Why the surprise, though? Investors have wanted to believe the impossible. Long accustomed to witnessing J&J executives repeatedly demonstrate impressive skills for managing financial results as needed, Wall Street seemed to assume they would have the same ability to make ‘facts on the ground’ go their way. Of course, tearing down and then rebuilding a key manufacturing plant is not the same thing as shifting numbers on spreadsheets. There are very different dynamics at work.
Here is a simple analogy that, more or less, sums up the situation that J&J has been facing at its infamous plant. Since we are big fans of The Food Network, we ask you to imagine a very comfortable, but dilapidated kitchen. Over the years, some wonderful dishes were cooked there, but eventually, those yummy meals began to taste anywhere from bland to yucky. There were funny smells. The presentation began to resemble a greasy diner. And once in a while, your stomach reacted very badly.
To fix the problem, you decide the time has come for a new kitchen – a genuine culinary teardown is in order. In its wake is a gorgeous cookery that looks ready for an Iron Chef showdown. But a thorny issue remains: despite the cost and effort you undertook, some of the same recipes are being used. This means having to go back and re-examine both the processes and equipment to sort out the cause before you can comfortably resume making those tasty meals again.
Of course, this oversimplifies the situation. A huge manufacturing plant that makes OTC medicines is obviously a more complicated beast than a kitchen, even one that is state of the art and used for making the finest meals for the most demanding crowds. But rebuilding an entire plant, which is what J&J is doing, takes enormous effort. And technology transfer is an imperfect science, especially if the underlying processes were problematic in the first place.
Now, many investors can intuitively appreciate and understand this sort of situation. But even those familiar enough with manufacturing regulations to grasp the subtleties and complexities involved are inclined to take the J&J management team at their word. Unfortunately, the executives at the health care giant demonstrated what can only be considered corporate hubris — better known as chutzpah, where we come from — when they suggested some months ago that the plant would be back on track much sooner.
However, the J&J executives are not the only team to recently disappoint investors with such miscues. A very similar problem is playing out in Lincoln, NE, where Novartis is struggling with a troubled manufacturing plant of its own. Although the effort falls short of a complete teardown and retooling, the Swiss drugmaker suspended production and recalled numerous OTC and animal health meds after suffering embarrassing quality-control gaffes and regulatory reproaches. In addition, a pharma company that had its pain meds packaged by Novartis at that site had to bring capacity in house and look for another contractor to meet demand.
In announcing the shutdown last January, the Novartis team attempted to downplay the ramifications by maintaining the combined annual sales of the products made at the facility amounted to less than 2% of Novartis group sales overall. In other words, this was the proverbial drop in the bucket and not worth getting alarmed about. But one Wall Street analyst was not so sanguine and estimated that lost sales could amount to $560 million over the ensuing 12-month period.
It turns out that forecast could be modest. In the first quarter, sales of consumer health products — which include OTC items and animal health meds made in Nebraska — plunged 20% to $932 million. In real dollars, sales fell by $237 million. Now, multiply that figure by four quarters and you have $948 million in lost sales for 2012. Of course, this is a rough estimate, but you get the idea. Such concerns helped drive Novartis stock down on the day that earnings were released.
Wait, you say! The Novartis team has indicated that some shipments should resume in May, albeit slowly. If accurate, the sales hit should not reach such depths, correct? However, the Novartis executives also acknowledged that a contract was signed with a third-party manufacturer to boost supplies. One does not need to read tea leaves to understand the possible implication — the internal fixes are taking longer than planned. To what extent sales can be recovered remains to be seen.
If this sounds somewhat familiar, it should. Yet another drugmaker falls behind schedule in restoring a fallen plant and investors act with surprise. The parallel to J&J is, unfortunately, rather plain. In both cases, management either offered overly optimistic assessments for returning to something that resembled normal production or they simply pooh-poohed the potential fallout. And in both cases, investors wanted to believe them.
Those with real shirtsleeves manufacturing experience, however, know better. Retooling a plant takes time and lots of money, too. A small army of consultants, for instance, has been shuffling in and out of the Fort Washington plant that J&J hopes will one day go back online. Similarly, our sources say that Novartis has retained consultants for the same reasons, although a spokesman has denied their presence is anything other than routine.
Investors, however, should brace themselves for still more surprises. Why? There is another unknown beyond the predictable delays and setbacks that can occur when a troubled plant is given a makeover. And that other unknown is the FDA. Just because the J&J and Novartis execs are willing to offer predictions about resuming production does not mean — at all — that the agency will bestow the expected blessing at the hoped-for moments.
Remember that J&J is already operating under a consent decree, which means regulatory scrutiny will likely be painful. The health care giant is not only a big prize, but the FDA has reason to lean heavily on the Fort Washington plant after being harshly criticized by some members of Congress for going too easy a couple of years ago on a J&J plant in Puerto Rico, which also contributed to the series of product recalls of such venerable over-the-counter meds as Tylenol.
And while all the attention given Novartis has to do with its woes in Nebraska, the FDA is actually picking through several of its other plants as well. Last fall, the agency sent the drug maker a warning letter for “significant violations” at two other US plants — Broomfield, CO and Wilson, NC — as well as a Sandoz plant in Boucherville, Quebec, in Canada, which has since halted some production. The FDA has also spent time recently at a Novartis plant in Suffern, NY, but hasn’t issued any citations yet regarding that site.
Such moves are all part of the new get-tough approach at the agency, which is still defensive over the heparin scandal four years ago. Slapping J&J with a consent decree was expected. But inspecting multiple Novartis plants almost simultaneously suggests the FDA is taking a holistic view of production practices — and this places added pressure on the management team. Investors should be advised to be very conservative in assessing any further managerial predictions.
More to the point, the execs at J&J and Novartis would do well to put aside the hubris. They may be adept at financial engineering, but giving the wrong impression about the extent of manufacturing problems — and what it will take to fix them — is disingenuous, if not irresponsible. Like it or not, they live in a new reality, one in which manufacturing problems are being taken ever more seriously and will require considerable effort to remedy.
There is an old saying, “Fool me once, shame on you, but fool me twice, then shame on me.” Investors have now been fooled twice (albeit by different companies). But these well-publicized miscues should serve as a warning about the braggadocio behind optimistic forecasts. And executives need to be more realistic. They simply cannot engineer their way out of every problem. Many investors will know better next time.
Ed Silverman is a prize-winning journalist who has covered the pharmaceutical industry for The Star-Ledger of New Jersey, one of the nation’s largest daily newspapers, for more than 12 years. Prior to joining The Star-Ledger, Ed spent six years at New York Newsday and previously worked at Investor’s Business Daily. Ed blogs about the drug industry at Pharmalot, at www.pharmalot.com. He can be reached at email@example.com.