Abbott 1Q13 – Nearly flat Diabetes Care growth; pivotal trial on track for next-gen CGM, with EU Launch by end of 2014 – April 18, 2013

Abbott CEO Miles White led the company’s 1Q13 financial results update yesterday. Worldwide Diabetes Care revenue of $316 million was nearly flat on both a reported (-0.5%) and operational (0.2%) basis from 1Q12, when sales declined 2% and 1%, respectively. Sequentially, sales fell 13% from 4Q12, when Abbott’s global diabetes care reached an all-time high. By region, sales decline was steepest in the US, where revenue of $133 million was down 4% on a quite challenging YOY comparison (1Q12 growth was 7%). Management noted pricing pressures and lower Medicare mail order purchases. Notably, Abbott believes competitive bidding will have less of a negative impact on its sales performance compared to competitors’, as the company does not have a high Medicare share and has a lower relative share of the mail order market. Internationally, revenue reached $183 million, up 2% as reported and 3% operationally on an easy comparison (1Q12 international revenue fell 9% and 7% as reported and operationally). Emerging markets were important drivers of both international Diabetes Care and company-wide sales: over 40% of Abbott’s overall sales were attributed to these geographies.

Looking forward to 2Q13, management expects flat operational growth. Three of the Big Four competitors have reported thus far (J&J, Roche, and Abbott) and each has described a market affected by pricing pressure and challenges related to CMS’ competitive bidding program. Combined revenue in 1Q13 totaled $1,495 million, down 7% from the three competitors’ pooled revenue in 1Q12.

Pipeline news focused on the company’s next-generation CGM sensor. The company is on track with expectations outlined in 4Q12: a pivotal study is expected to start by the end of 2013 and Abbott intends to bring the product to the European market by the end of 2014 (unfortunately, no mention of a US timeline). Improvements with the FreeStyle Navigator II focused primarily on receiver form factor and a smaller transmitter, and we hope the next-generation sensor will also bring further accuracy improvements. While not mentioned on the call, earlier this week Abbott issued a voluntary recall of its FreeStyle InsuLinx meter for a software issue that caused the meter to react inappropriately at blood glucose valued above 1,023 mg/dl. The meter both displays and stores a blood glucose value that is 1,024 mg/dl less than the actual concentration. The recall occurred in the wake of J&J’s nearly identical recall of all OneTouch Verio IQ, OneTouch Pro, and OneTouch Verio Pro+ meters.

Management commented that Abbott’s Diabetes Care business has increasingly focused on insulin- dependent, frequent testers, and that ongoing research efforts target “a segment of the market that is a lot less cost-sensitive and much more performance-sensitive.” While a strategic move on Abbott’s part that reflects the realities of an increasingly challenging marketplace, we also hope that broad innovation in diabetes technology does not overlook less-profitable patients – we’re not too worried since Abbott has certainly demonstrated the importance of of innovative devices that improve outcomes, make diabetes easier to manage, especially in the face of a dramatic shortage of HCPs.

DIABETES CARE FINANCIALS

• Global Diabetes Care revenue 0f $316 million in 1Q13 represented nearly flat growth from 1Q12. During the same period last year, growth declined 2% and 1%, respectively. By region, US sales declined 4% on a challenging year-over-year (YOY) comparison (1Q12 sales grew 7%). Internationally, sales grew 2% as reported and 3% on an operational basis on an easy comparison to 1Q12 (sales in 1Q12 declined 9% and 7%, respectively).

• Abbott Diabetes Care recorded its lowest quarterly revenue since 1Q10; however, it closely mirrors recent first quarter performances. Sales were $318 million in 1Q12, $325 million in 1Q11, and $295 million in 1Q10. In growth terms, Abbott has seen inconsistent first quarter performance in recent history: between 1Q09 and 1Q13, first quarter sales declined as steeply as 13% and increased as much as 10%.

• US revenue totaled $133 million, a 4% decline from 1Q12 on a challenging YOY comparison (1Q12 US growth was 7%). Diabetes Care will face another challenging comparison in 2Q13 given strong 2Q12 sales growth of 9%. Management remarked that share gains in the hospital and retail segments were offset by pricing pressures and lower Medicare mail order purchases.
  • Management noted that Abbott does not have a high Medicare share and has “one of the lowest shares in mail order.” As such, management believes the sales impact from the competitive bidding program will be comparatively less for Abbott than other industry players. The effects of the lower Medicare payments are still pending, as competitively bid payment amounts are to go into effect on July 1 if they “stick”. It’s possible that the Big Four blood glucose monitoring companies have already weathered some of this negative impact, though we expect the next few quarters will be just as challenging here in the US.
  • For greater discussion on competitive bidding, see our February 13 Closer Look at http://www.closeconcerns.com/knowledgebase/r/993d586e.

• International revenue of $183 million grew 2% on a reported basis and 3% on an operational basis from 1Q13 on an easy YOY comparison. During the same period last year, sales declined 9% and 7%, respectively. Using the same language as last quarter, management remarked that sales were driven by share gains in key emerging markets (China was highlighted) and continued uptake of the FreeStyle InsuLinx meter. Notably, emerging market growth for Diabetes Care was in the mid-teens. In addition to China, Brazil performance is said to have been very strong, as have sales in the Middle East.
  • Company-wide, emerging markets accounted for over 40% of company sales. Abbott sales in emerging markets were up 15% operationally from 1Q12. [We note that these figures include all Abbott divisions, not just Diabetes Care. We wonder what percentage of Diabetes Care sales came from emerging markets.] Yesterday morning’s discussion seemed to focus on the robust sales opportunity in these geographies driven by expanding healthcare systems. Indeed, in 4Q12 management forecasted that 50% of Abbott’s sales will occur in emerging markets by 2015. While emerging markets tend to be less predictable, said management “even a bad day in an emerging market looks a lot better than a developed market right now.” Developed markets for the company overall were down 3% YOY in the quarter.

• Sequentially, overall revenue was down 13% on a challenging comparison to record revenues in 4Q12. The overall decline was reflective of an 11% sequential decline in the US and a 14% sequential decline abroad. For comparison, overall revenue decreased sequentially by a comparable 9% in 4Q11 and slightly better 4% in 4Q10. Of course, 1Q is typically a soft quarter for device companies given the seasonality of patients’ insurance (e.g., resetting of deductibles).

• Looking forward to 2Q13, management guided for flat sales on an operational basis. Echoing comments made during the company’s 4Q12 update, management continues to expect growth in key emerging markets, and a negative US sales impact from CMS’ competitive bidding program. Management did not update its full-year Diabetes Care guidance from 4Q12 (flat sales on both a reported and operational basis).
• Compared to J&J and Roche, Abbott experienced a lower sales decline in the US, a region that is driving weak overall Diabetes Care performance this quarter. We note that a direct comparison between these competitors is challenging, as each company’s Diabetes Care business includes some fraction of non-blood glucose monitor revenue (continuous glucose monitoring outside the US for Abbott and insulin delivery globally for J&J and Roche). We look forward to providing additional comparison when Bayer reports on April 23. For more on J&J, see our 1Q13 report at http://www.closeconcerns.com/knowledgebase/r/59b616b4. For Roche 1Q13, see http://www.closeconcerns.com/knowledgebase/r/f5191b53.
  • Combined 1Q13 revenue for J&J, Abbott, and Roche was $1.5 billion, down 7% from the three competitors’ pooled revenue in 1Q12. The decline seems to reflect continued pricing pressure and reimbursement challenges, the latter of which are emerging in the US in a more substantial way on the eve of CMS’ competitive bidding program.

DEVICE  PIPELINE

• Abbott is on track to initiate a pivotal study of its next-generation CGM sensor by the end of 2013, and continues to expect an EU launch by the end of 2014. We look forward to learning greater detail on the pivotal trial and the improvements this device will provide over the FreeStyle Navigator II. As we noted at ATTD 2013, improvements in the FreeStyle Navigator II focused on ease of use and form factor (see below), and we hope the next- generation sensor will bring additional accuracy improvements to the system.
  • We continue to look forward to news on whether Abbott will consider regulatory submissions and launches outside the EU, particularly the US. We wonder if the deterrent has to do with the growing reimbursement challenges in BGM, high clinical trial bars from the FDA, stiffer competition from Dexcom, manufacturing constraints, or other factors – most likely, of course, it is multifactorial. Certainly, Abbott sees this area as worth investing in, so it is somewhat perplexing to hear no mention of a US strategy.
  • Abbott discussed its FreeStyle Navigator II continuous glucose monitor in greater detail at ATTD. The FreeStyle Navigator II has been under the radar since its low-key launch in Europe in fall 2012. Navigator II has an updated receiver and a 33% smaller transmitter; otherwise, the sensor technology and measurement methods are the same as the previous version. Indeed, the accuracy is nearly identical: a MARD of 12.3% and 84% of points in Zone A of the consensus error grid (n=2,843 total). Abbott representatives did not discuss plans for submission of the FreeStyle Navigator II to the FDA, or details on the company’s next-generation sensor. For greater discussion on the company’s ATTD presentation, please see page 37 of our ATTD report at http://www.closeconcerns.com/knowledgebase/r/54fc41b3.
• Abbott recently initiated a voluntary recall of its FreeStyle InsuLinx meter due to a software issue that causes the meter to react inappropriately to blood glucose values greater than 1,023 mg/dl. Once the FreeStyle InsuLinx meter's memory reaches 210 (i.e., 1,024 mg/dl), it forces a “wraparound” so that the result it provides starts back at zero. As such, the meter will display and store a value 1,024 mg/dl less than the actual concentration. Management did not discuss the recall during yesterday’s call.
  • To remedy the problem, patients can either request a free meter replacement or access a software update at http://www.freestyleinsulinx.com/swupdate. We believe it is notable that patients can download the software update online – this speaks to a major benefit of today’s increasingly cloud-based meter technology. It also forecasts a future pathway by which patients can seamlessly receive product improvements (similar to updating a smartphone app) as opposed to having to wait for a whole new device, which is a far more costly, time-intensive and resource-intensive process. We assume the FDA signed off on this decision and believe this signals that the Agency and industry are moving in a similar direction regarding software updates.
  • As a reminder, J&J similarly announced a voluntary recall of all OneTouch Verio IQ, OneTouch Pro, and OneTouch Verio Pro+ meters due to a software issue that causes the meters to react inappropriately to blood glucose values above 1,023 mg/dl. As we understand it, the J&J recall motivated Abbott to begin internal testing for this issue.
  • For our in depth discussion on the recalls, please see our April 16 Closer Look athttp://www.closeconcerns.com/knowledgebase/r/ccb61825.
• Abbott completed recruitment for a phase 4 efficacy study of its FreeStyle Navigator in patients on multiple daily injections, according to a February ClinicalTrials.gov update (Identifier: NCT01713348). Following a 14-day run-in with blinded CGM wear, patients will be randomized to either real-time CGM or standard SMBG (with blinded CGM wear) for a 14-day period. The primary outcome measurement is time in range; secondary outcomes include mean glucose, glycemic variability, frequency of finger-stick testing, and hyper- and hypoglycemic events to name a few. Abbott is expecting to enroll 90 patients; primary completion is slated for May 2013.
• Abbott did not provide additional updates on its diabetes pipeline. As a reminder, during last quarter’s update management remarked, “in 2013, we’re planning on several new product and software launches.” As we understood it, this was to include emerging market launches of products previously approved in other countries, as well as “next generation products” in developed markets (including a product based off the FreeStyle Precision platform).
• Abbott’s R&D efforts target “a segment of the market that is a lot less cost sensitive and much more performance sensitive.” Management explained that the business is increasingly focused on insulin-dependent, frequent testers. Financially, this seems like a smart, strategic move by Abbott. However, we also hope that the ongoing pricing pressures and reimbursement challenges will not prevent innovation directed towards patients who are less frequent testers or more price sensitive. Often, these groups could benefit the most from technological innovation, assuming access exists.

Questions and Answers

Q: Can you provide a perspective on the future drivers in diabetes? Is this sharp reduction in test strip reimbursement reflective of the numbers? Will you remind us of the Medicare and non-Medicare mix in this business?

A: In the US, first of all, it’s a rare circumstance where you're glad you do not have high share in a particular segment. It sounds like a rationalization, but we don't have a real high Medicare share and we have one of the lowest shares in mail order. The CMS competitive bidding that has been put in place in the United States is going to have an impact on all manufacturers. Relatively speaking it’s less on us because we are not highly indexed there. The business itself has segmented and focused on insulin-dependent users who frequently test their blood sugar for quite some time. This is a robust segment where we are steadily gaining shares. We've targeted our R&D efforts on next-generation sensors for users who are looking for more than just a test strip. We're looking for more information management, greater ease of testing and so forth.

I will tell you that the product lines that we have in development and in business today, are steadily moving along and will have tremendous value for patients. I was just out in California and met with the group for a day. I'm very pleased with what I see there. I think that we've targeted a segment of the market that is less cost sensitive and more performance sensitive around what they're testing and what information it provides them. I'm saying that the business is certainly positioned in the right place going forward over the coming years. Today it's a fiercely competitive commodity-type market for the patients with type 2 diabetes and the less-frequent testers.

Q: […] Can you comment on the competitive impact versus the new market development impact in these regions [emerging markets].

A: First of all, there is a great deal of new market growth. As healthcare systems and medical practices expand, as well as incomes, you will see the evolution of two or three, sometimes four kinds of pricing tiers and segments. There is often a high-end niche, a midmarket, a lower tier and sometimes a very low tier, all of which are growing. [Editor’s Note: This is very similar to the language Medtronic has used in discussing emerging markets at JP Morgan 2012 and 2013.] You see a migration of that mid tier to the upper tier in some cases. Multi-nationals and or exporters (not local manufacturers) in these markets are in the upper tiers and trying to move down while the local manufacturers in the lower to mid tiers are trying to move up. We see that in almost every business we're involved with. However, in spite of the fact there's multiple competitors (both local or multi-national) and pretty healthy competition amongst us all, we're all propelled by a strong tailwind of growth and expansion as healthcare system expands. We're careful to look at this internally and not to get too excited about our growth if we're not taking share. You know we need to pay attention to whether or not we're winning in these markets. It's wonderful to experience this growth; however, at the same time we're mindful that competitiveness is measured by shares as well. I would tell you that emerging markets are experiencing a tailwind of growth but at the same time, we're all mindful of the competition.

When we went through our planning process last fall, it was very clear what was coming in competitive bidding. The business and our plan totally factored in what has played out in the bidding process. We are well covered in our guidance for the evolution of the US market.

Q: What are your latest thoughts on strategy and focus with respect to your acquisition plans? What are your priorities either US or OUS, one business or another. Please talk about the pressure you feel or don't feel to move forward on that front?

A: I don't feel any particular pressure because I think there's a balance between the things you might like to do strategically versus the pricing or the values in the market...We were not so active last year, because first of all I think a lot of things weren't ready, and secondly, we were pretty focused on all of the activity with regard to the separation [Editor’s Note: this refers to the separation of AbbVie from Abbott]. With the separation behind us, we have been able to shift our attention, but this doesn't mean we're out on a buying spree either. We tend to be pretty selective. We always look to balance the value of the business and what we can do with the business, and the capacity of our businesses to absorb additional responsibilities. Whether it's big or small it takes a lot of effort to add something to your portfolio and drive it appropriately. So I'd say we're actively looking. It's often faster to be in the markets in Europe than it is in the US these days. I think that's fairly apparent, but that doesn't mean you only buy ex-US businesses or look at licensing ex-US products. The US is still a very important market for us, and it's one in which we hope to keep expanding. There's no distinction geographically at all.

-- by Kira Maker, Adam Brown, Marissa Lynn, and Kelly Close