Dendreon: Time Is Not On Your Side

| About: Dendreon Corporation (DNDN)
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It has been a couple of months since I last reported on Dendreon (NASDAQ:DNDN), the biotech firm that brings you the prostate cancer treatment Provenge. At that time, I cautioned investors about the company's financial flexibility, which has continued to deteriorate. With Dendreon having released its fourth quarter results, I'm here today to update you on the situation. While Dendreon appears to be making some strides in a positive direction, the company is still not there yet. 2013 will be a critical year, and if things don't go well, investors will likely face another bond issue or massive equity dilution. Here's why.

The worsening balance sheet:

The table below shows some key financial ratios for the company going back to Q1 of 2011 (dollar values in thousands). A couple of notes on the data provided below. First, the senior notes number includes those due in both 2014 and 2016. The second note is on those senior notes due 2016. In the March 2011 to September 2011 reported quarters, Dendreon reported those notes as current liabilities. Starting in the December 2011 quarter, they were shifted to long-term liabilities. For consistency and easy comparisons, I have included them as long-term liabilities for each of the quarters below, to get a more accurate view of the financial picture.

It appears that things didn't get too much worse in Q4, right? Well, it wasn't as good of a quarter as you might think. During the quarter, the company sold its New Jersey manufacturing facility, as part of their ongoing reorganization plan. This sale netted the company about $43 million. The company told us on the conference call that cash usage for the quarter was $15 million. However, if you take out the benefit from the sale, it would have been $58 million. So the numbers above could have been much worse, as they were boosted by a one-time issue that won't happen again.

Since Dendreon has told us repeatedly that they will not be cash flow positive until they reach $100 million in quarterly revenues, these numbers are likely to get much worse before they get better. I would not be surprised if the debt (liabilities to assets) ratio crosses the 100% level during Q1 of 2013. At this point, the company will have more liabilities on the balance sheet than assets.

Looking forward to 2013:

Thanks to Dendreon's closing of the NJ plant, they expect to see incremental increases in their cost of goods sold. Those savings should start in Q1 of 2013, and the company has pledged to see gross margins above 50% by Q3 of this year. As a point of reference, gross margins were 36.4% in Q4 (33.4% if you exclude chargebacks). This will help to reduce the company's losses, but it won't solve the entire problem. Also, we won't see the full effects for another few quarters.

The company also expects incremental improvement in selling, general, and administrative expenses through the 1st half of 2013 as well. Like the cost of goods sold benefits, they expect full benefits from their restructuring plan to start in Q3. However, they still are investing in their "commercial activities," which includes a "new investment of approximately $5 million per quarter for a targeted direct-to-consumer ad campaign." You may have seen a TV commercial for Provenge recently. I saw it for the first time about a week ago, and have seen it once or twice again since then. While getting the Provenge name out there should be beneficial, Dendreon must make sure they don't spend too much. How many times do we see drug commercials that we ignore because of the long list of side effects?

Overall, the reduction in the cost of goods sold and selling expenses should help move the needle. However, Q1 and Q2 could still see large cash burns, and there is no guarantee that they'll be cash flow positive once these restructuring efforts fully kick in. I'll cover this issue in the next segment.

The $100 million mark:

During the conference call, Dendreon reiterated their guidance to be cash flow breakeven when they hit a net trade sales level of $100 million. The question that many have asked, and for some time now, is when will that be?

I put together the following table showing where 2013 analyst estimates have trended over time. I've gone back to the middle of June 2012, and provided as much data as I could find. To see where current estimates stand, click here.

As you can see, analysts have been cutting down their estimates quite significantly over time. When I last reported on Dendreon in early November, analysts were looking for $84.4 million in revenues for this current quarter (Q1 of 2013). That average estimate now stands at $80.4 million, with analysts expecting a 2.1% decrease over the prior-year period.

When analyst estimates stood at $400 million or so for revenues this year, I said there was a very good chance of Dendreon hitting the $100 million quarterly mark this year. At $375 million, I said those chances were a bit reduced. Now we are at $358 million. Dendreon analysts expect about $193.5 million in revenues during the second half of 2013, so there is still a chance. However, if these forecasts keep coming down, we'll have to start looking to 2014. Every quarter they don't hit that mark means more cash is burned through, likely diluting shareholders a bit further. Also, no matter how good the company is at cutting costs, if they can't generate the revenues, huge losses will continue. That's why you see analysts cutting their EPS forecasts as well.

Looking for news in Europe:

Bulls are hoping that Dendreon will see good news out of Europe at some point this year. Here is what the CEO John Johnson said on the conference call.

I'm pleased with the great strides we have taken, but we still have more progress to make in 2013. We also continue to make progress advancing the global market opportunity for PROVENGE. In Europe, we have filed our application with the EMA and expect a regulatory decision in mid-2013. We continue to evaluate partnering strategies in Europe while we continue enrolling patients in the European open label study.

Opening up Provenge to Europe would be tremendously positive for the company, so look for that decision to come in the next 2-5 months. You are likely to see a huge move in this stock on this decision. If Dendreon gets good news, you are likely to see analysts boost their revenue numbers and the stock soar. But if we get bad news out of Europe, expect the stock to fall and the analyst numbers to be cut even more.

Analysts may be pricing in some good news already. The average estimate for Dendreon's 1st half revenues stands at $164.74 million. If you subtract that number from the full year expected total, analysts are looking for $193.55 million in the second half. That's a big jump.

Final Thoughts:

Dendreon is inching closer to that key $100 million mark, but it's still not there yet, and analysts are getting less positive by the week. Estimates have continued to be cut, meaning that milestone quarter could be further and further away. News out of Europe will be key to Dendreon's future.

Until then, Dendreon will continue to burn through cash at an alarming rate. While the reorganization plan should cut some expenses, we won't see a huge benefit from a plant sale again. Dendreon's liabilities are likely to exceed their assets, either by the end of this quarter or the next.

If Dendreon cannot hit that $100 million revenue mark this year, investors are likely to see one of two negative outcomes. The first is another issuance of debt, which will either carry a large interest rate or will be convertible, which means a lower interest rate but some dilution. The second outcome is the company raises money by selling stock, even less appealing for investors. Dendreon's market cap is just $833 million right now, so even a $50 million raise is quite a bit of dilution. Imagine if they need more. For now, time is not on Dendreon's side.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Investors are always reminded that before making any investment, you should do your own proper due diligence on any name directly or indirectly mentioned in this article. Investors should also consider seeking advice from a broker or financial adviser before making any investment decisions. Any material in this article should be considered general information, and not relied on as a formal investment recommendation.