J&J 1Q14 – Unprecedented 32% decline in US Diabetes Care; continued strong Invokana growth, diabetic nephropathy indication under investigation – April 15, 2014

This morning, Johnson and Johnson CEO Alex Gorsky led the company’s 1Q14 financial update. We’re bringing you our top five learnings from the call, including financial and pipeline updates for both Diabetes Care (LifeScan BGM and Animas insulin pumps) and Invokana (canagliflozin). Diabetes Care continued its sharp declines in the US (falling an unprecedented 32%), somewhat tempered by better performance internationally (up about 1%). This was the eighth straight quarter with a worldwide decline in Diabetes Care sales.

The 1Q14 story for J&J’s SGLT-2 inhibitor Invokana was much cheerier, with sales reaching roughly $89 million (based on our estimates) in Invokana’s fourth full quarter on the market. This represents very positive sequential growth from our $40-75 million estimate for Invokana in 4Q13 and the slope of the increase makes us think J&J should be in good shape to achieve $500 million in sales in 2014. Management announced that Vokanamet (Invokana/metformin IR fixed dose combination) has been re-submitted to the FDA (following its previous CRL) and that the new PDUFA date is August 2014. The company also reiterated Vokanamet’s positive CHMP opinion from February 2014.

Perhaps most notably for patients, J&J is officially investigating Invokana for diabetic nephropathy; while management did not comment during the call, the drug is now listed as phase 3 for diabetic nephropathy on the company’s pipeline. We speculated that this might have been possible after the company initiated the CREDENCE renal outcomes trial for Invokana in February, and it is extremely exciting to see the company actually move in that direction since diabetic nephropathy remains an area of profound unmet need (when the once-renowned Reata’s phase 3 trials failed, it was a very depressing day).

Our report on the top five highlights from this morning’s call contains more detail on each of the aforementioned points, along with a comparison between J&J and Roche’s financial results in Diabetes Care (Roche also reported this morning and fared better than J&J), more on Invokana’s market share, an SGLT-2 inhibitor competitive landscape, and overviews of J&J’s diabetes device and drug pipelines.

Top Five Highlights

1. Worldwide Diabetes Care (LifeScan/Animas) revenue totaled $512 million in 1Q14, declining 15% as reported and declining 14% operationally year-over-year (YOY). This marks the eighth consecutive quarter in which worldwide sales have declined. This quarter was also the largest worldwide decline (-15%) observed over that time period (4Q13 was the second largest, when quarterly revenue decreased 13% as reported and 12% operationally). Sequentially, worldwide Diabetes Care sales declined 9%, compared to a 1% sequential rise in 4Q13.

• US Diabetes Care 1Q14 revenue dropped an unprecedented 32% YOY and 12% sequentially, with sales reaching just $192 million. This is the greatest US decline we have seen since Close Concerns began covering J&J in 2002 and since 1998 when Kelly wrote about J&J during her Wall Street equity research years. We do note however, that the quarter’s 32% drop was from a shrinking base of $219 million in 4Q13, making it easier over time to show greater percentage declines. Still, the $192 million in sales was a shockingly low figure – for context, the lowest US sales figure in our model is $274 million, dating all the way back to mid-2005. This was even more surprising in light of January’s launch of the OneTouch VerioSync in the US. Management continues to attribute the US declines to price decreases from competitive bidding (effective July 1, 2013).
• International Diabetes Care performed somewhat better, with 1Q14 revenue totaling $320 million, up 0.9% as reported and up 2.9% operationally. The comparison to 1Q13 growth was on the easier side – international Diabetes Care growth was down 0.3% in 1Q13 (and grew 0.9% operationally). Sequentially, international revenue declined 7%, consistent with the 9% sequential decline in 1Q13 and the 7% decline seen in 1Q12 (likely related to seasonality).
• Roche also reported 1Q14 financial results today, faring much better than J&J in the US. Indeed, Roche’s North American revenue grew 6% (13% operationally), compared to J&J’s 32% decline in the US. By contrast, J&J has the edge internationally, with modest 0.9% reported growth vs. a 1.6% reported decline for Roche. Of the combined worldwide revenue for J&J and Roche in 1Q14, Roche held 54%, up from 49% of the companies’ pooled revenues in 1Q13. By our estimates, J&J and Roche held the majority of the BGM market in 2013 (~65%-67%).
• The poorer-than-expected showing in LifeScan/Animas raises the question how the rest of 2014 will look. Whether the diabetes unit will achieve over $2.0 billion in sales for 2014 is a question when thinking about annual results (which were $2.3 billion in 2013 and $2.6 billion in 2012 and 2011), although we believe the knowledge on diabetes from this business has been of major significance to Janssen’s Invokana; too, J&J has certainly shown commitment to and strong interest in diabetes historically. We do believe the company must be considering additional models, and though we did not hear about any on the call, we certainly would expect to hear more about different delivery models going forward.

Table 1: 1Q14 Roche and J&J Diabetes Care Revenue Comparison

Currency conversion for Roche based on average exchange rate on oanda.com (e.g., 1.1200 USD per CHF for January 1 – March 31). Different results are possible with different currency conversion. Roche does not report revenues for an international category, and the international value we report includes the company’s EMEA and RoW categories; as such, operational growth is not available. We also note that Roche’s US value is slightly inflated, as it includes revenue from Canada (“North America” sales). Reported growth for Roche is calculated based on CHF.

2. Management reemphasized in today’s Q&A that the Diabetes Care business continues to remain an integral part of J&J’s portfolio (despite the continued struggle in the US BGM market), as it strategically complements the company’s Invokana business. As J&J has consistently said (see our 4Q13 report), its broad approach to portfolio analysis is for a business to be either number one or two in its competing category, to have a clear plan of action to propel itself into these top two positions, or to have a business complement one of its other businesses. The third approach seems to be the bucket into which LifeScan/Animas falls – in today’s Q&A, management partially attributed Invokana’s successful launch to LifeScan/Animas and reps’ strong relationships with endocrinologists. Management also noted during today’s Q&A that despite significant pricing pressure in the US, its Diabetes Care business continues to be “a market leader” and holds strong market positions in the US, as well as continuing to show growth internationally. Of course, the Diabetes Care business’ complement to Invokana growth is likely the weightier factor for its continued position in the J&J portfolio. Of course, the “market leader” status of the US business unfortunately continues to decline by the quarter.

• J&J has an upcoming medical device business review coming on May 22, and we look forward to hearing management’s thoughts on the future of the Diabetes Care business, especially what is happening with the Finesse bolus-only insulin delivery device (additional studies were expected to start in 2013).

3. We estimate US sales of the SGLT-2 inhibitor Invokana (canagliflozin) were ~$89 million in 1Q14. Management said that Invokana contributed about 2.5 percentage points to overall US pharmaceutical growth in 1Q14 (which was 7.7%). By our calculations (and assuming that values from 2.25 to 2.75 would be rounded to 2.5), this gives a range of $80-$97 million for 1Q14. This appears to be a healthy rise from our estimates of $45-75 million in 4Q13, the first quarter that J&J gave an indication of Invokana’s financial performance. The first quarter of 2014 was Invokana’s fourth full quarter on the market.

• Invokana has now achieved 2.1% of total prescription (TRx) share in the US diabetes market (excluding insulin and metformin), up from 1.5% in 4Q13. Management did not report progress in NBRx (new to brand prescription) share, which it had reported in the past. TRx with endocrinologists (presumably in the same market of diabetes excluding insulin and metformin) grew to 6.6%, up more than 1% sequentially (exact value for 4Q13 not provided).
• As a reminder, Invokana was approved in Europe in November 2013. J&J has not specified whether the drug has launched in any European countries, and on today’s call, J&J did not break out international sales for the drug. During J&J’s 4Q13 financial update, management expected Invokana to launch in Germany and the UK in 1Q14. We would not expect that sales in either of these countries to be particularly strong given payers’ stringent expectations for showing benefit over generics (indeed, AZ withdrew its SGLT-2 inhibitor Forxiga from Germany in late 2013 due to the German Federal Joint Committee’s ruling that Forxiga showed no benefit over sulfonylureas, thus subjecting it to generic-level pricing). That said, we might be wrong about the UK given that this is a compound with a very favorable combination of effects, including good A1c drop, weight loss, no hypo, no nausea, etc. – while clearly some side effects of Invokana limit the drug for some patients, these side effects seem relatively easy to identify so patients can ascertain whether or not the drug will “work” for them. Ultimately, we think the drug could be positive on an adherence front, which is definitely important in the single-payer UK system. 
• Invokana will likely feel pressure from other entrants into the SGLT-2 inhibitor market although it was wonderful for J&J to get started early with their first-in-class compound in the US. AZ’s Farxiga (dapagliflozin) was approved in the US in January 2014 (and was already approved in Europe under the tradename Forxiga in November 2012 ahead of Invokana). Lilly’s empagliflozin is probably not too far from the market either – while it received a CRL from the FDA in March 2014, it received a positive CHMP opinion shortly thereafter. The FDA CRL cited issues at BI’s manufacturing plant in Germany so, presumably, it should be fairly straightforward to address (although the timeline is not yet clear). Other earlier stage SGLT-2 inhibitors in development include Pfizer/Merck’s ertugliflozin (phase 3), Astellas/Kotobuki’s ipragliflozin (approved in Japan; development program discontinued in the US and EU for commercial reasons), Taisho’s luseogliflozin (submitted in Japan), Islet Pharma/BHV Pharma/Kissei’s remogliflozin etabonate (phase 2), Theracos’ EGT0001442 (phase 2), Lexicon’s SGLT-1/SGLT-2 dual inhibitor LX4211 (phase 3 initiation for type 2 diabetes was expected in 2013, but Lexicon has yet to partner; phase 2 type 1 diabetes data shared yesterday), and Novartis’ SGLT-1/SGLT-2 dual inhibitor LIK066 (phase 2).

4. Management announced that Vokanamet (Invokana/metformin immediate release) was resubmitted to the US FDA in February 2014 with a PDUFA date in August 2014; management also reiterated Vokanamet’s positive CHMP opinion (as announced in February 2014). As a reminder, Vokanamet originally received a complete response letter (CRL) from the US FDA in December 2013. The FDA requested data demonstrating that the twice-daily dosing regimen of Vokanamet was comparable to that of the once-daily dosing of the approved Invokana single agent (since metformin immediate release [IR] is a twice-daily therapy, Invokana/metformin IR FDC must be dosed as a twice-daily combination). J&J is also working on an Invokana/metformin extended release (XR) FDC that would allow for once-daily dosing; that agent remains in phase 3.

5. J&J’s pharmaceutical pipeline now lists Invokana as phase 3 for a diabetic nephropathy indication. We suspected that pursuing a nephropathy indication would have been possible after J&J’s initiation of the CREDENCE renal outcomes trial, and it is exciting to see that the company is indeed trying to move in this direction. An indication for diabetic nephropathy would confer great differentiation to Invokana over other SGLT-2 inhibitors, though with CREDENCE’s primary completion date of February 2019, the indication may not come for quite some time. To our knowledge, there are no other SGLT-2 inhibitors under investigation for a nephropathy indication, but the theorized mechanism would suggest that any renal-protective benefits of Invokana could be a class effect (more details below).

• In February, upon initiation of the CREDENCE study, we had the opportunity to interview the canagliflozin compound development leader at Janssen, Dr. Norman Rosenthal. He walked us through the rationale for why one might believe that SGLT-2 inhibitors could be renal-protective. It has been hypothesized that SGLT-2 inhibitors may act directly on the kidneys in a manner independent of glycemic control. In Invokana's phase 3 program, the company saw a remarkable ~50% reduction in urinary albumin/creatinine ratios in the ~1,000 patients with renal impairment (to boot, 80% were already on an ACEi or ARB therapy). For comparison, the angiotensin receptor blocker (ARB) losartan (a blood pressure drug that is one of the current standard-of-care choices for chronic kidney disease patients) led to a 39% reduction in urinary albumin/creatinine ratios in clinical testing. Investigators have yet to conclude what the exact mechanism might be, but a leading hypothesis is that canagliflozin decreases intraglomerular pressure and hyperfiltration by increasing filtrate sodium levels and mediating vascular changes in glomerular efferents and afferents. Other possible mechanisms could involve Invokana's effects on blood pressure, uric acid, or atrial natriuretic peptide. For more details on CREDENCE’s trial design and the proposed mechanisms for SGLT-2 inhibitor renal-protection, please read our report on CREDENCE’s initiation, which includes our interview with Dr. Norman Rosenthal.
• Diabetic nephropathy remains an area of great unmet need. The current standard of care involves use of blood pressure-lowering agents and careful glycemic control. No current treatments can reverse kidney damage, so the fact that Invokana may actually improve kidney function is highly significant.

Pipeline Summaries

Table 2: J&J Diabetes Device Pipeline

Table 3: J&J Diabetes Drug Pipeline

• J&J also has several preclinical candidates developed through its partnership with Metabolex, created through its own discovery program, or licensed from Evotec AG and Harvard, including Dr. Douglas Melton’s potentially ground-breaking betatrophin for type 1 diabetes. As a reminder, J&J also entered into a partnership with NGM Biopharmaceuticals in 2013 to develop treatments for type 2 diabetes that mimic the glucoregulatory effects of metabolic surgery, and J&J has the option to acquire Vascular Pharma’s VPI-2690B pending completion of phase 2 (no trials have begun yet). VPI-2690B is a monoclonal antibody against the αVβ3 receptor that inhibits IGF-1 mediated smooth muscle cell proliferation stimulated by hyperglycemia, which could mitigate the effects of prolonged hyperglycemia in the kidney.

Questions and Answers

Q: You have a pretty robust late-stage pharmaceutical pipeline; I count six phase 3 products right now. Could you talk about the key pipeline milestones that we should look for in 2014 on the pharmaceutical side?

A: … For the diabetes pipeline, a significant number of abstracts showings have been scheduled for Invokana. At this point we can’t cite specific conferences because these abstracts haven’t been published yet. Additionally, one to watch for the coming year is the different six-dose combination for Invokana.

Q: I believe you recently had a complete response letter on the fixed dose combination with Invokana. What has changed in terms of your view as it sounds like you’re a bit more confident on getting approval this year? Was there additional data?

A: For the US, we actually resubmitted the response to the complete response letter in February and we have PDUFA data in August. We also did get recommendation for a fixed dose combo in Europe.

Q: With the sale of diagnostics, it’s hard not to reflect on the rest of the portfolio and look for other underperformers and diabetes quickly comes to mind. Could you talk about the diabetes outlook? What changes should we look for as we get past the price cut anniversary and are you taking a harder look at underperformers like diabetes? Do you need to be in this business longer term for the rest of the franchise? Or is [Diabetes Care] something that you might carve out at some point?

A: For diabetes overall and our approach to portfolio analysis, we’ve been very clear about some of the criteria we use to analyze the portfolio. One criteria is, are you number one or two in your market? Or secondly, do you have the capacity, technology, new products, etc. that could propel you to that number one or two spot? Or lastly, are you complimentary to any of our other businesses? So with respect to diabetes, despite the significant pricing pressure in the market overall that all companies have faced, our diabetes business is a market leader, has very strong market share positions, and is doing very well outside the US (it continues to grow nicely), and also is very complimentary to other parts of our business.

We attribute the successful launch of Invokana partly to the fact that we have very good relationships with endocrinologists as a result of our LifeScan business. So at this point we haven’t made any decisions with respect to other portfolio choices. But the diabetes business is well positioned overall in the marketplace and it is complementary to a significant part of our other business.

Q: In regards to the breakout of Invokana sales, can you add any color either on the actual sales or how much it contributed to growth?

A: As noted in the prepared remarks, Invokana contributed 2.5 points to US growth rate.

Q: As you’ve mentioned recently, you’ve allocated a lot of capital to the pharma business, and I know that you’ve acquired Synthes, which was a big acquisition for you. However, how do we think about the outlook for the medical device business relative to pharma? Pharma has been the engine driving growth for J&J; is that how the future for the company looks where pharma is the focus and devices exist alongside to generate cash? Or how should we think about how the med tech business continues to fit into the broader J&J business?

A: As you know we think of ourselves as a broadly based company in healthcare. We are the largest MD&D player in the market, so we obviously have a significant presence in hospitals, and that is a very important part of the overall healthcare system. So J&J is best positioned in medical devices, I believe, than any other medical device player given what’s happening in market with respect to hospitals and specifically speaking of the US with the advent of the Affordable Care Act (ACA) and Accountable Care Organizations (ACOs). We’re working to not only remain the largest player in medical devices but to take advantage of that position in the hospital setting with respect to providing total solutions to the marketplace.

So [MD&D] is a very important part of our business and it does drive substantial cash flow. In the past it’s been a significant contributor to growth from new products. I’m confident it will also be a significant contributor of growth for new products in the future as well. We have an upcoming medical device business review coming up on May 22 and you’ll hear Gary Pruden and Michelle Orsinger specifically talk about the surgery in the orthopedics business, and I look forward to sharing more information with you then.

-- by Jessica Dong, Jenny Tan, Adam Brown, Hannah Martin, and Kelly Close