Pharma Sales Bounce Back

The pharmaceutical industry experienced big changes in the first three months of 2010. Combined first-quarter sales and earnings rose by double digits, which marked a significant improvement compared with the declines that many drug companies posted for the first quarter of 2009 at the nadir of the economic downturn. Biotechnology firms as a group also showed renewed vigor. And as profit margins reflect, both drug and biotech companies remained highly profitable.

However, the strong results emerging in 2010 were tempered by enactment of the long-anticipated U.S. health care reform package. Although the law went into effect on March 23, just days before the quarter ended, some aspects applied retroactively to Jan. 1. As a consequence, sales slipped almost 1% from what had been forecast for the quarter.

“The expected global economic recovery removes an element of uncertainty for the industry over the next five years,” explains Murray Aitken, senior vice president of IMS Health. The market research firm estimates that the global pharmaceutical industry will grow 5–8% per year to reach $1.1 trillion by 2014. Emerging markets will be among the major growth drivers, even as the industry reaches a peak in patent expirations and generic competition. Meanwhile, health care reforms will spur fundamental change, “but the full impact may not be felt until the latter half of this decade,” he adds.

More immediately, drug companies have started to include the law’s impact in their 2010 sales and earnings guidance, and most have adjusted their annual estimates down by a few percent. According to stock analysts at Citigroup, the initial impact from Medicaid reimbursements in 2010 had been underestimated by Wall Street, and further downward revisions to predicted sales and earnings figures are expected for 2011.

U.S. health care reform will be a double-edged sword for pharma and biotech firms. In the near term, most firms will see some kind of minor hit to their top and bottom lines. Initially, sales figures will be negatively impacted as the minimum Medicaid reimbursement rate rises from 15.1% to 23.1%, effectively lowering the prices paid for drugs under Medicaid. In 2010, the industry-wide sales decrease is estimated at $4 billion, or about 2% of the U.S. branded pharmaceutical market.

In 2011, the drug industry expects to see sales drop by another 6%, or $11 billion overall. This decline will occur when Medicare provisions kick in, especially as the Part D “donut hole” is filled. Medicare Part D participants now cover any gap in coverage by paying out of pocket, up to a certain limit. Next year, drug firms will have to discount branded drugs by 50% for Part D participants paying to fill the hole.

Also in 2011, branded pharmaceutical companies will have to pay an additional fee, or tax, to the U.S. government. Industry executives point out that it has not yet been determined whether the fee will be allocated as a reduction to sales or taken as a cost against earnings. Over 10 years, health care reform is expected to cost the industry $100 billion to $115 billion, according to Johnson & Johnson Chief Financial Officer Dominic J. Caruso.

But eventually the costs should be balanced by the growing number of insured U.S. patients. “The real expansion to the industry won’t take effect until the uninsured patients enter the marketplace, which is not until 2014,” Caruso said in an April conference call with analysts. “We don’t expect a positive impact until then, and it would be very difficult right now to estimate what that would be.”

Depending on their mix of products and geographic sales, different companies will see the effect to varying degrees. J&J, for example, has a higher than average portion of its products falling under Medicaid. This year, the company expects to take a $450 million health-care-reform-related hit, the largest estimated by the major drug and biotech firms. Next year, however, the donut hole shouldn’t have as big an effect because fewer of its products fall under Medicare. J&J’s first-quarter-2010 sales and earnings rose by single digits.

Bristol-Myers Squibb, Eli Lilly & Co., and Pfizer also predicted large first-quarter and annual financial penalties from health care reform. Whereas results for BMS still grew by double digits, Lilly’s sales rose a lesser 9% and earnings fell by 1%. The company attributed the decline to foreign currency exchange rates and health care reform.

Pfizer’s results were anomalously high because of its acquisition of Wyeth. Its 54% increase in sales came from including Wyeth in first-quarter-2010 results but not in those for the comparable period in 2009. Although sales of several Wyeth biopharmaceutical products grew nicely, revenues from Pfizer’s own products declined about 1%.

Meanwhile, Merck & Co., which combined operations with Schering-Plough, did report results on a comparable year-to-year basis. Sales were up 7% and earnings up 12%, with a relatively minor impact from health care reform compared with other big U.S. companies. In a report to investors, Citigroup analysts said they believe that Merck has the least exposure to U.S. reform measures. And, as for many companies that have restructuring programs in place (C&EN, Feb. 22, page 24), it will use cost-cutting to nullify any effect.

In the short term, biotech companies are seeing the downward effect of U.S. health care reform as well. Four of the six major U.S. biotech firms that C&EN tracks reported reform-related declines ranging between 0.5 and 1.4% of their sales. Later, they too will face the government fee. Genzyme’s 7% sales drop and 56% earnings decline were due to other factors: serious manufacturing contamination problems that curtailed production and product supply.

Biotech firms are in a prime position to benefit from reform measures. Companies with fewer than 250 employees may be able to claim a tax credit on some drug discovery R&D projects (C&EN, April 12, page 21). The credit will help offset expenses, such as those connected with hiring scientists and conducting clinical studies.

For small or large companies developing biologic drugs, there are other benefits. The law creates a pathway to help regulators approve generic or follow-on versions. But as an incentive to developers, it grants 12 years of market exclusivity before a company will face generic competition.

This latter move helps preserve the framework for innovation, Amgen Chief Executive Officer Kevin Sharer told analysts in a conference call. The new follow-on biologics framework, he says, is fair to innovators, lets new entrants come in, and works for patients and doctors.

With less exposure to the U.S. market, European drug firms are expected to see less impact from new U.S. reforms than are domestic companies. AstraZeneca had already taken any impact into account before its first-quarter earnings were released, but others didn’t bother breaking out the numbers at all.

Diversification and geographic mix are factors at play for these firms. Novartis has been streamlining its business in the U.S. and focusing more on emerging markets. GlaxoSmithKline says “white pills/Western markets” made up 27% of first-quarter sales, compared with 32% in the same period last year. The company says it simply absorbed the adverse financial impact of U.S. health care reform.

Some European companies—GSK, Novartis, Roche, and Sanofi-Aventis—also saw sizable revenue boosts from their sales of H1N1 influenza products, although these will likely tail off.

Nevertheless, Citigroup analysts believe that the risk of European health care spending cuts has been overlooked. In 2009, investors were preoccupied with emerging U.S. health care reform. “With a watered-down version of reform now passed, understood, and largely priced-in,” the analysts wrote in a late-April report, “we believe cuts to European government budgets present a greater underappreciated risk in 2010.”

In Europe, where 70–90% of health care costs are government funded, budget deficits in several countries could lead to steps to reduce drug prices by 5–10% or to promote the use of generic drugs. Most of the impact would be in specialty pharmaceutical markets, and diversified drug companies would face less risk, the analysts conclude.