GlaxoSmithKline plc (GSK) Q4 2012 Earnings Call February 6, 2013 9:00 AM ET
Draft version. An edited version will be posted soon.
Sir Andrew Witty
Okay, good afternoon everybody. Welcome, thanks very much for coming to the GSK Annual Results. We’ll obviously as usual I’ll take you through a few slides, just to frame where we think things are at maybe cover a couple of the highlights from the results announcement today. And then Simon will take you through more of the detail, give you a sense of maybe shape a little bit of the year to come, and then most importantly give you the chance to ask any questions you might want to have.
Just a highlight to you, we have David Redfern in the room here, who is our Head of Strategy for the Company, very busy last year buying HGS shares in Theravance, the Indian business, Shionogi and few other things. So he’s been very active for us and has come out here for a rest. So it would be quite good, if you asked him lots of really difficult questions, so he doesn’t relax that much.
Let me take you through results, before I do that, unfortunately I think as many of this I needed to share with you the statement and hopefully to draw your attention to it, and you can probably recite it better than I can.
Let me move on to where we are as a group. Nothing is changing in terms of the strategy of the Company, but clearly as we move through the last few years, as things becoming clearer and clearer of what GSK really is. I think we’ve got a very clear case of a balanced business, balanced exposure geographically, a balanced exposure across our different sectors, our consumer business, our vaccines business and pharmaceutical business and also some very good opportunity around the development of our pipeline of new products.
So good balance, we’ve been very, very focused on building synergies within the organization. That exists at lots of different levels of course all of the organization increasingly works through a common core backbone of services that I talked about three or four years ago, that has led to very significant reductions in cost about 20% reduction in administration costs in the Company since 2008 [Audio Gap] the repatriation of cash, back to shareholders either through dividend growth or through share buybacks.
If we look across [Audio Gap] really there are kind of four different types of businesses we have, clearly we are all above the pro-innovation markets, I’ve talked about these in the past being particularly United States and Japan. Over third of the Group, obviously this is the part of the business, which is going to benefit the most from new products as they come through the final stages of regulatory approval. We worked hard to make sure that in both of those geographies we’ve got the right operating models to go forward. That’s been much more the focus in America as we’ve responded both to the shift in our portfolio, frankly some lack of competitiveness in our business four, five years ago, also to the effects of the Affordable Care Act. As you’ve seen I think sporadically we shared with you bits and pieces of what we’ve done differently there. I think we’re now a very, very strong commercial organization, only evidence from our early launches of niche products, small specialty products very, very encouraging in terms of share. We’re starting to see some nice improvements even in the bigger older products like Advair and its share performance, and also its market performance in the last few months. All of which is reassuring very good metrics coming back from the key decision makers in the U.S. marketplace, ready for the pipeline.
Japan, we’ve just launched Votrient sarcoma indication in Japan that was the 70th new product we’ve launched in Japan since the year 2000, and we have 30 more new products to launch in the next three or four years. So very exciting portfolio of opportunities to come I hope in these businesses, but both of them ready, really to start to move forward with where our hope will be bigger commercial opportunities than we’ve had in the past.
In Japan, specifically during the year, we built the joint venture with Daiichi Sankyo to ensure that in the vaccine space we can complement our new high-end vaccines with the base vaccine portfolio that Daiichi Sankyo has, and that’s of course in a very strong position for the long-term in Japan, I think as well.
Emerging markets obviously [Audio Gap] to be in the focus since I took over, we significantly increased our resource base there now you can see very material part of the group continues to grow very strongly. I was delighted last year although we suffered in the first quarter particularly with the Arab Spring, very strong recovery during the rest of the year, 16% up in the pharma, vaccines space in the fourth quarter very strong consumer business, and overall still a 10% growth rate.
As we started to see some of our multi-national peers growth rates drop off. I think that’s larger because we’ve got the right business model in these markets. We are very focused on innovation and great continued growth of our newer products, but we are also very focused on ensuring access of the body of the portfolio. So we see good volume numbers, we see good adoption of new products.
Just a look at Synflorix as one example £400 million of turnover, just for Synflorix, just in the emerging markets is really a good signal of the way in which we can generate adoption of newer products as well as sustain the old ones.
Europe of course has been the challenge very much the focus of last year disappointing for us to see the environment turnout more negatively than we anticipated, very much expressed through price so we continue to see our European business perform a round zero minus one type of volume movements.
Our biggest product Seretide last year actually grew 2% in volumes, had a significant price reduction. So the volumes nothing dramatic very much in line with where we see the market operating volume shares don’t look anything to be worried about, but like everybody else significant price pressure, although at the beginning of last year it felt like we were the only people to get such significant pressure as we have that Seretide price cut roll through, I think as the years going on you’ll see most of our peers have had very similar kind of price dynamics to our own. And actually when you look at our performance in Europe is very much along side the rest of the industry. But we are determined to do something about this, we don’t believe the European picture is going to suddenly improve, and we don’t think the European macroeconomic situation is going to facilitate in dramatic relaxation of pressure in Europe, and therefore as a group, we want to make sure that we do everything we can to maximize our efficiency in this region, while we then focus on the growth opportunities in the other 80% of the group. The very dangerous trap to become obsessed with Europe when in fact, everything else in the world shows great opportunity.
So we’ve already announced today, the beginnings of a significant restructuring program of our European business within our overall change program, I’ve announced today. This will focus on obviously reducing the size of these organizations, it will reduce the headcount of these organizations, eliminate overlap duplication in the like.
Most of that were full in the SG&A arena, so that will be administration sales organizations. There will be an element of redeployment, so some of the reductions in eliminations will be redeployed on some of the brands we think we might be a little underpowered on at the moment, all of that makes sense, it’s all completely obvious and it’s underway as we speak.
We are continuing however to look at bigger, broader strategic solutions to Europe, Europe is not a one or two year issue, we think it’s a strategic issue for the business, actually bumping for the industry, and so we continue to look at other options. We are not in a position today to share those details with you, but it is very much something which is on the front burner off the company, and we intend during 2013 to get to resolution and obviously when we do, we will share with you, what the shape of that look likes.
We’ve already signaled as an example of perhaps the least ambitious perimeter of what the next step might look like, that we are looking for a partner for albiglutide commercialization, so that might be one pathway, where we look to do more specific partner and to avoid build up of European infrastructure when we know it’s a relatively tough environment. At the other end of the perimeter, you know historically we’ve transacted deals like ViiV, where we’ve created very different structural approaches to try and resolve very complex pressures in a particular segment of our business. I’m not guiding you that we’re going to do either one of those things, I’m simply signaling to you the spread of the perimeter and I think that gives you a feel that we are very serious about looking for the right strategic response. But we need to make the right decision at the right moment and obviously not simply to synchronize with the results announcing.
So a lot going on in Europe, a lot of changes, a lot of work we have seen as you saw in Q4 a slight improvement in performance there, which is good a slight improvement in volume and a little bit of a reduction in the price pressure as predicted, because the Seretide price pressure went down a bit, but nonetheless we would expect 2013 to remain a negative price environment in Europe, as we saw last year, probably mid single-digit source of territory.
U.S. and Europe consumer businesses remain very strong, very dynamic particularly in America outstanding consumption growth every single month of last year we grew faster than our categories. In terms of consumption, we’ve seem very strong performance of all of our brands in these geographies particularly the oral care business; Sensodyne now $1 billion brand, it accounts about 8% of the world’s toothpaste market, so as a brand which most people think about as a bit of a niche is actually ended up or has become a very significant part of global toothpaste business, and has grown in double-digits for 14 of the last 15 quarters including the last quarter.
So very strong business, very good performance in America, very much benefited from stripping out of the ‘tail’, so by divesting ourselves of the ‘tail’ last year has really cleared the way for us to focus on essentially 15 brands, as 15 brands drive about 80% of that organization. It’s an extremely concentrated business, and has got a very, very sharp focus.
As I mentioned two brands, Lucozade and Ribena really sit a little bit outside of the very strong synergy points of this business, that’s why they are up for review. Again this is a review which as no predetermined decision, and has no options ruled in or out. So it could the most conservative end of the perimeter, conclude that we should invest more and we should carry on doing what we are doing, but with more investment in different geographies, and it could at the far end of the perimeter include divestment of these assets.
So that perimeter is as wide as that no decisions taken and I think we have the first phone call from a bank at 12, 18 and we had six since. So all credit to the investment bank community although I was surprised it took them 18 minutes to get on the phone.
R&D I think has been a really tremendous story for us during 2012, really the continuation of the momentum, which has been building up in R&D organization, very strong delivery of clinical trial results, fabulous delivery of efficiency in the trial environment something like three times as many patients in GSK, clinical trials today as compared to 2008.
So a massive step-up in activity, trials getting done, many trials finishing early, many trials coming under budget, all of which or why we’ve been able to hold our R&D budget flat to down, even with this massive step-up in pipeline, really the truth if you will, the efficiencies that we’ve begun to put in place in that organization, 14 assets still to report are over the next couple of years, and we think with the six, which are already under review, kind of the potential to have 15 new drugs or vaccines, that’s not line extensions as 15 complete new drugs or vaccines in the next couple of years.
Lots of news this year, lots of catalysts for those of you who love catalysts. So there will be lots of moments, where I’m going to be very nervous, you’re going to be very interested, and we’ll see how we both feel in the morning, it’s going to be one of those sort of years, it’s a very different solid atmosphere for us, obviously it is going to be lots of twists and turns in this year, not everything is going to go smoothly, there’s bound to be twists and turns as we go along.
So we’ll see how the year progresses, but we’re in a great shape, we built six files in already, and of course, during the year, we’ll also get the first data back on the major three therapeutic vaccines, and darapladib, and while we’ve always signaled that those are high risk, but very high return opportunities, it’s impossible not to get excited about as those days start to progress toward us.
So a lot coming in terms of pipeline, I really couldn’t be happier in terms of the progression of what we’ve done there, and been able to do all of that, and at the same time, show that we can be more efficient, and our R&D is not simply a function of how much money you throw at it.
We believe and we have the first two (inaudible) obviously at the regulators. We believe we have the opportunity for up to 10 new respiratory drugs in the next five or six years. And we are very confident of our view that we can grow our respiratory franchise over the medium-term as these new products start to roll in, not withstanding the fact that they will inevitably be continued price and in some areas generic pressure, to some of our existing products.
One of the reasons, why we have been buying up our stakes in our partners is because of our increasing confidence in the assets and our desire to get more economic control and also to simplify some of the relationships, so to avoid having to negotiate everything to speed up decision making and buy up the economics, it was really behind our deployment of capital last year, and essentially almost of our bolt-on acquisitions all of our deployments last year were targeted around that arena.
In terms of looking how we simplify the business, I covered a couple of these things, the first to you’ll see these are updates on the numbers you’ve seen before, a very substantial reductions in the size of R&D footprint as an example, it’s a much leaner organization almost on every dimension to much more creative organizations and much more accountable organization, we’re certainly leaner. We are in the midst of change in our manufacturing organization, and the change program, I’ve announced today, £1.5 billion charge for about £1 billion of savings covers the European restructuring. It covers the elements of the changes that we are stimulating in R&D manufacture. This is going to lead I think to a really significant technology leap for the company. Areas for example we are going to be accelerating is a jump toward more continuous process manufacture, a shift from synthetic chemical reaction to enzymatic reactions, and a whole reframing of how we do analytical testing in all of our facilities. The net-net of all of that a very significant reduction in process time, very significant reduction in cost, carbon footprint inventory and speed. All of those things are on offer and we’ve been spent in parts of the organization we almost never talk to you about in our platform sciences units.
We’ve been working over the last five, or six years on the series of technologies, which we believe now are ready to industrialize, we commissioned the first, we began building the first facility in September of last year in Singapore where we are going to start deploying the enzymatic technologies into market selling actually first of all, but it’s already been deployed in two of our pipeline assets, and will not be accelerated across the rest of the organization.
Just to give you a little sense of what that all means, because I could see when I said enzymatic reactions one or two people kind of glazed over just for a second, just to bring that into what that might mean from an economics point of view, a couple of metrics. So when we normally make a chemical, which goes into medicine we need a facility which is about 900 square meters in size that gives you a sense on average to do at this way it takes about 100 square meters, so you are talking about a massive reduction in capital deployment and space occupancy obviously, you will see something like a 50% reduction in carbon footprint insolvent use up to a 50% reduction in cost, is our enormous levels on the biggest part of the cost base in terms of the cost of goods.
How big could this be [Audio Gap] other issues form the past, reinvented [Audio Gap] I think it reflects the capability and the focus of the organization to relentlessly keep looking for ways to build momentum into long-term value creation.
All of that of course, is design to generate sustainable sales growth, we think this year should be a year of growth, small growth, low growth with leverage, but nonetheless a year of growth, obviously we hope that that would have happened last year, but with the pressures we saw in Europe combined with a decision to dispose some of the tail, that really took that growth away. This year, we think we can get to growth, we’ll have to see what the environment throws at us, but based on what we see today, we expect that. We’re confident we can deliver EPS growth, lot of that leverage comes from our financial engineering, and Simon will touch on this a little bit more, the work has gone on to refinance the Group, reduce our cost of borrowing, really has made a significant difference as of course does the tax rate.
So all of that should start to deliver for us a very, very consistent delivery over the next few years as the pipeline start to feed into the top. We continue to work to reduce working capital and of course, we continue to then focus on returning the cash back to shareholders.
We’re guiding today, that we will increase the dividend again, that’s our goal consistently increase the dividend, we’ve done it today by 6%, we continue to aim to do that during ’13, and we will continue to buy back shares initially setting a range of £1 billion to £2 billion, very simple architecture for the company, very much focused on sales, driving into the top of an efficient organization, using leverage at any place we can within the P&L to try and maximize the EPS growth, with a view that the focus should be on organic growth, and it should be on returning cash to shareholders rather than significant acquisitions. Those are essentially the key messages for you, I think we’re in good shape.
Last year wasn’t quite where we hope to be where we’d be but [Audio Gap] see the way it turned out wasn’t far off either. And so the key for us as we go forward this year is to lock in on the growth opportunities, make the right decisions on the strategic challenges of Europe, Lucozade and Ribena make sure that the R&D pipeline continues to move forward. There are bound to be twists and turns during the year, I certainly start 2013 with a very high degree of confidence.
With that I am going to hand over to Simon.
Simon Dingemans
Thanks Andrew. Clearly, as Andrew has highlighted 2012 was a challenging year and one [Audio Gap] by looking back on it turned out to be a lot more challenging than we had expected at the beginning of the year. But I am very pleased with how the business performed and responded during the course of the year to those challenges, and equally pleased that we were able to deliver on the updated guidance that we gave you back in October, delivering sales broadly in line with last year, flat excluding the drag from the OTC disposals, and earnings per share flat on the year before.
Europe was obviously a key issue for us to deal with during the course of the year, and in fact if you look at the near £400 million drag that Europe introduced to the Group, that reflects basically all of the downturn that we saw at the group level as well. So you can see the sort of scale of the challenge that we have to deal with. And I think what made it particularly difficult to respond to, was the way in which the formal austerity measures really spread in a very diverse way across the continent and really played out in different markets in very different ways, which meant the business had to become a lot more agile, a lot more adept in tackling those challenges, and I think the business has responded very well, and even though, today we’ve announced a number of changes, and some restructuring charges to put Europe on to a sound of footing, if that’s not where we’ve started from already a number of changes during the latter part of last year, and already we’ve taken a number of resources and reallocated them across the business to make sure that we’re really focusing where the European business can make the best return.
and I think from my perspective, that’s also very encouraging in the way in which the financial strategy that we’ve laid out for the Company and the financial metrics and architecture that we’ve given the businesses really being applied out at the front-line, so that was not only meant reducing cost, but it’s also meant reallocating resources either back to the Group for other purposes, where we can see better returns or even within Europe, where picking two or three of our key products, putting extra resources, and extra investment behind them, which might see counter intuitive in the face of that sort of pressure has actually led to some of the volume growth that Andrew described for you, and really allowed us to improve our market positions in a number of key territories across the continents, and we’re going to be looking to do much more of that as we go into the continuing review of the European business during 2013.
I think more broadly across the business, you can also see other areas where the financial strategy is really starting to bite and have a material impact on our bottom line performance. I’m particularly pleased with the progress we’ve made in delivering our funding objectives a year early with our net interest cost now down over 200 basis points from the year before I came and that’s really a function of taking advantage of different opportunities on the interest rate curve, refinancing some of our debts and really building a much more sustainable and flexible capital structure to fund the business going forward.
Equally on the tax rate, now I’ll talk some more about that going forward. I think we really build a much more sustainable position to allow us to continue to improve and continue to deliver value at the bottom line.
Equally on the cost side, we’ve got a number of ongoing programs, our OE program which is now coming to an end. The new initiatives we have announced today, but also we continue to look at areas where we can release value either on an ongoing basis or an one-off basis, they all contribute to our flexibility to be able to deliver funding to the businesses, where we can deliver the best return and the best growth. As some of the benefits changes that we’ve highlighted in the release today even though they maybe lumpy in the way they deliver value, really a) put those plans on to a sustainable long term basis for our employees, but they also release a lot more funding flexibility into the company. And is something we’ve been working on for sometime even though they have only arrived in the fourth quarter this year, and we will be looking for further opportunities along that line.
And I think equally has Andrew highlighted the financial strategy is one of the key drivers why during the course of last year and this year, we’ve looked at some of the assets that we got coming through the pipeline, some of our partnership arrangements and have bought in the economics during the coarse of this year to really make sure that we are driving at the end of the day, the more sustainable long-term earnings per share growth. And I think it’s worth remembering that the strategy that we have outlined to support the Group’s objectives, it’s designed to drive two things; earnings per share and free cash flow growth, and that’s why the guidance we have given is focused on earnings per share. And we deliver the earnings per share, the focus we now have across the Group on free cash flow conversion will deliver the cash flow that we can either use to reinvest in further opportunities or return back to the shareholders as dividends and buybacks as we said before and that will be done on a very rigorous CFROI basis benchmarking those opportunities to see where the best returns can be delivered.
So if we turn to the results for 2012, as we said I think good delivery particularly in the second half of the year, and particularly pleased with how a number of the key objectives we had in the fourth quarter came through. We highlighted back in October that we had a significant number of vaccines deliveries to make in the emerging markets especially, but also the U.S. saw a very good takeout from the vaccines business in the fourth quarter as well, and that is not delivered without lot of effort from the vaccines business to make sure they arrive with the patients, and the right timeframe and in the right markets, so a good successful execution there; equally emerging markets pharma business consistently picking up the pace since that disruption of the Arab Spring in Q1.
Europe again also a slightly lower rate of declining Q4, I think partly reflecting some of the measures we have already taken, but I think it’s too early to call that a trend, because clearly the markets remain very challenging, but I think that also helped to contribute to the overall delivery. I think the U.S. also making progress, although we did see slightly less stocking in the fourth quarter than we have historically seen, that maybe a change in pattern where we are still working through how that may flow into Q1, but I think that is why we have ended up as a little short of where we were expecting in the U.S., but overall general performance very strong.
And the operating level, good contribution for a variety of cost saving measures really allowing us to minimize the impact of the top line drag of the operating level to around 30 basis points. We flagged on top of that the cost of HGS coming in the back half of the third quarter and into the fourth quarter, we take about 30 basis points this year, clearly that’s going to fade out as we go into 2013, and then contribute from 2014 onwards.
So overall, I think we’ve managed to deal with a very unpredictable environment and maintain pretty much the same margin as we had last year. The leverage has really come at the bottom half of the P&L in the financial measures, which we’ve described in the release today, but good progress on the funding, tax, looking at the share accounts and the benefits of the share buyback allows us to deliver core earnings per share flat on last year.
Quick run on cash flow, which is obviously one of our core metrics, down 17 for the year, and I think that really reflects just a continued focus on generating and converting earnings cash, but also during the year as we flagged a year ago, we were going to need to put a bit more investments into the capital expenditure behind the delivery of the pipeline and also the absolute amount of working capital released during the year, lower than the 2011, but still a very good contribution that has allowed us to fund €6.3 billion of distributions back to shareholders during the year.
If you look at the sales contribution, then and look underneath that in terms of the overall mix, as Andrew highlighted, we went into the year expecting a material drag from the disposals of the OTC businesses, we aren’t sure exactly when they would get exited, but we saw that combined with the final stages of roll up of Avandia. and then the comparison with the Spike and Cervarix that we saw in 2011 through the five cohort catch up program in Japan, which really put above 600 million of drag into the sales level for 2012.
Now I’ll come back to some of that still, we’ll play out in the first half of next year, but that obviously is a material factor, I think if you then look at the shape of what the contributions from the different businesses have delivered during 2012, you can see immediately the drag factor that Europe and the $400 million decline really introduces into the mix, because rest of it is very consistent with the patent what we’ve described for you over the last several quarter. The U.S. broadly flat when you strip away the decline of Avandia, generics of offsetting the continued growth of the promoted products and really without new products to add that mix. The U.S. is holding steady, but needs that extra additional portfolio to be able to really move forward. These likewise, experiencing generic pressures and obviously it has an exciting new product with the regulators at the moment, but again, that’s going to need new product before that really moves forward and then offset by the continued strong performances of our emerging market businesses, our Japanese business and our consumer businesses, which are consistently delivered over the course of 2012.
And at an absolute you can see that leases down 1% broadly in line with last year, but Europe really being the swing factor in our performance and when you look forward into 2013, the reason why we’ve given guidance at 1% is that we continue to see some drag from those exiting businesses, most of that the fall in Q1, we have about 400 million in total to flow through the course of 2013. But when you look at that business below those drug factors and you can see without calling it a very different position in Europe that again, we need the pipeline to move the U.S. forward, we need the pipeline to move forward without that, that remains a relatively high degree of offset against our existing growth businesses, which means it’s expecting about 1% for 2013 on a constant currency basis.
If we look cost side of the margin, I think you can see very much the dynamics that we’ve talked about before and how we want to manage the P&L to drive bottom line performance, we’ve had a number of different offsetting factors, but overall the key message that the margin is broadly the same as last year despite the top line pressures that we’ve seen really reflects our continuing balance of releasing cost savings from our established businesses, putting them behind our growth drivers in the emerging markets and putting them behind getting ready for the pipeline if and when it’s approved by the regulators.
And that’s going to be the patent very much during 2013, but I think if you look at the overall mix, you can see the SG&A block city in the middle, which really reflects holding that expense steady in the phase of affording sales line, we think that’s the right thing that we’ve done given that if we pull back, we have to put it into the business again, it will be slow on the uptake if we get these products approved. The rest really reflects the mix and the impact of just lower sales against relatively static cost base.
I think if you loot at R&D, this is also a good example where we’ve been able to manage your expense despite obviously a lot going on in the R&D business that they maintain that focus on cost control, they maintain that focus on efficiency and we’ve got a number of phasing benefits in the course of the year, but they have maintained a very tight discipline on the amount they are investing.
Going forward they are going to have to also pick up the additional R&D cost as a result of folding machine over the interest back in directly to these as we work on dolutegravir and also the HGS costs. So I think we are continuing to manage that to the broadly flat guidance we gave you at the beginning of 2012, from about £3.6 billion and we’ll work within that parameter to make sure that we are really driving the best returns out of the R&D portfolio that we can.
I think on the SG&A side equally more consistency looking to release resource from our developed markets continuing to put them behind new great markets and you can see broadly that balance during the course of the year, quite a lot of the structural savings that we have made out, the OE program now coming to an end, and these savings really being about, the ongoing measures and the improvements I took about a couple of times before particularly in terms of our functional capability as Andrew highlighted we are continuing to roll out on ELP platforms, we will have our three quarters of our European business by revenues on to the ELP platform by the middle of this year, that’s starting drives some significant changes and open up new opportunities as well, to simplify the functional and administrative costs of the company, which just over in the first two of our business centers which really going to be hubs to provide coverage across both Europe and now the central part of the EMAP businesses, three or four more to come, but I think we are already making significant progress that leads us confident, we can continue to offset the investments we need with the release of cost measures one-offs on going or a combination of both, that will hopefully allow us to play this position forward and that’s certainly the plan. I think what you can say is that fixed sort of flat cost number, against the declining sales obviously is the other 0.5% that you saw in the margin impact during the course of the year.
Where we see more pressure is at the cost of goods line and many of the measures that are contained within the new change program we’ve identified today, really designed to address the ongoing competitiveness of our supply chains, and how we really adapt them to both the considerable burden of expansion there bringing as many new products through the pipeline is going to require from our manufacturing businesses and they are already gearing up to do that. A new product inevitably takes some time to develop to the optimum margin and cost structure, but also making sure that we are continuing to take cost out of the manufacturing line, supplying into emerging markets and those were up by the price point is different, that we’ve already seen even in the last six months and the focus of these new programs that have been summarized in the released today. Significant changes, so take Ventolin where we’ve had a number of product presentations of Ventolin designed to go into the emerging markets.
By taking some of the lessons from the consumer business and really designing those products for value, we’ve reduced costs to suppliers, by not just sort 10% or 20%, but 70%, 80%, which not only makes us competitive with the local producers in those markets, but also allows us to access more patients and broaden out the access and coverage of those markets again opening up new opportunities for us to expand in an emerging market, so I think it’s just a small example for our products like Ventolin, which is 30 years old where you can still make very significant changes while learning the supply lines with the end customer are making sure that you are really focused on where the value sits in that chain.
So I think overall again a little bit like you have seen on the SG&A side, cost managements and OE savings are on the lines of the sort of programs I’ve described offsetting our current drag that we have in the cost of goods line of the mix of the business is it as it’s changed over the last two or three years, clearly as the pipeline comes through and those sales go to the U.S. or Japan, then that mix is likely to change, but this is the fact that we need to continue to build into our plans make sure that we are covering the costs and the impact of that.
I think the shorter term issue is clearly being volume where in a declining sales and volume are particularly one where sales of declined is quickly as they have in Europe, moving the manufacturing changed to respond is quite difficult particularly when some lost supply lines are 18 months long and we have seen here some volume impact in the course of 2012 some of that was still flow into 2013 as we unwind some of the impacts from this year, but one of the reasons we want to shorten our supply chain is to allow us to be much more responsive to these sort of pressures going forward.
So overall, the savings that we’re expecting to make out to the new program will total a billion pounds by 2016, that’s going to be faced as in deed where the savings are to the OE program, I think like that program, you should expect us to both invest as well as release to the bottom line typically, our patent has been roughly 50-50 in terms of those benefits, and I would expect that this is probably a little bit more concentration on the investment side in the short-term as we get ourselves ready for the pipeline, but we do expect progressive delivery of those benefits into the mix and we will allow those to flow through as we see the opportunities. But this will take a number of years to really reach full run rate, we think that’s the right thing to do given the number of moving pass that’s we’re having to manage.
So on the financial side, as I highlighted earlier, we set out a couple of years ago, some targets to reduce on that funding costs by a couple of hundred basis points, we’ve delivered that this year, a year earlier than the plant and we’re continuing to look at ways of improving that and it’s worth remembering, we’ve taken the net debt of the company out from 9 million to around 14 billion, the interest charge this year is pretty much the same as last year in 2012 relative to 2011, really reflecting the progress that we’ve made in the way in which we’re funding the group, equally on the tax side, we’ve delivered 24.4% this year again, ahead of 25% target a year earlier that we set out, and this really is a function of the continuing efforts we’re making to restructure the way in which the grouped operations and its financial structure aligned and you’ll see in the release today, some of the details of some of the moves that we’ve made to bring substantial of our intellectual property back to the UK and that was thundering the course of last year, that has contributed a little bit in terms of how we have ended up this year, but it’s really about the story going forward, why we believe we can take 24.4% from the 2012 and 24 in ‘13 and we continue to look for ways to improve that going forward as we now have a significant amount of our pipelines sitting in the UK available to access the patent box and some of the patented symptoms around that, which go with the investment and the activity we’re also bringing back to the UK, so that we believe that is the sustainable position going forward and one that’s going to contribute materially to the bottom line in the future years as the pipeline delivers.
We bought of 2.5 billion back, and next year, we’re looking again, like last year, to start with a similar shape of a range of 1 to 2 billion, we’ll see how we progress during the course of the year, but that will very much depend on where alternative investments might come, maybe they don’t in which case we’ll work away through the arrangement, I think it’s too early to call that, and we’ll keep that under review, I think that’s very much this is a patent that we followed in the last couple of years, so again, for 2013. So I think the other bits of the financial structure for next year is that we should, we were expecting the financing expense to be again broadly similar, core tax rates are identified at 24. And so hopefully, you’ll see that with sales guidance of 1%, earnings per share guidance of 3% to 4% that we are delivering leverage through the P&L, but it’s across the P&L and we’ve always made it clear that we expect more leverage from the financial side and the shorter-term until we see the pipeline beginning to make material contributions.
I think the core EPS that we reported 112.7 just flat also the total EPS of 92.9, when we instituted core, we gave you guidance that there was typically 10 or 11 times of different delta between the two this year, higher than that and really the main difference is a 9P tax charge related to the implications and costs of moving the IP from around the world back into the UK which is driving the tax benefits I’ve just described, so that’s really the reason that delta this year is a bit higher than we would seen previously.
Quickly on IS 19, which we will be adopting from the 1st of January to 2013, this as you will recall is really about substituting return rates on assets for the discount rate that you’re using, so increases the cost of your benefit plans, restaking 2012 takes it for 112.7 to 111.4 to 1.3p coming off that. Our estimate for 2013, is that it will have an impact of about 2.5p on a like for like basis that really reflects the obviously the continuing decline in interest rates and to the impact of the discount rate that has.
So turning to free cash flow, I think I’ll call particularly here the working capital 400 million of contribution to the cash. We continue to make steady progress here, the numbers in days terms during the course of the year, we’ve got a number of distorting factors in there from a reflecting and a number of the intangible adjustments we made to brining the transactions of the economic interests that we’ve described, but overall we made about five days progress and we continue to set up programs inside the company to deliver steady and most importantly sustained progress, and while we have probably made the most progress in the short term in receivables and payables that has also help manage our risk in Europe, clearly and in terms of sovereign risks, that we’re probably coming to the end of that in terms of where material improvements might receive, and so that real focus in 2012 has been putting in place a series of programs to give both the vaccines and pharmaceutical and consumer manufacturing businesses real end-to-end ownership of the inventory across the company.
So that we remove the buffers we remove the sort of interfaces across the company where inventory tends to accumulate and particularly end in the third and fourth quarters last year we saw those programs already dropping quite a lots of finished goods materials and inventories out of the commercial operations lots more still to do but that’s really where the opportunity will be going forward.
I think as we highlighted during the course of the year the legal challenges obviously our material impact on the free cash flow, but we have effectively funded those in terms of how we think about it of the balance sheet in the same ways we have done the various acquisitions we have made during the course of the year. So free cash flow $4.7 billion pre-legal contributing to the distributions of $6.3 billion that we have made during the course of the year and really that does increase financing that legal charge and also the HGS and other acquisitions that we have made during the course of the year even $14 billion on net basis.
So to summarize our guidance for the year 3%, 4% on a constant exchange rate basis of the earnings level and that is the key metric that we are focused on driven off an assumption for sales growth of around 1% gain on a constant currency basis, really reflecting the mix of those different growth drivers, the U.S. waiting for the pipeline and the continuing offset from the exit of Avandia, the OTC disposals and Cervarix, which you’ll remember the third wave of that came in Q1 2012 is a little bit more of that to come, but even absorbing that we still expect to grow this yea, most importantly, the leverage coming through the P&L with the financial side contributing more allowing us to continue to invest behind the pipeline, behind those growth drivers and make sure that we’re building the right and most sustainable platform to the earnings per share growth in the future.
With that, I’ll hand it back over to Andrew.
Sir Andrew Witty
Right, thank you very much Simon. And let’s open up for questions please. Simon give me a piece of paper please. Yeah, go ahead, yeah. So I got a piece of paper.
Unidentified Company Representative
Yes. In case, you got 14 subparts to the first question.
Unidentified Company Representative
Thank you.
Unidentified Analyst
And good afternoon (inaudible) [BNP Paribas]. Few quick questions, first on emerging markets, could you tell us what is behind the success and the quick performance of this division this year, is it due to the restricting [UNMs] last year, or is it due to a certain measures, I remember a few years ago you presented a slide where [Stiefel] curve in India you have decreased massively the price and at the same time you’ve served a kind of strong increasing volumes. My second question is on the recently launched products, could you share with us if there is some new dynamics on new products there, because they were present still 7% of your total turn over? And third one, on the restructuring, could you share with us, could you give us color on what’s new could be done at Glaxo on the restructuring sing notably in Europe. No later than yesterday some of your competitors suggested that, if you want to keep some pricing power in Europe, you need to keep some operations and some business like in the research high value added business. Thank you.
Unidentified Company Representative
Okay, great, thanks. So in terms of the Em success, first of all I am very proud of the performance there, because we continue to see very robust growth, that warble at the beginning of last year with the Arab Spring really in the Middle East. Since then we’ve seen a very strong recovery, what are the key observations, first of all, I see it is a very broad base, so every business in [REM] business portfolio has had a very continue to do very well, Latina, Middle East and Africa, even the lease developed countries growing dramatically, very strong China performance, very good India performance, very good Russia performance actually. So across the board, we’re seeing all the regions move well, and in a funny away, it’s very analogous to consumer. Consumer is also delivering very broad multiregion, multicategory growth, which I’m very encouraged about, it feels very sustainable actually. So that’s the key, how is that happening again, we’ve seen across all the key, I think in the top 15 products in emerging markets, the only product that didn’t grow last year was Cervarix, because it was rolling off some big tenants, every single other product was growing.
So it was very deep growth, within that, you’ve got product like Votrient, going great, we got products like Synflorix and new products going great and you’ve also got Ventolin [Zina] and when was the last time we have talked about [Zina] again, tipped in about 10 million pounds of growth last year. And so all the way through that portfolio, what does that reflect; I think an increasing ability to drive access of every product. so where we’ve got older products we’ve used price typically to drive our way into another tier of the marketplace from where we were before, we’ve talked about that many times strategically as a goal. And I think it remains quite a key differentiator for us versus most of our peers, and then gradually the emerging markets are doing for us better and better job with the new product, so the innovative product, we’re starting to capture significant opportunities we go through.
So I think that every chance that will continue. It’s just to reflect maybe, yeah, I think this is quite good thing to reflect you guys, some of you know, we’ve restructured our interface between R&D and commercial franchise groups, which is essentially the mechanism through which we get from the commentaries, input to R&D of what they need and through which R&D communicated the countries what’s coming through the advanced pipeline. Historically, that’s been dominated by U.S. and Europe and within Europe, it was dominated by the UK, Germany and France. We have seven franchise groups, I think it’s a very interesting reflection on how we view the world, the UK, Europe no longer sits on any of the franchise groups, the UK only sits on (inaudible), France, Germany and Italy sit on two or three each, Japan is on all of the them, America is on all of them, Brazil is one all of them, China is all of them, it tells you everything you need to know about what we think about the future, and the whole way in which we are thinking about this we start significant opportunity to layer on more and more innovation opportunity on top of that access strategy and I think that’s really it’s encouraging so far but that’s really – forward in the next few years.
So that’s the first one, in terms of generally new launches, as I said repeatedly we’ve had lot of new launches but they generally being niches. Actually as you rightly say, they now account for about 7% of total, so given that there is no single big product in there almost several big products in there not bad. So what are the lesions we are seeing.
First of all we are seeing great performances in short, if you look at things like for Promacta in the U.S., you look at things like Votrient particularly since the approval of sarcoma very strong performance, if you look at the performance actually of Votrient across the world, if you look at the (inaudible) in Europe, very strong performance. So you a very good performance is generally lessons learned every thing is taken about a year longer than you’d expect from old models, so all the cards are about a year to the right. It’s about patient resilience and kind of sticking attitude through that first year or two, seeing the same with Benlysta everybody expected big bangs at the beginning we’re seeing a nice steady click forward through Benlysta in the U.S.
So those it’s all about being a little more patient than we used to be, why well because of the whole world is more cautious not pricing that access point of view. All systems almost everywhere in the world have got more gritted than they used to have. There is more inertia in the system that they used to be.
What we’re finding is, we are needing fraction of the resource we used to have, so much lower levels of sales forces, we are not talking about specialty products launched in America with less than 50 people per product a very dramatically down and where we would have been historically, all because of the change in the structure by in patents all because of the change in structure where decisions are being made particularly accelerated, not accelerated in parallel to the [ACI] right. So very different from that point of view, and that actually we are seeing great performance again in the U.S. of businesses which were restructured first to award a new ways of operating, so oncology specialty business, vaccine business, all performing very well which is (inaudible) high degrees of confidence with the primary care business, which is now also reform the same way ready for the pipeline of products coming.
In terms of creative solutions to Europe, well, we are working on it. So I think we are as I said it in my introductory comments, we are very we view this as a strategic shift and therefore we won’t explore rather or not the last strategic options for us to resolve we are going to do the obvious things we are doing the obvious things in terms of right sizing scaling and all of the rest of it. We have very few R&D centers now in Europe, we have Britain as a very material R&D center, we have the unit in France and we have a unit in Spain, the unit in France is 1 DPU and the unit in Spain is neglect to disease research unit. Those are the only two research facilities we now have in Continental Europe we have manufactured in may be four, five countries but not in all of them. So over the years we have relatively small amount of that it’s been absolutely no evidence to me that’s made any more easy or difficult to get things done in Europe it’s just difficult it’s not a lot of obvious examples to me that others you got lots of footprint have any easier, so I don’t think that’s particularly relevant and what is relevant is you have data and the key to the future for Europe will be who can get the incremental access point versus everybody else, whether that means a little bit more price or a little bit more speed or a little bit more open as a volume right, in terms of the opportunities and all comes down to data generation, production of the right persuasive data, but all of that is going to be against a relatively contraction rate, well, all right, because I think it is very little evidence to support view, which says that healthcare budgets are going to grow significantly in Europe in the next five to 10 years, I just kind of see how you get there from the macroeconomic situation. So if that’s the background, then it’s all about trying to find that extra point of opportunity within what is a pretty difficult box, that’s why we need to keep looking to see what might be alternative approaches. We’ll see as we go through the year, and as I said, some of those things were already underway, like looking for partners, whether there’s anything more exciting, we have to wait and see, okay. Andrew?
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