Expert Financial Analysis and Reporting

Key Investment Issues

Investment sentiment on Dendreon has deteriorated so much that investors seem to be only focusing on what has gone wrong and what can go wrong. I think that this pervasive state of gloominess is causing people to ignore some encouraging signs.

• Reimbursement has become predictable for physicians and most are receiving payment within 30 days.
• Dendreon’s goal at the beginning of the year was to have prepared 500 sites for infusing Provenge. They have exceeded this goal and reached 680 sites.
• Provenge is making progress in gaining acceptance in the key urology market which is about 75% of the addressable market; 20% of prescriptions are now coming from the urology community up from 7% earlier this year.
• Going into 2011, management issued guidance that Provenge sales would reach $350 to $400 million in 2011 and then at mid-year had to withdraw guidance as sales fell short of expectations.
• Management believes that this guidance mistake was because they failed to anticipate physician concerns about reimbursement. Most physicians, especially in community practices, are treating one patient and waiting for payment before treating the next. Dendreon had expected physicians to infuse 1 to 2 patients per month and instead the ratio is 0.5.
• Dendreon has found that physicians generally need to treat 5-6 patients before they gain enough confidence in reimbursement so that they are willing to treat more than one patient at the same time which could result in them treating one, two or more patients per month. This process takes about one year.
• The company believes that only 30% of the physicians who could use Provenge in their practice have either used the product or are scheduled to infuse it. The company appears to just be scratching the surface of the US addressable market. There is the potential to reach many more doctors and to increase the amount of prescribing of doctors who are currently using Provenge.

Investment Thesis

I think that investors have so little confidence in Dendreon’s management that they will want to see an actual inflection in sales before they regain confidence. This is likely to begin in mid-2012 if Dendreon’s assessment of the situation is accurate. There was a surge in physician enrollments in mid-2011 and if these physicians take a year to gain confidence in reimbursement before they begin to treat several patients at once, there should be a sharp uptick in Provenge sales in mid-2012. Between now and then, I think that skepticism in regard to anything that Dendreon management says may cause the stock to bounce around at current levels. Still, I think that there is value in the stock at these levels and waiting for the inflection to occur could cause investors to miss what could to be a sharp upward spike in price if Dendreon’s reading of the market is correct.

Investors are questioning what peak sales of Provenge might be. Management issued guidance that the company could reach profitability if Provenge reaches $500 million of sales. Some investors have taken this to mean that this will be the peak sales level, but management says that it is running the company on the basis that sales will significantly surpass $500 million. In the first year of marketing, Provenge sales are on track to exceed $200 million. If Provenge follows the launch pattern of other oncology drugs, its sales could exceed $1 billion.

There are lots of things that investors are worrying about such as competition from Johnson & Johnson’s (JNJ) drug Zytiga and Medivation’s new drug MDV3100; Provenge’s price; whether Provenge’s survival benefit is meaningful, etc. I recognize these as valid issues but I believe that they are obstacles that can be overcome. I address these in this report.

Background and Recent Reporting Data

I am struck by how many people have labeled the Provenge launch as disappointing and a failure and yet it is one of the best biotechnology launches of all time. In 2011, the first full year of marketing, it is on track to do over $200 million of sales. The only cancer drug that comes readily to mind that has beaten Provenge in its first year of marketing is Celgene’s (CELG) Revlimid which did $304 million.

The problem for investors has not been with the actual launch of Provenge, but rather the expectations set by management. Early in 2011, management was guiding to Provenge sales of $350 to $400 million in 2011. Then in the second quarter of 2011 conference call, the company dropped its full year sales guidance and indicated that it expected only modest sequential sales growth for 3Q, 2011 and 4Q, 2011 and continuing into the first half of 2012. This resulted in a drop in Street expectations for Provenge sales in 2011 to $190 to $210 million and led to a 65% drop in the stock price from the mid-$30s to $10 to $13 per share. .

Management erred significantly in setting expectations so high. On Wall Street, the formula for success is to under-promise and outperform. Dendreon got this message upside down. Consider where the stock might be if management had set expectations for sales of $150 million in 2011 and then adjusted guidance upward to $200 million. I am confident in saying that the stock would not have been trading in the $30 to $40 price range seen in early 2011, but I think it would be considerably higher than the current $8.50.

Third quarter sales (before chargebacks and rebates) reached $65.8 million, up 30% sequentially from the second quarter. This was encouraging, but investors were alarmed when the company reported during the conference call for 3Q, 2011 that October sales were $26.4 million which compared to $25.0 million in September. It also reported that its initial reading (as of November 2) was that November bookings were running below October levels. Management continued to guide toward modest quarterly sequential sales increases and did not comment on when sales might begin to show more significant growth. This was alarming to many investors and the stock dropped from $10.00 before the call to $6.50 afterwards.

The critical issue for investors is not what sales are going to be in 4Q, 2011, but when they begin to grow at more than a modest rate and what level peak sales might reach. With that said, I will go over some items that will affect 4Q, 2011. The company reported that the late October snowstorm in the Northeast had cost them about one day of sales which I calculate to be as much as $3.0 million; this sale will be pushed into November. Also, November and December medical procedures are often negatively impacted by the holiday season as patients push their procedures out into the new year. Another factor that will affect reported sales is that the company has been reporting gross sales and net sales. The difference between the two is charge offs and rebates, principally to Medicare. However, they have now identified those accounts that are entitled to charge offs and rebates and they will now report just one revenue figure and that is essentially what has been called net sales. This is shown in Table 1.

Management has been providing updates on quarterly sales from July through October and these numbers are shown below. They emphasized that 4Q, 2011 sales will be up modestly and strongly indicated that the 30% sequential sales increase from 2Q to 3Q will not be repeated in 4Q. I am estimating monthly net sales as follows:

Important Metrics Cited in the Third Quarter

Dendreon released some interesting metrics for the third quarter. It has identified approximately 1000 accounts that treat about 80% of prostate cancer patients eligible for Provenge. Within these accounts there are often several doctors practicing so that there can be several infusion sites within each account. Dendreon believes that it has established a business relationship with physicians who account for about 30% of the potential addressable market suggesting that they are in the early stages of penetrating the market.

They have completed the servicing process that is necessary to prepare for infusion in 680 sites. Their goal at the beginning of the year was 500 sites so that they have exceeded their goal. There have been 425 sites that have infused Provenge and altogether 475 sites have either infused or have scheduled an infusion; this is up from 130 sites in 1Q, 2011.

In 2010 and early 2011, most of Provenge’s sales were to academic centers and primarily to oncologists. Dendreon estimates that 75% of the potential patients for Provenge are treated by urologists. It seems to be making progress as the number of prescriptions written by urologists in the 3Q was 20% up from 7% in 1Q. In addition, 70% of prescriptions are now written in the non-academic community setting. These numbers suggest progress and also that the company is just scratching the surface of the potential market.

Why Was Guidance So Wrong and When Will Sales Begin to Ramp?

Dendreon’s initial guidance was based on the assumption that they would see one to two patients treated at each infusion site each month. Remember that each patient treated receives three infusions over a one month period. This assumption held up well for the first 50 sites. These were major academic sites that in retrospect were much more comfortable with and able to deal with the patient selection and reimbursement issues than community based urologists. As they began to expand into urology practices which are 75% of the addressable market for Provenge, they began to see a sharp slowdown in patient treatments to about 0.4 to 0.5 infusions per month.

As Dendreon tried to understand what was going on, they came to realize that they had underestimated how urologists would react to the patient election and especially the reimbursement issues. As they delved into the issue, they found that urologists were generally treating one patient over the course of thirty days, billing the payor and waiting about 30 days to get paid. Physicians were essentially making sure that they were getting paid as each patient represented an accounts receivable of $93,000 and this was the limit of risk they were initially willing to take until they became comfortable that they could select patients for whom they could readily be paid. After the two month period covering treatment and reimbursement, they could then schedule the next patient. This results in roughly 0.5 treatments per month rather than the 1.0 to 2.0 that Dendreon had expected.

Based on talking with doctors, Dendreon believes that in general the physician has to have a positive experience with 4 to 6 patients before they are comfortable enough that they are willing to infuse more than one patient every two months. This takes about 8 to 12 months per doctor. They started the large ramp of physicians in 2Q, 2011 and continued in 3Q, 2011. If these physicians take ten to twelve months to begin to expand their patients treated from one every two months to a greater number, there should be a meaningful ramp up in sales beginning in late mid-2012.

Reimbursement Progress

The Provenge launch started with reimbursement based on a miscellaneous J code. This led to confusion, paperwork and back and forth conversations between the doctor and payor. In some cases, payment was stretched out to 90 days during which time the doctor was unsure if he was going to get paid. Provenge reimbursement has now moved from the miscellaneous J code to an electronic adjudication under a Q code that is product specific and under which doctors are routinely paid in 30 days. There have been cases of payment as soon as 8 days.

The national coverage assessment conducted by CMS resulted in a national coverage decision for Provenge. This confirms that Medicare will reimburse at about $93,000 when Provenge is used in accordance with its label which indicates that indicates that Provenge can be used to treat men who: (1) have failed hormone therapy, (2) have metastatic disease, (3) are asymptomatic or mildly asymptomatic, (4) have rising PSA even though testosterone levels in the blood are at castration levels and (5) are not taking opioids for their pain. Dendreon’s market research indicates that over 70% of oncologists and urologists are aware of the CMS decision.

Dendreon reports that about 70% of patients are getting Provenge with no out of pocket costs and for the remainder there is a patient assistance program. Co-pays and out of pocket expense do not seem to be a barrier to Provenge use.

The Benefit of Provenge

A constant and recurring investor criticism of Provenge is that the 4.1 months median survival advantage shown is a very modest benefit for patients. Median survival is that point in time at which 50% of patients have died and 50% remain alive. It is too often interpreted overly simplistically as the length of time that patients taking Provenge can expect to have their life prolonged. It is not that simple.

Provenge was slow to demonstrate a therapeutic effect in the pivotal clinical trials. For the first eight months of the trials there were equal numbers of men dying in the Provenge and the control group. Then there began a separation in which patients on Provenge began to live longer than control patients. At the end of three years, 33% of patients on Provenge were alive versus 22% in the control arm. This means that 9 out of every 100 patients treated with Provenge would have died after three years without Provenge therapy.

The clinical data suggests that Provenge works differently in different groups of prostate cancer patients. In some, it has little effect either because Provenge is not effective or the patients’ disease is too advanced. Such patients die at about the same rate with or without Provenge. In other groups of patients, positive benefits are seen as patients enjoy survival benefits measured in years. Like all drugs, Provenge appears to work better in some patients than others and in those who respond to the drug, the benefit is quite substantial and much greater than 4.1 months median survival suggests.

The 4.1 months median survival must also be put in historical context. There have only been four other drugs that have shown 4.1 months or more median survival in metastatic cancer. Alimta, Avastin and Herceptin have all gone on to be mainstays of cancer therapy and billion dollar plus drugs. The fourth drug is MDV 3100 which showed 4.8 months median survival in metastatic prostate cancer and is not yet on the market. Xytiga just missed with 3.9 months median survival.

Another point that should be understood is that 80% of control patients who showed disease progression were given Provenge which had been frozen. Remember that progression free survival was the initial endpoint of studies and was later switched to survival. This means that the 4.1 months survival advantage might have been understated because many of the control patients were given Provenge and may have benefitted from it. The 4.1 months is likely understated, perhaps significantly, but there is no way to accurately determine this.

Where do Zytiga, MDV 3100 and Provenge Fit into Prostate Cancer Therapy

In the treatment of prostate cancer, 70% of men who are diagnosed can be cured with radical prostatectomy surgery or brachytherapy (radiation therapy). The remaining 30% go on to hormone therapy which lowers levels of testosterone in the body to castration levels. All of these patients will eventually become resistant to hormone therapy and progress to metastatic disease. It is at this stage of the disease that Provenge can play a role.

Before Provenge, the only course of treatment available after hormone therapy failed was chemotherapy. Oftentimes, patients who became castration resistant would go untreated until they began to show the symptoms of the disease which was pain resulting from metastases to the bone.

Johnson & Johnson’s Zytiga and Medivation’s MDV3100 have both shown impressive results for patients who have failed chemotherapy. This is the patient population in which Zytiga is now being used and it will be the initial market for MDV 3100. However, both of these products will also go on to be marketed in the same patient group in which Provenge is now indicated; castration resistant patients with metastases who have not yet progressed to chemotherapy.

Zytiga and MDV 3100 will probably be given the same label indication as Provenge in the 2013-2014 time frame. This will then present an issue for doctors on how and when to use these three agents. This will not be a decision about which of these agents to use, but rather in what order (sequencing) or in what combination. It might be logical to start with Provenge and get its benefit. It only requires 30 days to administer the drug and receive its benefits whereas patients will be placed on therapeutic regimens for Zytiga and MDV 3100 that will last for a year or several years.

Most doctors hypothesize that the stronger the immune system, the greater will be the effect of Provenge. This argues for using Provenge as early as possible and before or in combination with the other two drugs. This is particularly true of Zytiga which requires the concomitant use of a steroid that weakens the immune system, Provenge does not preclude the use of abiraterone or MDV 3100 and indeed they might be used together or sequentially. MDC 3100 can most likely be given with Provenge while Zytiga may be delayed for 30 to 90 days.

Disclosure: The author of this article owned shares of Dendreon at the time this note was written. This should be taken into account as it may introduce bias into the conclusions and interpretations that are made. In reading this note, you acknowledge that you have not used it as the sole basis of your decision making and that all investment decisions are based on your own analysis. An investment in Dendreon carries substantial risk and investors could potentially lose much of their investment. The reader acknowledges that he/she has carefully read the Investment Approach, Terms/Conditions and Disclosures sections in the About Us section of the website. The reader acknowledges that he/she will not hold SmithOnStocks accountable for any investment loss that may be incurred if a decision is made to invest in Dendreon.