GSK

Business Context and Reporting Period

Company: GlaxoSmithKline plc (GSK)
Filing Type: Form 6-K (Interim Management Report)
Reporting Period: Second Quarter (Q2) and First Half (H1) ended 30 June 2008
Announcement Date: 23 July 2008

GSK reported Q2 2008 results, highlighting a transition in its pharmaceutical portfolio due to generic competition in the USA and declining sales of Avandia. Management announced three new strategic priorities: growing a diversified global business, delivering more products of value, and simplifying the operating model. The company remains on track to meet its 2008 financial guidance.

Key Financial Metrics

Note: CER = Constant Exchange Rate. Business Performance excludes restructuring charges.

Material Changes vs. Prior Period

• Revenue Decline: Q2 turnover fell 2% at CER, driven by a 46% drop in Avandia sales and increased generic competition in the USA (specifically for Wellbutrin, Zofran, and Coreg). Excluding these factors, US turnover grew 13%.
• Profitability: Business performance operating margin increased 2.2 percentage points in Q2 to 36.2%, aided by lower legal charges (£3m credit vs £103m charge in Q2 2007) and operational excellence savings. Statutory results were impacted by £187m in restructuring charges.
• Product Performance:
  • Pharmaceuticals: Vaccines sales grew 34% (Q2) and 23% (H1). Seretide/Advair grew 6% (Q2). Avandia sales declined 46% (Q2).
  • Consumer Healthcare: Sales declined 1% (Q2) due to lower alli sales and smoking cessation competition. Excluding these, sales grew 7%.
• Balance Sheet: Net assets decreased by £2,203 million to £7,707 million, primarily due to share buy-backs, dividend payments, and a widening pension deficit (net deficit increased to £716 million).

Guidance, Outlook, and Risks

• Guidance: GSK maintains its expectation of a mid-single digit percentage decline in business performance EPS at constant exchange rates for the full year 2008.
• Strategic Priorities:
  • Grow a diversified global business: Focus on emerging markets (new collaboration with Aspen) and pipeline delivery (12 approvals in 2008 including Entereg, Kinrix, Rotarix, and Tyverb).
  • Deliver more products of value: R&D reorganized into 8 therapy areas; acquisition of Sirtris completed; new collaboration on almorexant for insomnia.
  • Simplify operating model: Initiatives to improve manufacturing efficiency and cost savings.
• Capital Allocation:
  • Dividends: Q2 dividend increased 8% to 13p per share.
  • Share Buy-backs: The timeline for the remaining £6.5 billion of the £12 billion programme has been extended beyond July 2009 to allow flexibility for strategic investments. Approximately £1 billion is expected to be repurchased in the last five months of 2008.
• Risks and Contingencies:
  • Legal: Aggregate provision for legal disputes is £1.1 billion. Notable developments include a $81 million verdict in Alabama (AWP litigation) which GSK intends to appeal, and a settlement with Biota Holdings for AUD 20 million regarding Relenza.
  • Avandia: Outlook remains uncertain despite supportive long-term data presented at the American Diabetes Association meeting.
  • Patent Expiry: Continued risk of generic competition impacting key products.

Investor Verification Checklist

• Avandia Trajectory: Verify the sustainability of the 46% sales decline and the impact of ongoing cardiovascular safety studies on future revenue.
• Generic Competition Impact: Assess the long-term revenue erosion from patent expirations on Wellbutrin, Zofran, and Coreg in the US market.
• Restructuring Costs: Confirm the realization of the projected £700 million annual pre-tax savings from the Operational Excellence programme by 2010.
• Pension Deficit: Monitor the volatility of the pension deficit, which widened significantly to £716 million due to asset value reductions and inflation rate changes.
• Share Buy-back Execution: Track the pace of the extended £6.5 billion buy-back programme and its impact on net debt levels.