Sluggish Sales Among Device Giants Signify CRDM Market Slump? Gary Ellis knew it would be difficu

Sluggish Sales Among Device Giants Signify CRDM Market Slump?

Gary Ellis knew it would be difficult to avoid the subject. The rumors had been circulating for months, thanks to some shrewd Wall Street analysts, apprehensive cardiologists and to a large extent, a controversial article in the Journal of the American Medical Association (JAMA). The chatter continued throughout the first quarter of the year, then intensified in late April, just as Ellis was preparing to review with analysts the fiscal 2011 performance of Medtronic Inc.

During the rumor ramp-up, the pundits treated their hypotheses like fact, even though they had very little evidence to support their suspicions. What scant proof the postulates had came from the most recent earnings reports of the device industry’s heavy hitters, companies such as Boston Scientific Corp. and St. Jude Medical Inc., which showed spikes in gross profit or respectable earnings per share ratios but sinking pacemaker and implantable cardioverter defibrillator (ICD) sales. Analysts had long suspected that the U.S. cardiac rhythm disease management (CRDM) market was mired in a slump; they just needed someone to confirm it for them.

That someone was Ellis, the chief financial officer at Medtronic. Unlike his rivals at St. Jude Medical, Ellis verified the CRDM market’s downward slide during an April 29 conference call with analysts.

“We’ve clearly seen a dramatic slowing in the U.S. ICD market,” he said. “We estimate the U.S. ICD market decline in the high single digits, with declining procedural volumes driving the market slowdown. That’s actually continuing to be declining, and I think that’s clear in the marketplace. Most people have been seeing that and feeling that.”

Most companies have seen and felt it too, though it has been most painful for device firms that depend heavily on CRDM devices for profit. Medtronic, for example, reported a 5 percent drop in sales of its cardiac rhythm management products during fiscal 2011 (ended April 29). Sales fell to $5 billion from $5.26 billion in fiscal 2010, and each quarter in FY2011 paled in comparison to the previous year, with sales off by as much as 8.3 percent in the first quarter.

Pacemaker revenue and defibrillator sales were off as well, down 4.3 percent and 6.5 percent, respectively, compared with FY2010. The sales slide in these categories followed a similar path to the quarter-by-quarter performance of the unit as a whole—pacemaker sales, for instance, slipped most precipitously during the first quarter (ended July 30, 2010), diving 11.7 percent to $473 million, according to Medtronic’s fourth-quarter and full-year earnings report. Defibrillator sales tumbled steadily as well, falling most significantly during the fourth quarter to $760 million, a 13.7 percent drop compared with the fourth quarter of fiscal 2010. The quarterly comparison included a bump from the massive ICD shipment hold that affected Boston Scientific in early 2010. Excluding the effect of that shipment hold, ICD revenue at Medtronic was down 8 percent on a constant-currency basis.

The slumping CRDM market appeared to deteriorate more rapidly in the United States over the last fiscal year, accelerating significantly during the first three months of 2011. Ellis attributed the speedy descent of the U.S. market to a variety of factors, including a January JAMA article that questioned the need for ICDs. The story cited a study that showed 22.5 percent of patients typically fall short of the medical guidelines necessary to receive the $25,000 devices. The findings did not determine a reason for such a high rate of non-compliance with the guidelines, but author Sana M. Al-Khatib, M.D., offered an explanation to The New York Times, blaming the failure on physicians’ lack of knowledge and awareness of Medicare’s National Coverage Determination criteria. Such ignorance—as startling as it is sobering—certainly contributed to weak demand for ICDs in the first three months of 2011, but other factors in place long before the JAMA article was published very well could explain lower device sales last year. One such factor was an investigation by the U.S. Justice Department into hospitals’ ICD billing to Medicare; another was the government’s prosecution of St. Jude Medical for allegedly paying kickbacks to entice doctors to implant the company’s pacemakers and defibrillators (the St. Paul, Minn.-based firm agreed in January to pay the government $16 million to resolve the allegations).

“There appears to be several factors affecting procedures, but our field checks indicate that primary drivers are the January JAMA article on ICD utilization and the DOJ (Department of Justice) investigations of hospitals,” Ellis conceded to analysts during his conference call. “We clearly have seen slowing implant rates across the marketplace. As a result of that, hospitals were clearly looking at their inventory levels. We were doing the same thing.”

Many companies looked more closely at their inventory levels over the winter as hospitals took a more cautious approach to ICD implantations. The drop in demand resulted in fewer bulk orders for companies such as Medtronic—Ellis claimed the total value of defibrillator deals in the fourth quarter was $30 million to $40 million below the levels of previous quarters. Though it was a sizeable loss—the Minneapolis, Minn.-based device manufacturer depends on cardiac rhythm management products to generate nearly one-third of its total yearly revenue—Ellis and other executives insisted that the shortfall is a temporary one.
During his dialogue with analysts, Ellis called the loss a “one-time item” that only would recur if the CRDM market further deteriorates (which is quite possible, considering the federal government is not yet finished with its investigation of hospitals’ ICD Medicare billing).

Boston Scientific, however, is not convinced. Spooked by the softness in its CRDM business and reports from cardiologists about eroding procedure volume, the Natick, Mass.-based company took a nearly $700 million hit during the first quarter, ended March 31. Executive vice president and chief financial officer Jeffrey Capello dubbed the write-down a “goodwill

balance” and said the decision to write off such a massive amount of potential revenue was based on management’s assessment of the market’s future, including all the various players.

“As we watched the quarter unfold and checked the market, we saw a softening of the rate of implants that had us go back and look at our assumptions that we’d done a year ago,” Capello told analysts during an April 21 earnings conference call. “As a result of some of these [pressures], which we believe are temporary…we reduced our expectations for the next couple of years relative to [Cardiac Rhythm Management (CRM)] growth. After which point, we believe that these temporary pressures will leave based on the fact that the technologies underpenetrated the market and they come back to more normal growth.”

In the meantime, Boston Scientific executives will have to modify their expectations for the company’s CRM division. First-quarter sales were off by 8.4 percent and worldwide pacemaker revenue fell 4 percent, according to the company’s Q1 earnings report (which, incidentally, contained some creative comparisons with the same period in 2010). For the most part, worldwide ICD sales rose minimally during the first three months of the year, climbing 4 percent to $559 million. Global defibrillator system sales also increased, jumping 7 percent to $417 million. However, a closer look at Boston Scientific’s numbers reveals that the firm benefited more from a favorable comparison than a strong performance.

Near the end of Q1 2010, the company abruptly stopped all shipments and pulled the field inventory of its ICDs and cardiac resynchronization therapy defibrillators after discovering that it missed two U.S. Food and Drug Administration filings. The move cost the company an estimated $72 million in sales as well as precious market share during that quarter. Boston Scientific, however, did not include the $72 million in its Q1 2010 tally for global ICD sales. Doing so would have pushed the total to $610 million and forced executives to concede that sales were down considerably this year.

To avoid such a confession, executives touted the company’s first-quarter

performance to analysts and downplayed both the seriousness and longevity of the CRDM market slump. “We expect this market to decline in mid-single digits in the near term, but return to flattish growth medium-term,” Boston Scientific President and CEO Ray Elliott predicted. “Pricing pressure continues to be a challenge, but we are now also seeing evidence of weakening in plant volumes in the U.S. We believe physician reaction to JAMA study results in early January and the DOJ and local inquiries into ICD implant appropriateness of use is contributing, but we don’t believe they will be long-lasting.”

Elliott’s rivals at St. Jude Medical share his rosy outlook for the CRDM market, though they contend that the sector will experience minimal growth this year. And for good reason: Worldwide sales of the company’s ICDs were up 3 percent in the first quarter (ended April 2) to $465 million, and total cardiac rhythm management revenue—which includes proceeds from the firm’s ICD and pacemaker product lines—climbed 1 percent to $762 million. U.S. pacemaker sales climbed 2 percent to $131 million, though that increase was offset by a 3 percent slide in international pacemaker sales during the first quarter.

St. Jude Medical executives claim the increases in CRM sales prove the market quickly shook off any lasting impact of the JAMA article and federal investigations of ICD Medicare billing.

“Those issues are very small issues with little impact on the global CRM market. When you look closely at the percent of available population that is potentially impacted by the JAMA article, it amounted to just a very small percent of the total opportunity and really was not material on a total global basis,” St. Jude Medical Chairman, President and CEO Daniel J. Starks told analysts during an April 20 earnings conference call. “We expect the CRM market to continue growing in 2011 at about the rate it grew in 2010. We calculate that the global CRM market in 2010 grew about 2 percent. So we expect the global CRM market to continue growing at a lowsingle-digit rate in 2011.”