Encouraging Quarter for Adolor, Waiting for Phase II Data on ADL-5945

Apr.28.11 | About: Merck & (MRK)

Introduction

I wrote an introductory report on Adolor (ADLR) on February 18, 2011 called "Adolor, a Small Stock to Watch." This note is a follow-up so that interested investors may want to refer to that report for a more detailed discussion of the company.

Entereg Results in the First Quarter Were Excellent

The results of the first quarter were on target with expectations. Entereg achieved sales of $7.5 million which was an increase of 41% from 1Q, 2010 and a slight sequential increase from the $7.3 million of 4Q, 2010. The company reported that the Entereg business is now operating at an annual run rate of $30 million, a level at which it is now at cash flow break even.

Looking first at year over year results for Entereg, the company benefited from a price increase of 6% taken in April of 2010 and another 9% increase taken in January of 2011. Adolor reported that the year over year unit growth was on the order of 20% to 25%. Management reports that the strong unit growth resulted from both an expansion in the number of hospitals in which Entereg is sold and also deeper penetration within exiting hospitals. The unit growth trend appears to be sustainable and the company should also be able to continue to realize price increases going forward. I continue to estimate Entereg sales of $37 million in 2011 and $46 million in 2012.

The modest sequential increase in Entereg sales from $7.3 million in 4Q, 2010 to $7.5 million in 1Q, 2011 was attributed to normal seasonal patterns in hospital elective surgeries that result in a sluggish first quarter and also some buildup of inventories by wholesalers in 4Q, 2010. The sequential performance this year is much better than was one year ago when there was a sharp sequential decline from $7.5 million in 4Q, 2009 to $5.3 million in 1Q, 2010. Hence, the sequential decline of this year’s first quarter seems normal.

Update on ADL-5945

Management stated that enrollment trends for ADL-5945 are on target and reiterated guidance that topline data on the 200 patient Phase II trial will be released in 3Q, 2011. Adolor believes that if the results are positive that it may be able to realize a partnering deal before the end of 2011. I am a little concerned that this timeline might be too aggressive.

Financials

Adolor burned about $7 million in the quarter so that it ended 1Q, 2011 with $39.3 million of cash. This quarterly burn could diminish slightly over the course of the year, but we would still look for a cumulative burn over the next three quarters of $15 to $18 million. This would result in yearend cash position of $21 to $24 million if there is no partnering deal on ADL-5945 and no new equity is raised.

Stock Opinion

The market is clearly focused on Adolor’s declining cash position and is concerned that the company may have to do an equity offering in 2011 or early 2012 which at the market capitalization of $65 million could be significantly dilutive. The company is hoping that success with the Phase II trial of ADL-5945 can drive a partnering deal in 2011 that will negate the need for new equity. And very quietly, Entereg is now in a position to generate positive cash flow. I estimate that it can create a positive cash contribution of $3 million in 2011 and $8 million in 2012.

There is a lot riding on the upcoming Phase II data on ADL-5945 and the potential for doing a partnering deal that will hopefully be done off of those results. Success could have a dramatic impact on the stock and I could see the stock doubling; after all the current market capitalization is only $65 million. On the other hand, if the results are negative, there would be an immediate and sharply negative impact on the stock. Even if the results are positive, the market may be cautious on the stock until a partnering deal is actually concluded.

I think that there is value in the company even if ADL-5945 fails. Adolor could emerge as small, but profitable enterprise based only on Entereg prospects. Hence, there is potential for the stock even if ADL-5945 fails, but the stock would likely have a meaningful decline before the market began to focus on a new company primarily based on Entereg.

I am obviously interested in this company and have considered putting a buy on the stock. However, there are two key questions with the investment thesis that I can not answer with confidence: (1) will the ADL-5945 Phase II data be positive, (2) and if so, can the company really conclude a partnering deal by the need of 2011? If I could have 75% confidence that both of these questions would have a positive outcome, I would recommend the stock. However, I am not at that point and continue to be neutral.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.