Can Novartis JAK Up Incyte's Profitability?

Paul Friedman, chief executive of Incyte, believes that a newly-inked collaborative and licensing deal with Novartis for INCB18424, an oral JAK1/JAK2 inhibitor entering late-stage development for the blood disorder myelofibrosis, could drive the company to first-time profitability. Although early clinical evidence suggests that regulating cell signaling through this cytokine pathway may provide therapeutic benefits, the company still has to clear FDA and European regulatory hurdles before declaring any transformative victory.

Excessive signaling through the janus kinase (JAK) pathways is believed to play a critical role in a number of disease states, including myeloproliferative disorders, other cancers, and inflammatory conditions such as rheumatoid arthritis and psoriasis. Incyte has discovered multiple potent and orally available JAK inhibitors that are selective for JAK1 and JAK2.

Incyte's lead JAK inhibitor, INCB18424, is being evaluated in two international trials, COMFORT-I and COMFORT-II. The primary endpoint will benchmark the demonstrated reduction in spleen volume (greater than 35 percent) in subjects with primary myelofibrosis (MF). Although exact etiology is unknown, it is believed that the JAK2 protein (either mutated or not) stuck in the "on" position is the pathogenesis behind MF and other myeloid malignancies. An abnormal proliferation of blood cells in MF patients clinically manifests as an enlarged spleen and bone marrow scarring.

Under terms of the agreement, Novartis will make an upfront payment of $150 million to Incyte plus an immediate $60 million milestone payment for the initiation of the European Phase-3 trial (COMFORT-II). Consequently, Novartis will retain responsibility for the future development and commercialization of INCB18424 in all hematology-oncology indications outside of the US, with potential milestone payments up to $1.1 billion (followed by royalty streams, post-approval).

In addition to capital infusions, the deal is a logistical win for Incyte. The Swiss drug maker has extensive know-how and experience with the development and marketing of protein kinase inhibitors for blood cancers, including: (1) Gleevec (imatinib), the preferred treatment for newly diagnosed patients with chronic myeloid leukemia (CML); and (2) Tasigna (nilotinib), a next-generation tyrosine kinase inhibitor, approved for CML-patients resistant to Gleevac or other prior blood cancer treatments.

Incyte retained exclusive rights for the development and potential commercialization of INCB18424 in the US. With more than 100,000 patients suffering from MF or related disorders, on the surface this looks like a sound commercial strategy. Think again -- although the company had about $361 million in cash available as of November 5, no revenue stream currently exists to fund in-house development.

To borrow a lyric from Barney the Purple Dinosaur, "if raindrops were lemon drops, oh what a rain that would be!" A look at recent SEC filings, including the most recent third-quarter 10Q, soured me on the notion that Incyte has a viable strategy to become a leading drug discovery and development company of novel small molecule therapies. Its drug product pipeline for inflammatory, diabetic, and cancer-related diseases consists mostly of compounds in early stages of development.

With an accumulated deficit of $1.3 billion sitting on its balance sheet, Incyte knows first hand the financial risks that coincide with navigating a small molecule compound from proof-in-principle and clinical trials to FDA approval and commercial viability:

• Demonstrated efficacy for its high-affinity nicotinic acid agonist, INCB19602 (or HM74a), in lowering fasting plasma glucose levels in type II diabetics was inconclusive.
• INCB19602 is being benched in favor of an inhibitor of 11-beta HSD1, INCB13739. In a dose-ranging study of 300 patients with refractory type-2 diabetes taking metformin, the addition of INCB1379 resulted in clinically significant improvements in glycemic control. Unfortunately, with an unwieldy $635.6 million in long-term debt sitting on its balance sheet, Incyte will need a partner to finance further study of this drug.
• Dexelvucitabine and the chemokine CCR-5 antagonist INCB9471 -- two erstwhile investigational treatments for HIV,: the former was discontinued after an observed higher incidence of elevated pancreatic enzymes in drug-treated patients; the latter was shelved in April 2008 so the company could shift scarce research dollars to its promising JAK inhibitor program.

Share count, which has climbed 41 percent to 118 million in the last two years, is expected to head higher. Management admitted in its earnings filing that should stakeholders look to convert the recently offered 4.75 percent senior notes, the 92 million shares still reserved in its treasury is not a sufficient number for issuance upon demanded converted. Talk about dilution -- executives are asking shareholders to approve a resolution to increase the number of authorized shares from 200 million to 400 million.

Those folks who "felt a thrill going up their legs" (with apologies to MSNBC's Chris Matthews) upon hearing news of the Novartis deal might want to recheck the pulse of peripheral circulation. Back in November 2005 the same chief executive Friedman trumpeted a potential $803 million deal that gave Pfizer exclusive global development and commercialization rights to Incyte's portfolio of CCR-2 antagonists compounds. This well went dry after Incyte pumped out $40 million in payments from Pfizer.

Cash flow from operations was negative $106.2 million for the nine-months ended September. Although I believe INCB18424 holds significant promise -- and could likely be first in class to hit the market -- there is no way in any bubble universe that Incyte can reach its dream of becoming the next Gilead Sciences. The large amount of debt and debt service obligations will likely force the company to sell off stateside commercial rights of INCB1824 for (at a minimum) myeloproliferative disorders in the next 12 to 18 months.