Recent setbacks for two of its most important pipeline projects, as well as a tougher pricing environment in key Western countries, will take a toll on Roche in 2010 and beyond, company executives told analysts during a half-year earnings call on July 22.

The company faces "stronger headwinds" because of the impact of U.S. health care reform and austerity measures by some European governments, CEO Severin Schwan warned analysts. "Finally, the financial crisis has arrived with the pharmaceutical industry," he said - a pointed remark coming from one of the industry's leading performers over the past decade.

"The market environment is getting more challenging and we have had these effects in our pipeline," said Schwan. "We cannot deny this reality. We have to proactively adapt to this reality. And that means a more rigorous focus on operational excellence on our cost structures, on further improving our operational productivities." Despite the business pressures, he insisted that Roche is "sticking to its guidance" for the full year, which aims for double-digit growth in its core earnings per share at constant exchange rates and mid-single digit growth in group sales.

The tough times - and the company's determination to maintain its margins - already are reflected in the company's performance for the first half of the year. Total sales were CHF 24.6 billion ($23.6 billion), up 5 percent year over year in local currency (excluding impact of exchange rate fluctuations). Pharma sales rose 4 percent to CHF 19.4 billion ($18.6 billion). That was well below the stream of high-single digit and double-digit growth rates of the company's previous boom years and largely due to a decline in Tamiflu , the generization of CellCept and the impact of health care reforms.

Pharma operating profit (before exceptional items) was up 9 percent to CHF 8 billion and margins rose from 39.1 percent to 41.3 percent. Net income for the group as a whole rose 37 percent to CHF 5.6 billion. The group's overall operating margins improved by 2.3 percent and its core earnings per share rose 11 percent, despite the challenges.

Sizing Up The Genentech Acquisition

To get there, however, the company had to undertake operational efficiencies, most of which, executives emphasized, it did quietly and without much elaboration on details. "We did not make a big announcement like many of our colleagues or peers in the industry, big restructuring announcement, but believe me, we worked very hard at those costs, and we have managed them and we will keep managing them very, very carefully," said Pascal Soriot, Chief Operating Officer of Roche's Pharma Division, adding "our commercial investment is stable and our R&D is not growing much." The category of selling, general and administrative expense, therefore, is declining, he said.

Because of its strong cash flow, Roche is able to buy back early $2.5 billion worth of the bonds and notes issued to pay for its $46 billion acquisition of Genentech, as the latest in a series of transactions that has reduced its debt for that transaction by a third.

Roche has been preparing for a tougher business environment, with the biggest evidence being its decision in July 2008 to buy out the portion of Genentech it did not already own. Roche had bought a majority share in Genentech in the 1990s, and increasingly depended on it to fuel its pharma growth. As Genentech became more successful its ranks swelled, so that by the time Roche bid for full control, it had almost as many employees as Roche's entire U.S. operations. In buying Genentech, Roche Chairman Franz Humer noted the two companies had "parallel structures in an environment that was getting more cost-conscious" (¹ Also see "Roche’s High Stakes Gambit For Genentech" - Pink Sheet, 28 July, 2008.).

Roche's appointment in April 2009 of Soriot, who had been head of its pharma commercial operations, as head of its Pharma Division was a sign of efforts to bring Genentech into Roche's fold (² Also see "Genentech Reorganization Signals Shift To New Model Under Roche" - Pink Sheet, 15 April, 2009.).

Indeed, synergies from the Genentech transaction are behind much of Roche's current cost-cutting plans. Executives were careful to assure analysts that the company is on track to cut CHF 800 million in costs this year and CHF 1 billion in 2011, although they would not disclose specific actions Roche has taken. They are also considering several cost-cutting scenarios in response to recent setbacks, which they will consider over the next few weeks or months.

And executives said the company is slightly decreasing its R&D spend - a move that analysts seemed to be looking for. "You are the only drug company on the planet that has been increasing R&D," said Jo Walton, an analyst with Credit Suisse in London. Andrew Baum of Morgan Stanley noted the huge number of Roche employees at ASCO this year in order to highlight the company's bloat. "Roche isn't necessarily the first company that springs to mind as being thin," he said.

Avastin, Taspoglutide Setbacks "Disappointing"

In part, executives' sober tone reflected recent troubles with clinical development programs for two key drugs, Avastin (bevacizumab) in breast cancer, and taspoglutide, Roche's first drug for type 2 diabetes, which is in Phase III clinical trials.

On July 20, FDA's Oncology Drugs Advisory Committee voted against recommending full approval for use of Avastin as first-line treatment in HER2-neu negative metastatic breast cancer patients, an indication that had been cleared as an accelerated approval. If FDA ultimately sides with ODAC, Roche will have to stop selling the drug for that indication in the U.S. The agency deadline for a decision is September 17.

And for taspoglutide, the hypersensitivity issues that arose during a Phase III trial mean a delay of 12 to 18 months in the regulatory filing, which Schwan called "a big disappointment" (³ Also see "Roche's Wildcard GLP-1 Not A Spoiler After All; Amylin Stock Soars On Taspoglutide Setback" - Pink Sheet, 18 June, 2010.). Pushing the filing from 2011, as Roche originally planned, to 2012 or 2013 will have an "immediate" impact on the U.S. pharma commercial structure, noted CFO Erich Hunziker. The metabolic and primary care sales organization that would support the drug currently consists of 750 reps, who also sell Boniva for osteoarthritis, Nutropin , and other older drugs. In addition, the company is looking at actions it might take with its European primary care commercial operations.

Still Reeling From The Avastin Panel Review

The negative vote from FDA's external advisors on Avastin is still a fresh wound, and on the earnings call (roughly 36 hours after the vote), Avastin Franchise Director Stefan Frings sounded off.

Accusing the agency of having "stacked the deck against Avastin by choosing voting members who were previously negative" on the drug, he also noted that the briefing booklet "honing in on medians and overall PFS {progression free survival], rather ignoring hazard ratios." And Roche, as the sponsor, he added, wasn't alone in its ire at the outcome: immediately after the vote, thought leaders contacted the company to say they "were rather appalled" by the committee's decision.

"This is not a Mylotarg situation," he went on, referring to Pfizer's recent decision to withdraw that drug for acute myeloid leukemia from the market because of excessive mortality. "There is no increased mortality and risk factors always point in favor of Avastin," he insisted, adding, "Avastin is a meaningful option for certain patients with negative breast cancer."

Soriot was more diplomatic, stating that the company "needs to work with FDA" to understand the relationships of PFS and hazard ratios and to have clear "expectations for rules of the game for all projects going forward." If the company loses the first-line breast cancer indication, it will lose its compendium listing and then insurance companies will have to decide whether to continue to cover the drug for that indication, so the impact on sales could range from zero to as much as $1 billion, executives said.

Soriot noted that an application for use of Avastin in second-line metastatic breast cancer, based on the RIBBON-2 study (a trial of Avastin plus chemotherapy for second-line therapy) is filed in the U.S. and is in the works in Europe. Overall, the company's oncology product line sales grew by 9 percent in the first half of 2010, driven by Avastin's 14 percent rise in sales and inroads in emerging markets. The drug has full approval for use in colorectal cancer and that indication is not affected by the ODAC decision, he said. Furthermore, it is well on its way toward adding an ovarian cancer claim - a setting with the potential of longer treatment duration. The first Phase III trial was presented at ASCO and the second trial, ICON7, will be presented in October (⁴ Also see "Another Phase III Study Supports Avastin Expansion To Ovarian Cancer" - Pink Sheet, 2 July, 2010.).

Despite the setbacks, the company remains committed to innovation, Soriot said. It filed for U.S. regulatory approval of the Herceptin follow-on T-DM1 in July as a BLA, which is "exciting," he noted, because in that category the drug, if approved, will have 12-year data exclusivity until 2023, which is beyond its patent expiration date in the U.S.

"Let me also point out in spite of these setbacks we do have one of the leading product pipelines in industry," he said, noting that Roche has more than 10 new NMEs and 30 line-extensions in late-stage.

- Wendy Diller ( ⁵ w.diller@elsevier.com )

Clinical Development Setbacks, Pricing Pressures Hit Roche

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