Memorandum

Johnson 4Q08: Tough diabetes quarter reflects deteriorating economy and challenging managed care environment – January 20, 2009

J&J announced 4Q08 results on January 20 in a call led by CEO Bill Weldon who discussed a range of topics including the tough diabetes quarter. LifeScan/Animas (Diabetes Franchise) sales were $579 million, down 10% worldwide, (6% operationally), reflecting $275 million in the US, down 18%, and $304 million internationally, down slightly 0.7% compared to 4Q07 (up 7.5% operationally). On a more positive note, Animas had yet another standout quarter with operational growth of 40%. For 2008, Diabetes Franchise (LifeScan and Animas) sales reached $2.5 billion, up 6.8% globally (3.9% operationally), reflecting $1.27 billion in US revenue, flat from last year (0.4% growth), and $1.27 billion overseas, up 14% (7.8% operationally). One silver lining in our view is the opportunity in international and emerging markets this is the first year that international sales have exceeded sales in the US. Growth in some of these markets is quite robust and there is definitely a great deal of room for penetration. Management noted that increasing customer frugality during these tough economic times was particularly impacting the diabetes glucose monitoring market in the US (and internationally) because it requires repeated out of pocket expenses. While the US certainly has opportunities for new growth in terms of new patients, the domestic business has been hit hard by reduced testing caused in part by glycemic dependent drugs and in part by economic factors (more cost shifting to patients, patients losing insurance, etc). We will look to news from Abbott (Jan. 21), Roche (Feb. 4), Bayer (March 3), and HDI (TBA) to better understand the extent of the impact of the recession in this market. We discerned wellness as a major thrust at J&J with a couple of recent small acquisitions we also suspect the REALIZE adjustable gastric band (approved in 2008 in the US) business isextremely strong though results aren’t broken out. Last, J&J certainly sounds open to acquisitions, particularly on the smaller side, if the right fit emerges.

  • In 4Q08, LifeScan/Animas (Diabetes Franchise) sales were $579 million, down 10% worldwide, (6.1% operationally). Sales reached $275 million in the US – down 18% year on year and 21% sequentially – and $304 million internationally, roughly flat compared to 4Q07 (up 7.5% operationally) and down 4.4% sequentially. There was a one-time factor related to rebating; sans this, the global sales drop would have been about 2%. Management also mentioned pricing pressure, which we can imagine may have been a big factor – managed care certainly has a lot of power at present and there are a number of poorly designed (but technology randomly controlled trials) studies that are probably driving justification at plans for less testing.
  • For 2008, the Diabetes Franchise sales reached $2.5 billion, up 6.8% globally (3.9% operationally). This reflects $1.265 billion in US revenue, flat from last year (0.4% growth), and$1.270 billion overseas, up 14% (7.8% operationally). Note that this is the first year that the international business exceeded the US business in revenue – last year, the US represented 53% of revenue, in 2006 it represented 56%, in 2005 and 2004 it represented 54%, and it was 57% ofrevenue in 2003.
  • The Animas business grew 40% on an operational basis. Management attributed this to strong international growth and new product development. This business unit has continually delivered impressive growth since J&J’s purchase in late 2005 – double digit every quarter since its purchase, 40% last quarter and over 30% for the last six quarters.
  • Weldon discussed potential market trends following the economic slowdown, which affect J&J’s businesses. He noted cutbacks in healthcare treatments and pressure on consumer spending negatively affecting chronic conditions like diabetes that require more out of pocket spending for consumables like test strips. He expressed confidence in the company’s ability to adjust appropriately to these market conditions.
  • In the comprehensive care pipeline slide, management noted 2009 as the planned submission timeframe for the DexCom/Animas integrated glucose monitor/insulin pump PMA. We believe that this will be a strong entry for Animas and will expand both the pump and CGM markets. Also in the pipeline were planned submissions in 2009 for the OneTouch Vita meter (US), its no-coding meter, and the Diabetes High Accuracy Blood Glucose Testing System, which is new to us. The Vita meter was approved in Europe in 2008.
  • HealthMedia and the Human Performance Institute were highlighted as new growth platforms in the wellness and prevention arena. These are wellness programs designed to keep employees engaged and productive. In October 2008, J&J acquired HealthMedia followed by their acquisition of Human Performance Institute in December 2008. These companies will operate within the J&J Wellness & Prevention business platform. We are excited to see J&J Corporate pursuing more wellness businesses and think these should serve the company well – despite the economy, this is an area of growing interest to businesses.
  • The REALIZE adjustable gastric band was highlighted as a growth contributor to Ethicon Endosurgery which increased 5% (9% operationally). As a reminder, the REALIZE Band C was approved/cleared in the US during 2008. We would love to have more details on this business, which we suspect is extremely strong.

Questions and Answers

Q: What is J&J’s pharma strategy in this regulatory environment?

A: Specialty markets are less impacted. We’ve modified our strategy but haven’t really changed it as we’ve historically been focused on specialty markets. We have identified therapeutic areas on which to focus.

Q: Regarding services like HealthMedia and Human Performance Institute – will this pace of acquisitions continue going forward?

A: With the impact of obesity and diabetes worldwide, more people are focused on their health. Government administrations are beginning to focus on keeping people healthy. We zeroed in on prevention and wellness and we think there’s a strong business model with these services. We pay $400 less per employee on healthcare than most companies because we have 4% tobacco users vs. 20% in a normal population, and we have a focus on obesity, cholesterol, and hypertension. We’ve documented that it adds to productivity, engagement, and reduces absenteeism. We wouldn’t go into large acquisitions but we will build on the base we have started.

Q: Comment on J&J’s disease management strategy.

A: We shy away from the term disease management these days and look at patient management instead. We combine this patient-centric view with research into biomarkers etc and work to provide the entire continuum of care. For example, with diabetes and obesity, we have pumps, strips, Splenda, behavior modification programs, and banding.

Q: Do you anticipate major policy changes in 2009?

A: I think the administration is talking about coverage and cost – increasing access and affordability. We’ll work closely and support them to get patients better healthcare. The critical thing is addressing the economic situation. There are a lot of things that will have short-term impact but we need to think longer- term. Healthcare costs will sky rocket if we don’t address childhood obesity issue. But first and foremost we have to address the economy.

Q: Is the challenging regulatory environment the reason we’re seeing fewer pharma deals?

A: We were becoming out of balance on pharma side. The regulatory bodies in many parts of the world have been struggling and with some of them they’ve become risk averse. Our strategy: if it’s the right acquisition we’re going to do it to create shareholder return long term.