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Whalebone Advisory provides investor relations and strategic advisory services to publicy-traded, pre-IPO, and development stage healthcare companies.
July 21, 2017

GOP HC Reform Effort Close to Dead, So What Now?
Plus: JNJ Earnings Read-Through, ISRG Posts Another Blowout

It was another rollercoaster week for the healthcare reform effort. With two more Senate Republicans, Mike Lee (UT) and Jerry Moran (KS), expressing firm opposition to the Better Care Reconciliation Act (BCRA), Majority Leader Mitch McConnell officially pulled the bill on Tuesday once it became clear it had no chance of passage. McConnell next pivoted to pursuing a clean repeal of the ACA, which would include a two-year implementation delay to enable more time to create a workable replacement bill. However, McConnell failed to win sufficient support from his caucus for even that idea, as key Senate moderates – including Shelley Moore Capito (WV), Susan Collins (ME), Lisa Murkowski (AK), and Rob Portman (OH) – all promised to vote against such a measure. The CBO scored this idea as reducing deficits by $473 billion but resulting in 32 million fewer insured by 2026.
There was some movement on Wednesday and Thursday from Republican Senators coming back to the table to try to bridge their differences, holding late-night sessions and receiving increased pressure from President Trump to revive the effort. Complicating matters for McConnell, however, was the sad news on Wednesday that John McCain (AZ) has been diagnosed with glioblastoma, calling into question his availability in the coming weeks. And with Collins almost 100% voting against any measure, McConnell cannot afford to lose any other Senators.
So, what now? Repeal now, replace later will not happen. Neither, it seems, will any version of the BCRA, although there is a faint light still flickering. The short answer is that Congress will likely now embark on a more bipartisan effort to address ways to stabilize the health insurance exchanges. However, exchange enrollment remains a relatively small percentage of the overall healthcare picture. The much more significant question is what to do with Medicaid, which represents 20% of the total population (as well as the topic that yielded the most disagreement among House and Senate Republicans). It therefore seems unlikely that this Congress will be able to get together on a sensible and workable Medicaid reform effort.
From a bigger picture standpoint, this process also raises serious questions about whether this Congress will be able to get together on tax reform, which McConnell will likely move on to in the next few weeks (barring a miraculous turnaround for healthcare). President Trump, Speaker Paul Ryan, and McConnell can all claim that tax reform was actually their top legislative priority, but the healthcare process exposed serious differences among the various factions within the Republican caucus. It is therefore unclear how the wishes of the pro-growth members promoting deep tax cuts will coexist with the deficit hawks espousing more modest cuts. And if they cannot come together on tax reform (although it is way too early to make that assessment), then what happens to the Republican majorities in the midterm elections next year?
We should know much more about the fate of healthcare reform next week, but it seems that attention will very quickly move to stabilizing the exchanges and finding alternate ways to improve the ACA at the margins. In the meantime, the Street’s focus can likely return more fully to fundamentals like pricing, utilization, and investment trends.

JNJ's Mixed 2Q Results Suggest Stable Ortho and Surgical Trends

Johnson & Johnson’s (JNJ) 2Q results were largely mixed, but they also provided important read-throughs to medtech, pharma, and consumer healthcare. For the quarter, total revenue came in slightly below the Street as Medical Devices were in line, Pharma missed slightly, and Consumer was a bit above consensus. Among the positives were Cardiovascular and Vision Care in Devices; Stelara, Prezista, Darzalex, and Xarelto in Pharma; and Oral Care and Beauty in Consumer. On the flip side, Diabetes saw another material shortfall, as did Remicade, Simponi, and Invokana.
Nevertheless, management did raise the lower end of 2017 revenue guidance, as well as the entire 2017 EPS guidance range, partially on better FX trends but also on improved stability in several key product franchises. There are still concerns about certain Pharma products in light of generic competition, but overall, most products were in line or above consensus.
On the medtech side, orthopedic trends appear relatively stable, suggesting that Zimmer Biomet’s (ZBH) pre-announced miss last week truly is a function of company-specific manufacturing and operational issues and not broader macro trends. Orthopedic pricing remained negative (as it has consistently for the last several years), but hip and knee volumes and mix were nicely positive, suggesting positive trends for Stryker (SYK) and Smith & Nephew (SNN). Spine sales were negative, although that could suggest further share losses, while positive general surgery results suggest strong utilization trends, which bodes well for companies like Medtronic (MDT), Intuitive Surgical (ISRG, see below), and SYK. The company also continues to explore divestiture options for its Diabetes business.

Earnings Review: Another Blowout for ISRG, Generally Solid Results All Around

Beyond JNJ, several other large companies reported this week, and results were largely positive. We review key reports below:

  • United Healthcare (UNH). 2Q revenue was in line with consensus, while better-than-expected medical loss ratio and operating margin brought EPS ahead of the Street by $0.08, encouraging management to raise the midpoint of 2017 EPS guidance by that amount. Optum growth impressed once again, with backlog up 19% year-to-date, and Medicare Advantage enrollment continues to exceed expectations. Headwinds from the exchange market could impact 2018, but management will address that on next quarter’s call.
  • Danaher (DHR). 2Q revenue was inline, while improved operating margin drove an EPS beat. However, core growth came in below expectations, led mainly by softness in Dental, suggesting continued secular headwinds in this segment that has experienced ongoing headwinds for several quarters now and possibly portending a challenging quarter for Dentsply Sirona (XRAY). The Life Science segment was in line with consensus, indicating broad stability in the Tools space.
  • Abbott Labs (ABT). A strong performance from the Medical Devices segment, particularly Neuromodulation and Diabetes, drove a top-line beat, while EPS also came in ahead (largely on favorable FX and tax rate, and management raised 2017 EPS guidance. The impact of Alere is still unclear, as that deal is supposed to close by the end of the third quarter, but it was apparent that the St. Jude integration is progressing well.
  • AthenaHealth (ATHN). 2Q revenue came in slightly ahead of the Street, while better gross margin and operating margin led to a significant EPS beat. Despite the upside, some analysts expressed concern over the relatively soft bookings number, although management reiterated full-year bookings guidance, and the fourth quarter is typically the company’s strongest bookings quarter.
  • Intuitive Surgical (ISRG). ISRG posted another solid beat and raise quarter, as both system sales and procedure growth topped analyst estimates. The system placement beat was particularly impressive given that the company received clearance for its new X system during the quarter, so there has not yet been any benefit from a new product cycle. Continued strength in US general surgery, notably hernia repair, drove the procedure growth upside and gave management comfort in raising 2017 procedure growth guidance from 12-14% to 14-15%. The new target implies a slowdown in the second half, and ISRG tends to be conservative in setting guidance targets, so the Street sees plenty of upside to that range.

In Other News: MDT Facing Challenging Quarter, VRTX Reports Stellar CF Data, PODD Going Direct in Europe, ARAY Pre-Announces In-Line Quarter

In an interview with Bloomberg, Medtronic (MDT) CFO Karen Parkhill on Monday disclosed that a company-wide computer outage last month caused a delay in certain product sales. While the problem has been resolved, it will likely push certain sales into the September quarter, although Parkhill did not quantify the lost revenue other than to reiterate that the company still expects fiscal first quarter revenue to be within its guided 4-5% growth range (albeit, toward the lower end).
In addition, Parkhill also noted that the company is experiencing a shortage of sensors for its MiniMed 670G closed-loop diabetes management system. The shortage will have no impact on existing customers as MDT is prioritizing its current installed base for its existing sensor inventory. Therefore, the issue should only impact new patient acquisition. The company is preparing a new manufacturing line to be in place by the fiscal third quarter, which suggests that 2Q diabetes sales could also be under pressure. The stock, therefore, struggled this week as investors determine whether MDT can post better results in the second half of its fiscal year. MDT reports 1Q results on August 22.
Vertex (VRTX) shares rallied this week after the company reported positive data from its Phase 1 and Phase 2 studies of its triple combination regimens for Cystic Fibrosis. The Street had been waiting on these data and now view the company largely as a de-risked story. Some analysts also pointed to VRTX as a possible M&A target in light of the orphan drug possibility and long-duration IP surrounding the CF franchise. VRTX is expected to pursue expedited commercialization in order to take advantage of its complete greenfield over the next few years.
Insulet (PODD) on Thursday announced that it is terminating its European distribution agreement with Ypsomed and will begin selling direct in July 2018 once the agreement expires. There will likely be a short-term margin hit as PODD ramps up spending to build a sales and marketing infrastructure, and there may also be some sales disruption. But over the long term, the Street sees a meaningful margin expansion opportunity and should help sales growth once the new sales team is in place and operating at full capacity.
Accuray (ARAY) on Monday pre-announced in-line order growth for its fiscal fourth quarter, although that is in line with expectations that management lowered materially on its third quarter call. While in-line pre-announcements are rare, the Street views the news as ARAY management’s attempt to allay potential concerns over the launch of Varian’s (VAR) lower-cost Halcyon system that could pose a further competitive threat to ARAY. The company will report its 4Q results on August 22.

The Week Ahead: Earnings, Earnings, Earnings

Looking ahead, earnings season continues in full force next week, with dozens of companies reporting results across all healthcare sectors. The table below provides a preview of the key companies reporting next week.

Earnings Release/Conf. Call June Qtr Consensus Revenue/EPS 2017 Consensus Revenue/EPS What to Look for on the Call
Biogen (BIIB) Tuesday BMO, 8:00am ET $2.81 billion /
$11.41 billion / $20.46 Color on the long-term multiple sclerosis franchise and progress on replacing CFO Paul Clancy
Waters (WAT) Tuesday BMO,
8:00am ET
$553.0 million / $1.71 $2.26 billion / $7.33 Color on the health of end markets and on opportunities to accelerate top-line growth and expand margins
Centene (CNC) Tuesday BMO, 8:30am ET $11.70 billion / $1.30 $46.86 billion / $4.79 Updated thoughts from last month’s Investor Day regarding exchange markets, Medicare Advantage, and M&A
Quest Diagnostics (DGX) Tuesday BMO, 8:30am ET $1.94 billion /
$7.69 billion / $5.57 Management color on Walmart partnerships and Cape Cod Health acquisition, as well as comments on overall utilization
Eli Lilly (LLY) Tuesday BMO, 9:00am ET $5.60 billion /
$22.14 billion / $4.12 A general pipeline update and thoughts on drug pricing trends
HCA Healthcare (HCA) Tuesday BMO, 10:00am ET $10.76 billion / $1.81 $43.36 billion / $7.36 Overall utilization trends, the impact of the failed reform effort, and capital deployment priorities (including M&A)
Amgen (AMGN) Tuesday AMC, 5:00pm ET $5.67 billion /
$22.67 billion / $12.47 Color on the reimbursement pathway for Repatha and an update on erenumab data
Express Scripts (ESRX) Tuesday AMC, 7/26 at 8:30am ET $25.41 billion / $1.71 $101.56 billion / $6.97 An update on the ANTM exit situation and commentary on the drug pricing environment
Universal Health Services (UHS) Tuesday AMC, 7/26 at 9:00am ET $2.86 billion /
$11.42 billion / $7.97 Commentary on utilization and reimbursement trends and an update on the UK investigation
Anthem (ANTM) Wednesday BMO, 8:30am ET $22.28 billion / $3.22 $88.75 billion / $11.78 Thoughts on the company’s post-ESRX PBM plans and M&A strategy following CI breakup
Baxter International (BAX) Wednesday BMO, 8:30am ET $2.59 billion /
$10.37 billion / $2.27 Color on Claris integration plans and M&A priorities going forward
Integra Lifesciences (IART) Wednesday BMO, 8:30am ET $283.6 million / $0.45 $1.13 billion / $1.92 An update on the Codman deal and organic growth opportunities from new product launches
Thermo Fisher (TMO) Wednesday BMO, 8:30am ET $4.92 billion /
$19.68 billion / $9.24 Progress on the PTHN acquisition and more color on the cross-selling opportunities
Lab Corp (LH) Wednesday BMO, 9:00am ET $2.47 billion /
$9.86 billion / $9.43 Updated thoughts on M&A strategy (targeting a CRO?) and UNH contract renewal status
CONMED (CNMD) Wednesday AMC, 4:30pm ET $194.5 million / $0.41 $777.0 million / $1.87 Update on AirSeal progress, as well as top-line acceleration and margin expansion plans
 Gilead Sciences (GILD) Wednesday AMC, 4:30pm ET $6.31 billion /
$24.55 billion / $8.16 An update on the Hep C franchise and pricing environment, as well as the HIV market opportunity
Edwards Lifesciences (EW) Wednesday AMC, 5:00pm ET $839.2 million / $0.88 $3.35 billion / $3.54 A closer look at US and O-US TAVR sales and commentary on coming BSX competition
Varian Medical (VAR) Wednesday AMC, 5:00pm ET $663.9 million / $0.95 $2.75 billion / $3.92 Commentary on early uptake of the new Halcyon system and what the US opportunity is
Vertex Pharmaceuticals (VRTX) Wednesday AMC, 5:15pm ET $486.7 million / $0.35 $2.17 billion / $1.64 See discussion above
Abiomed (ABMD) Thursday BMO, 8:00am ET $130.5 million / $0.42 $570.4 million / $1.84 Management color on the high-risk PCI opportunity and how to win greater acceptance of Impella via referrals
Boston Scientific (BSX) Thursday BMO, 8:00am ET $2.21 billion /
$8.88 billion / $1.25 Margin expansion progress and future opportunities as well as color on Lotus Edge
Zimmer Biomet (ZBH) Thursday BMO, 8:00am ET $1.95 billion /
$7.86 billion / $8.51 Commentary on CEO change and on turnaround progress, starting with resolution of manufacturing issues
Celgene (CELG) Thursday BMO, 9:00am ET $3.23 billion /
$13.19 billion / $7.28 Management color on the BeiGene PD1 collaboration agreement
Bristol-Myers (BMY) Thursday BMO, 10:30am ET $5.07 billion /
$20.32 billion / $2.95 Updates on Opdivo and Orencia as well as thoughts on the drug pricing environment
Align Technology (ALGN) Thursday AMC, 4:30pm ET $343.6 million / $0.73 $1.36 billion / $3.26 Color on what the teen market runway looks like and the broader O-US opportunity
Cerner (CERN) Thursday AMC, 4:30pm ET $1.30 billion /
$5.21 billion / $2.51 Other than Neal Patterson’s untimely passing, general color on hospital capex trends
NuVasive (NUVA) Thursday AMC, 4:30pm ET $262.2 million / $0.44 $1.07 billion / $2.01 Comments on sales force expansion plans and the LessRay and Modulus XLIF opportunities
Stryker (SYK) Thursday AMC, 4:30pm ET $2.98 billion /
$12.23 billion / $6.43 Color on the extent of market share gains in the wake of ZBH disruption and on NVDQ deal
Merck (MRK) Friday BMO, 8:00am ET $9.74 billion /
$40.04 billion / $3.85 Commentary on the FDA’s clinical hold on the three Keytruda studies
Hill-Rom (HRC) Friday BMO,
8:30am ET
$695.5 million / $0.91 $2.76 billion / $3.86 General color on the hospital capital spending environment
McKesson (MCK) Friday BMO, 8:30am ET $51.23 billion / $2.83 $205.43 billion / $12.11 Broad commentary on generic drug pricing trends and the overall pharmacy market, as well as updated M&A plans
AbbVie (ABBV) Friday BMO, 9:00am ET $6.93 billion /
$27.76 billion / $5.53 An update on Humira biosimilars and Imbruvica sales following JNJ’s results

We will review these earnings reports in next week’s edition. As always, we welcome all feedback, and have a great weekend!


Jeremy Feffer
Managing Member
Whalebone Advisory, LLC
T: 646.580.5583 | M: 917.749.1494
Copyright © 2017 Whalebone Advisory LLC, All rights reserved.

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