and sharper generic competition to Lovaza. The impact of these issues on the quarter (most) [ph] important momentum in other parts of the business. We continued to deliver strong growth in several strategic areas where we’d be investing in emerging markets the vaccines especially in the emerging markets. And our oncology portfolio also delivered further progress.
We’ve continued to see greater stability from the business in Europe and our portfolio of new products is starting to make a material contribution with Tivicay, Mekinist and Tafinlar are doing particularly well and Breo and Anora are beginning to build. While the respiratory launches are clearly developing more slowly, we’ve always expected that it would take time and investment to build them to their full potential compared to the relatively rapid uptake of a more special allergy launches.
In the mean time looking at the second half of 2014 and as always there are a number of variables that increase the degree of uncertainty caused during the quarter including stocking patents and securing and delivering on large tenders and at the same time we expect Advair in the U.S. the consumer supply issues in Lovaza to continue to impact our reported growth. As a result and given where we are year-to-date we no longer expect to grow sales this year.
We continue to manage our cost base tightly and still expect to deliver at least £400 million of incremental restructuring savings during 2014, including the benefit of the structural savings of £200 million I have previously highlighted. And it looks likely that these will now fall into Q3.
As we’ve discussed in the past our plan has always been for most of these savings and other cost control measures to be reinvested behind our new launches and other growth opportunities as well as in new capacity and technology for our manufacturing operations.
Continuing with these investments is key to delivering the full potential of our pipeline and securing the future growth drivers for our key pharma vaccines in consumers businesses. As a result given our revised sales expectations we now expect full year core EPS to be broadly similar to 2013 on a constant currency basis and ex-divestments.
Before commenting on the detail of the Q2 core performance, I should point out that the sustained strength of sterling against most currencies is negatively impacting our reported top line growth and given the large proportion of our manufacturing and R&D cost base is located in the UK, the negative impacted currency is even more pronounced on our earnings, it’s also up impacting our sterling cash flows.
We currently estimate the full year adverse impact of currency if rates remain at their current levels to be around 7% on the top line and around 12% core at EPS level. This is a bit lower than the first half negative currency impact in part because in the second half of last year we had exchange losses of around £63 million.
Turning to the quarter, group sales down 4% reflecting the challenges we’ve already discussed. And in particular in the U.S., US pharma and vaccine sales are down 10% in the quarter and this primarily reflects a 21% reduction in the underlying performance of Advair.
Price pressure remains significant with price impacting Advair sales in the quarter by 7%. Volume reductions of 14% reflected the contracting changes we discussed at Q1, but also the early impact of our new launches which together have adjusted Advair on to a new trend line that would likely see it continue to decline in sales over the next two to three years while we transition to our new respiratory portfolio.
Oncology sales in the U.S. continues to do very well growing 42% in the quarter. In Europe pharma and vaccine and sales were flatter than last year despite increasing competition in the respiratory market particularly. Growth from oncology products Avodart and [indiscernible] all help to offset lower Seretide sales which were down 4% mainly due to price reductions. Vaccines down 5% due in part to a number of shipments to several products that are now expected in the second half.
In emerging markets total sales of our pharma and vaccines business grew 11% or 15% excluding the China effect. Sales in China were down 25% including the established products, showing further stability in the quarter-on-quarter trend that we’ve reported on over the last several quarters. Growth in the region was led by 26% growth in vaccines with significant tender wins for Synflorix and pediatric vaccines.
In Japan sales were down 7% as a result of wholesalers destocking following their Q1 stock build ahead of a tax increase and year-to-date Japan is up 5% despite a weaker allergy season.
Turning to ViiV, ViiV Healthcare sales grew 13% in Q2 in large part due to the very successful launch of Tivicay in the U.S. The launch of Tivicay is now just getting started in Europe and Japan, and the business is also waiting regulatory decisions in the U.S. and Europe for its new three-in-one [indiscernible]. If all goes well these could be launched in some markets during the second half of the year.
For consumer the business was down 4% in Q2 and reported terms of sales in all three of its regions were impacted by supply disruptions particularly for smoking cessation products. We now have in place remediation plans for these issues and the supply position is beginning to improve. Overall we expect the consumer business to be broadly flat at the top line for the year.
Look at our operating costs. The operating margin excluding currency effects was down 3.2 percentage points. The margin decline partly reflects the impact on cost of goods and an adverse shift in mix particularly given the U.S. decline in respiratory sales. But the primary driver was the increase in the quarter in SG&A as we reinvest cost savings to support our new launches particularly in the U.S., Japan and Europe. We delivered further financial efficiencies in the bottom half of the P&L with interest down from 183 million in Q2 last year to £156 million this quarter, reflecting the improved funding profile of the group. And our effective tax rate was also down 2 percentage points from Q2 last year to 22% for the quarter in line with our expectations for the full year.
Turning to cash flow. Fundamentally, our business remains strongly cash generative and we continue to focus on improving the conversion of earnings into cash. Cash flow in the first half howsoever been impacted significantly by currency with the strength of sterling cost against around £500 million of £1 billion decline in cash flow relative to the first half of 2013. The remainder reflects the disposals we made last year and the decline in operating profit reflecting the impact of trading particularly in the U.S.
First half cash flow is generally a bit lower than the second half looking at historic patterns, with working capital a negative factor given seasonal and other requirements particularly in vaccines. New launches are added to the pressure this year and inventory is the main driver of the increase in approximately 14 days in working capital compared to Q2 last year.
Inventory days, in particularly, are likely to remain higher over the balance of the year, leave working capital at the end of 2014 slightly high overall than last year in days terms, as we ensure supply behind the rollout of new products and launches. Our focus on longer term improvements in inventory and other working capital efficiencies is unchanged.
Net debt at the end of the quarter was 14.4 billion, 1.3 billion lower than a year ago but 1.8 billion higher than the year end number. This increases the year end is due to the 0.7 billion spent on increasing our shareholding in our Indian pharmaceutical company and cash returns to shareholders mainly dividends. We continue to prioritize the dividend and our returns to our shareholders on the 6% increase in the dividend to £0.19 for the quarter reflects our confidence in the momentum across the business despite the near term challenges we are addressing.
We’ve repurchased £238 million of our own shares during the first half. We will keep our share repurchase program in place but given the net impact of currency on our cash flows share repurchases over the balance of the year are likely to be immaterial. Any proceeds from disposals including any from our established products portfolio will be retained in the short term to ensure our flexibility to invest behind the new launches. Our manufacturing enhancements as well as the continued restructuring of our cost base but longer term we will continue to consider share buybacks alongside the dividend whether those repurchases offer an attractive return.
And with that I’ll turn it back to Andrew for questions.
Andrew Witty
Thanks Simon. And if I could ask the operator to start the Q&A session please.
Question-and-Answer Session