Memorandum

Worldwide revenues of $629 million down 5.3% as reported (1.1% operationally); reflects largest decline since 2009 – October 16, 2012

Executive Highlights

  • Diabetes Care (LifeScan/Animas) revenue totaled $629 million, down 5.3% as reported and down 1.1% operationally from $664 million in 3Q11. This reflected a -6.5% sequential growth from 2Q12.
  • There were no updates on the device pipeline or the July 13 acquisition of Calibra Medical, maker of the Finesse insulin delivery device.
  • Canagliflozin has been submitted for approval in five additional countries. Management expressed confidence regarding the drug’s effects on cardiovascular risk.

This morning, J&J CFO Dominic Caruso led the company’s 3Q12 financial results update. Diabetes Care (LifeScan/Animas) revenue totaled $629 million, down 5.3% as reported and down 1.1% operationally from 3Q11 revenues of $664 million. Although the worldwide reported performance is the largest decline J&J has seen since 2Q09 (-9.5%), we note that this quarter represented a particularly challenging comparison as 3Q11 revenues had risen over 8%. Sequentially, worldwide revenue decreased 6.5% from 2Q12. US Diabetes Care revenues of $328 million fell 3% from 3Q11 sales of $338 million, the first time growth has declined in the US since 3Q09. The disappointing US performance was attributed to declines in both mail order and hospital sales. International revenues of $301 million fell 7.7% as reported and climbed 0.8% operationally, indicating slightly positive underlying performance masked by the relative strength of the US dollar. Management reported “strong” sales in emerging markets that were partially offset by lowered sales in some developed markets, likely Europe if we had to guess (this was the exact language used in the 2Q12 call). Compared to Roche, who also reported weak quarterly sales today, J&J’s 3Q12 performance was slightly better in both the US and abroad. Together, J&J and Roche’s quarterly revenue totals just over $1.2 billion, down 13% sequentially and down 12% year over year – notably, J&J and Roche’s joint total quarterly revenues haven’t been this low in over four years (since 1Q09).

Though we had been hoping for more news on the July 13 acquisition of Calibra Medical, there was no mention in the call and a brief acknowledgement in the quarter’s press release. On the pipeline front, J&J has a number of products in the near-term, including the OneTouch VerioSync (pending FDA 510(k) clearance), a new version of the OneTouch Verio BGM (planned US and EU submission in 2012), the Animas Vibe pump integrated with the Dexcom G4 (planned FDA submission in 2012), and the OneTouch Ping Verio insulin pump (planned US submission in 2012). We expect a broad diabetes device pipeline update during the November 1 J&J Medical Devices and Diagnostics Business Review meeting.

On the pharmaceutical front, management stated that canagliflozin was filed in five countries in 3Q12, but provided no updates on the drug’s regulatory review in the US and in Europe. Management also highlighted canagliflozin’s cardiovascular outcomes trial CANVAS, noting that results so far have demonstrated “solid cardiovascular safety” for the drug. A second interim analysis for CANVAS is targeted for mid-2013, and management expects continued discussion on canagliflozin’s CV risk during the anticipated FDA advisory committee meeting. During the call, management also noted that the FDA approved Nucynta ER (extended release tapentadol), a twice-daily oral opioid, for the management of diabetic peripheral neuropathy (DPN).

FINANCIALS

  • Worldwide revenue for J&J Diabetes Care (LifeScan/Animas) totaled $629 million in 3Q12, a decline of 5.3% as reported and a decline of 1.1% operationally from sales of $664 million in 3Q11. On the earnings call, management avoided stating the reported performance decline of 5.3%, instead only mentioning the operational results. We note that the strengthening dollar had a significant negative impact (-8.5%) on reported international performance.
 

3Q12 Revenue in millions

Reported (Operational) Growth from 3Q11

J&J Diabetes Care

$629

-5.3% (-1.1%)

US

$328

-3.0% (-3.0%)

International

$301

-7.7% (0.8%)

  • This quarter’s worldwide reported growth of -5.3% was the largest decline J&J since 2Q09 (-9.5%) and the second straight quarter with negative growth. We note that this was a challenging comparison from solid 3Q11 reported growth of 8.3% and operational growth of 4.4%. Worldwide operational performance of -1.1% was the lowest since 4Q10. The last time operational growth declined was some time ago, in 4Q10 (-1.8%). The table below shows how J&J’s sales over time have become increasingly challenging.

Worldwide Sales

 

2Q11

3Q11

4Q11

1Q12

2Q12

3Q12

Worldwide Revenue (millions)

$681

$664

$670

$670

$673

$629

Reported Growth

(Year-over-Year)

 

10.6%

 

8.3%

 

4.0%

 

5.2%

 

-1.2%

 

-5.3%

Operational Growth

(Year-over-Year)

 

5.3%

 

4.4%

 

4.1%

 

6.6%

 

2.9%

 

-1.1 %

  • The 3% reported decline in US sales this quarter represented the first decline in since 3Q09. Management attributed the lackluster US performance to a reduction in both mail order and hospital sales. Mail order was also cited last quarter as a reason for weak US sales. We note that the year-over-year comparison this quarter was relatively easy, since 3Q11 sales were flat year-over-year – the fact that revenues still declined reiterates that the US business has been increasingly challenging. That said, we do also note that some of the sales may be “lumpy” – 1Q12 sales rose over 13%.

US Sales

 

2Q11

3Q11

4Q11

1Q12

2Q12

3Q12

US Revenue (millions)

$333

$338

$330

$352

$337

$328

Reported/Operational Growth

(Year-over-Year)

 

 

6.4%

 

 

0.0%

 

 

3.8%

 

 

13.2%

 

 

1.2%

 

 

-3.0%

  • International Diabetes Care revenues of $301 million were strongly affected by currency fluctuations (-8.5%), though operational performance was mildly positive at 0.8%. Management attributed the performance to “strong sales” in emerging markets partiallyoffset by lower sales in some of the developed markets (we assume this means Europe) – this was the exact language used in last quarter’s call. This quarter’s operational performance is a notable downtick from the 9.8% operational growth seen in 3Q11. On the bright side, operational performance was slightly improved over a weak 1Q12. The international performance continues a negative reported growth trend seen in 1Q12 and 2Q12 and represents the lowest reported growth seen outside the US in a quarter since 3Q10.

International Sales

 

2Q11

3Q11

4Q11

1Q12

2Q12

3Q12

International Revenue

(millions)

 

$348

 

$326

 

$340

 

$318

 

$336

 

$301

Reported Growth

(Year-over-Year)

 

14.9%

 

18.5%

 

4.3%

 

-2.5%

 

-3.4%

 

-7.7%

Operational Growth

(Year-over-Year)

 

4.1%

 

9.8%

 

4.4%

 

0.2%

 

4.6%

 

0.8%

  • Worldwide Diabetes Care revenue decreased 6.5% sequentially from sales of $673 million in 2Q12, the largest sequential decline seen since 1Q10. This was a challenging comparison as 2Q12 worldwide revenues represented the second best quarter of sales in the last three years. The 3Q12 sequential decline was nearly triple the 3Q11 sequential decline of 2.5%, though we note that 2Q11 had record worldwide sales of $681 million – the best diabetes care sales ever recorded by J&J. The international business was dramatically hit on a sequential basis this quarter, reflecting both flat operational performance (0.8%) and negative currency impact (- 8.5%). For the US, the only comparable sequential decline in recent quarters occurred in 2Q12 and was a reflection of impressive 1Q12 US sales of $352 million (the highest in the last four years).

Sequential Performance

 

2Q11

3Q11

4Q11

1Q12

2Q12

3Q12

Worldwide Sequential Growth

 

6.9%

 

-2.5%

 

0.9%

 

0.0%

 

0.4%

 

-6.5%

US Sequential Growth

7.1%

1.5%

-2.4%

6.7%

-4.3%

-2.7%

International Sequential Growth

 

6.7%

 

-6.3%

 

4.3%

 

-6.5%

 

5.7%

 

-10.4%

  • Roche revenue totaled 453 million CHF ($471 million) outside of North America, while J&J revenue ex-US was $301 million. Together, industry revenue totaled $1.2 billion, down 13% sequentially and down 12% year over year. J&J’s performance reflects a J&J “gain” of $71 million on the $242 million gap between the companies’ respective OUS sales in 2Q12. We emphasize that whereas currency effects were positive for Roche in 3Q12 (with a weakening Swiss franc), J&J incurred negative currency effects (from a strengthening US dollar).
 

3Q12 Revenue in Millions

Reported (Operational) Growth from 3Q11

Roche, Outside North America

$471*

-2.6%**

J&J, International

$301

-7.7% (0.8%)

*Currency conversion based on average exchange rate from July 1 – September 30 on oanda.com: 1.0394 USD per CHF.

**Roche does not specifically break out operational growth for Diabetes Care outside North America.

  • We expect reimbursement pressures in Europe to once again be a common thread in the Big Four BGM companies’ (Roche, J&J, Bayer, Abbott) financial updates. J&J management commented that strong sales in emerging markets were partially offset by lower sales in some of the developed markets – we assume poor reimbursement climates in Europe represented a major factor in this result. Pricing pressures and reimbursement cuts were also cited by Roche management, with Germany in particular posing problems.
  • In the US, J&J Diabetes Care revenue totaled $328 million vs. Roche’s North America total of $129 million. This represents a 3Q12 “gap” between the two companies of $199 million, a $29 million gain for J&J over its 2Q12 advantage of $170 million. While Roche’s revenue decline from 3Q11 was much larger than J&J’s, Roche fell from a smaller base. We look forward to providing additional industry comparisons when Abbott reports on October 17 and Bayer reports on October 30.
 

3Q12 Revenue in Millions

Reported Growth from 3Q11

Roche, North America

$129*

-11.4%

J&J, US

$328

-3%

*Currency conversion based on average exchange rate from April 1 – June 30 on oanda.com: 1.0692 USD per CHF.

  • The BGM market faces ever increasing pricing pressure in the US, affected by: 1) increasing access to low cost meters and strips (i.e., Walmart’s ReliOn Prime program which offers a 50-ct box of strips for $9); and 2) Centers for Medicare and Medicaid Services’ (CMS) competitive bidding program. Under the competitive bidding pilot for mail order strips, costs ranged from $13.88-$15.62 per 50-ct box ($0.28-$0.31 per strip), down from the 2011 national fee schedule average of $32.47; results from the latest round of competitive bidding are expected soon. Furthermore, CMS may decide to invoke its inherent reasonableness authority and adjust the current fee schedule for retail strips based on mail order competitive bidding results rather than wait to implement a competitive bidding program specifically for retail strips. For further discussion, please see our July 25 coverage of CMS’ public hearing on inherent reasonableness for retail strips at: http://www.closeconcerns.com/knowledgebase/r/a8833356. We are still working to adjust our 2013 model for competitive bidding, but we believe a downward revenue of at least 10% is likely in order.

DIAGNOSTICS AND DEVICES PIPELINE

  • Management succinctly acknowledged the Calibra Medical acquisition in the last line of this quarter’s press release, though no further information was given on the call. The statement characterized Calibra’s Finesse as a “unique, wearable three-day insulin patch designed to offer a convenient and discrete mealtime insulin dosing option for people with diabetes who take multiple daily injections of insulin.” The deal closed a few days before last quarter’s call but was not announced publically, we suspect because it was under the threshold for disclosure. As a reminder, Calibra Medical’s Finesse is used for bolusing short-acting insulin, is entirely mechanical (on-device buttons), is very small (2” long, 1” wide, and only 1/4” thick), will be targeted both at type 2s as well as type 1 patients as we understand it, and was originally approved by the FDA in early 2010 (an updated version was approved in April 2012). See our J&J 2Q12 report at http://www.closeconcerns.com/knowledgebase/r/155a6576 for an extensive review of Calibra’s Finesse and why we think the deal makes a great deal of strategic sense for J&J.
    • There are a number of questions that have not yet been addressed related to the Finesse, including 1) commercialization plans, timing, and pricing; 2) reimbursement prospects; 3) impact on the competitive landscape; 4) internal focus given Animas’ established insulin delivery business; 5) patient impressions of the technology; 6) international regulatory plans; 7) possible plans for future generations and changes to the technology. We think it will be great for J&J to bring another alternative to its franchise that will improve insulin delivery.
  • Disappointingly, there were no updates on the device pipeline front mentioned in the call. Products in the company’s pipeline are noted below with a few minor changes from last quarter in the way they are now listed on the medical device pipeline slide deck (i.e., name, countries).

Pipeline Product

Timeline

Notes

OneTouch VerioSync Blood Glucose Meter

Pending FDA 510(k) clearance

Allows wireless communication between a Verio meter and an iPhone app. For more information, see pages 6-7 in our AADE 2012 Exhibit Hall report at http://www.closeconcerns.com/knowledgebase/r/82754763. This product was not listed on this quarter or last quarter’s pipeline slide decks but we believe it could be a very big part of J&J’s future strategy.

OneTouch Verio Blood Glucose System (Version 3)

Planned US and EU submissions in 2012

3Q12’s slide deck now specifies the US and EU as regions for this product. We are not clear on what advancements this might have, though based on the nomenclature we believe the strips will be the same as those used for current Verio products.

Animas Vibe Insulin Pump with integrated Dexcom G4 CGM

Planned US submission in 2012

As a reminder, this will be a PMA supplement filed by Dexcom. The recent Dexcom G4 Platinum FDA approval conference call suggested that the goal is to submit the PMA supplement to the FDA before the end of the year; however, there is some additional system testing that needs to go into the filing, which could mean that it be delayed until January 2013. For more information, see our Dexcom report at

http://www.closeconcerns.com/knowledgebase/r/47018008.

OneTouch Ping Verio Insulin Pump with Meter Remote

Planned US submission in 2012

We suspect this will resemble the current OneTouch Ping insulin pump and meter remote but replace the handheld with a Verio meter. It’s unclear if this will also have Dexcom G4 integration, though from a patient perspective we hope that it does.

OneTouch Verio Pro+ Point of Care Glucose Meter

Planned Japan submission in 2012

This in-hospital meter has already been approved in the EU. A “version 1.5” is targeted for submission in 2013 or later in the EU and Japan. We were interested to see that the US is not listed for submission and wonder why that is the case.

Next Generation Glucose Testing

Planned US and EU submission in 2013 or after

We assume this is a new line of strips beyond the current Verio platform.

Next Generation OneTouch UltraVue Verio Platform

Planned Japan submission in 2013 or after

This could be the same as the above entry, though we cannot be sure since they are listed separately on the slide.
Hypoglycemia-Hyperglycemia Mitigation System Studies ongoing We saw data on this control-to-range system in two posters at ADA 2012. At the time, the posters separately indicated that "further studies are underway" and "further studies are being planned". A 20-patient phase 1 study started in July and was completed in September (clinicaltrials.gov identifier: NCT01638299). We hope to see more data at ATTD 2013 in Paris.
  • LifeScan has two phase 4 trials currently posted on clinicaltrials.gov that will investigate clinical outcomes in the US and EU using the Verio IQ blood glucose meter (clinicaltrials.gov identifiers: NCT01631643 [EU] and NCT01627899 [US]). Both are expected to enroll 45 patients and the primary outcome is change in A1c from baseline to week 24. Neither is currently listed as recruiting participants though the study start dates have already passed (August 2012 for the EU study and June 2012 for the US study). The studies are expected to end in Summer 2013.
  • On November 1 at 8:30 am EST, J&J will provide a more in-depth review of the Medical Devices and Diagnostics businesses. At that meeting, the three heads of the Devices and Diagnostics business groups will update the investment community on new product offerings and the strategic direction of the businesses. We hope to hear more information on the Calibra Medical acquisition during this call as well as a slew of upcoming products noted above.

PHARMACEUTICALS PIPELINE

  • J&J submitted canagliflozin to five additional regulatory agencies in 3Q12; the drug remains under regulatory review in the US and in Europe (it was submitted in May and June 2012, respectively; for details on the FDA submission, please see our May 31, 2012 Closer Look at http://www.closeconcerns.com/knowledgebase/r/013b33f5). During the call, management emphasized canagliflozin’s large phase 3 development program (nine studies with over 10,000 participants) and positioned the drug as a favorable second-tier therapy option after metformin thanks to its glycemic efficacy, associated weight loss, and convenient administration as a once daily oral drug. Management also expressed confidence regarding canagliflozin’s safety profile, stating that the increased incidence of urinary tract infections (which appears to be a class-wide side effect) is not dose-dependent and can be treated with over the counter medications. The company also noted that an increased risk for breast or bladder cancer has not been observed in the clinical trials – as a reminder, cancer risk has been a significant concern surrounding BMS/AZ’s dapagliflozin, and is believed to have been a significant factor behind the FDA’s complete response letter for the drug. No updates were provided on J&J’s fixed-dose canagliflozin/metformin combination product, which remains in phase 3 studies.
  • Management noted the favorable results from CANVAS, the 4,400-person cardiovascular outcomes study of canagliflozin scheduled to complete in April 2013. A second interim analysis for CANVAS is expected in mid-2013. New data from a substudy ofCANVAS participants taking insulin (≥30 U insulin per day at baseline) were presented in a poster at EASD 2012: at 18 weeks, greater improvements in A1c were observed with canagliflozin 100 mg (-0.63%) and canagliflozin 300 mg (-0.72%) versus placebo (+0.01%). Patients on canagliflozin also experienced significant reductions in fasting plasma glucose, weight, and systolic blood pressure compared to placebo, but higher rates of genital and urinary tract infections, as well as osmotic diuresis-related adverse events. During Q&A, management confirmed that the CANVAS data submitted to the FDA showed “solid cardiovascular safety”, though they expect continued to debate on the drug’s CV risk during canagliflozin’s anticipated advisory committee hearing (to our knowledge, the FDA has not scheduled a meeting).
  • New phase 3 data on canagliflozin’s associated weight loss was presented at a poster during EASD 2012. Substudy analysis from two phase 3 studies showed that loss of fat mass accounted for approximately two-thirds of the overall weight loss seen with canagliflozin treatment (the remaining weight loss was attributed to the loss of lean mass). Specifically, patients on canagliflozin 100 mg and canagliflozin 300 mg experienced average 5.4% and 5.6% losses of subcutaneous fat, compared to 7.3% and 8.1% losses of visceral fat, respectively.
  • In August, the FDA approved Nucynta ER (extended release tapentadol, a twice- daily oral opioid) for the management of pain associated with diabetic peripheral neuropathy (DPN). Previously, the only FDA approved medications for DPN were Pfizer's anticonvulsant Lyrica (pregabalin) and Eli Lilly’s antidepressant Cymbalta (duloxetine). Pregabalin is the only "level A" recommended treatment (pharmacologic or otherwise) for DPN in the guideline developed by the American Academy of Neurology, the American Association of Neuromuscular & Electrodiagnostic Medicine and the American Academy of Physical Medicine and Rehabilitation. All other drugs and devices (including transcutaneous electrical nerve stimulation [TENS] devices) are “level B.” As we understand it, Nucynta ER may be particularly useful in patients with more intense pain that does not respond to current treatments.
  • There is still no DPN treatment that is disease-modifying; all currently available treatments merely treat pain symptoms. Because of the complexity of the underlying mechanisms of DPN, finding one broadly effective treatment option has been notoriously difficult, so we are encouraged to see new options available to patients. NeuroMetrix’s Sensus [a TENS device] was also recently approved for DPN; for more details about the Sensus please see our August 7, 2012 Closer Look at http://www.closeconcerns.com/knowledgebase/r/c726efae). For context, Nucynta regular release was approved in 2008 for acute pain relief, and Nucynta ER was approved in 2011 by the FDA for management of chronic pain requiring 24-hour analgesics. The sNDA for a DPN indication was submitted in October 2011 and approved in August 2012. For more background on Nucynta ER, please see our November 13, 2011 Closer Look at http://www.closeconcerns.com/knowledgebase/r/e06ec377.
  • Management provided no new information on the other drugs in J&J’s cardiometabolic pipeline. To our knowledge, J&J MTP inhibitor remains in phase two (JNJ- 16269110; no active trials on ClinicalTrials.gov). The pipeline also includes an insulin sensitizer (which we suspect is JNJ-41443532 and was in phase 2 as of May 2011; also no ongoing studies listed on clinicaltrials.gov), as well as various preclinical candidates developed through J&J’s partnership with Metabolex, created through its own discovery program, or licensed from Evotec AG and Harvard.

Questions and Answers:

Q: The Street’s been a bit cautious about canagliflozin because of challenges in diabetes in getting products through the FDA and challenges in having successful commercial launches post-approval. Can you talk about your confidence in its safety profile and your discussions with the FDA on that?

A: We are pretty confident in canagliflozin. If you look at cancer, there was no evidence of any clinically meaningful imbalance in the incidence of cancer including breast/bladder in clinical trials. We’re confident from that side that we have a safe compound. As for urinary tract infections, if you look at our studies also and in pooled analyses of UTI incidence, it comes out to 5.9 for the 100 mg dose and 4.3 for 300 mg dose. There is no real dose-related increase and this side effect is well known for this type of compound. Typically this is managed with OTC medication.

From a long-term safety perspective, we are doing the CANVAS study, and the first part of the data went to the FDA. We’ll have an interim analysis in 2013. It’s an event driven trial so we will see when it is finished, but we’re confident that in those data the support is there for a filing and approval. We think the data show solid cardiovascular safety, and the balance between the LDL increase, if you look at overall ratios, LDL, sorry I meant HDL, were absolutely okay. If you look at that and combine it with the blood pressure decrease and improved weight and glycemic control, we think the balance between efficacy and safety is very solid for canagliflozin.

Q: Following up on canagliflozin, can you talk about the cardiovascular safety in a bit more detail given the LDL signal? It seems possible that the FDA would look closely at the interim data from the CANVAS trial or perhaps a composite of the CV data across phase 3. Might the data actually show a CV benefit? If not, from a regulatory perspective, would it make sense to approve a drug without CV benefit?

A: It’s difficult for me to judge what regulators will do, but based on the information and what we’ve submitted, all the information is in favor of a good safety profile and a balanced cardiovascular risk. We think the benefits significantly balance the cardiovascular risk. Therefore I think we’ll have to see. We anticipate we’ll have an advisory panel before the approval so more debate will happen there. People will be more prepared to address these questions at that point.

-- by Adam Brown, Nina Ran, Jessica Dong, Kira Maker, and Kelly Close