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Dendreon Corporation (DNDN - Analyst Report) recently announced that it will lay off 500 employees tantamount to roughly a quarter of its workforce as part of a drastic restructuring plan. The plan was announced to reduce spending to cope with disappointing sales of its prostate cancer vaccine Provenge. Dendreon also announced the departure of its chief operating officer Hans Bishop.

Last month, Dendreon reported weaker-than-expected second quarter sales of Provenge. Subsequently, the company withdrew its revenue guidance for the drug, sending its share price down sharply. In August 2011, Dendreon reported modest Provenge gross revenue of approximately $22 million. August sales were however 15% above the sales recorded in the preceding month.

Despite the favorable reimbursement environment for Provenge following the final CMS decision and implementation of the Q-code, management believes most physicians are still unaware of these developments. Moreover, due to the short duration of therapy (about 4-6 weeks) the full costs associated with Provenge have to be paid out by the physicians within a month and thereafter they have to wait/hope for reimbursement. These physicians were thus not comfortable with the cost density of Provenge and did not freely prescribe the drug. Management lacks visibility on when the doctors will become more comfortable with the positive reimbursement developments as well as the cost density of Provenge. The company now expects modest sequential revenue growth in the remaining quarters of 2011.

Dendreon has received approval to manufacture Provenge at three facilities: New Jersey, Los Angeles and Atlanta. It had hired employees at these facilities well in advance in order to keep the manufacturing process smooth in the hope that Provenge will prove to be a hit among doctors. However, with Provenge sales failing to meet exalted expectations, management now feels that it is significantly overstaffed resulting in the inevitable workforce reduction. The largest share of the layoffs will thus be manufacturing related.

As of August 31, 2011, Dendreon had cash, cash equivalents, and short- and long-term investments of approximately $600 million. Due to the reduced spending levels following the restructuring, Dendreon aims to achieve a cash flow break-even position in the US by generating approximately $500 million in annual revenue in 2011. It hopes to achieve this without any additional financing and with a slower approach on infrastructure improvements.

Dendreon expects to incur total employee-related restructuring costs of approximately $21 million, which includes approximately $5 million in non-cash expenses. The restructuring is expected to generate annual savings of approximately $120 million. R&D expenses are expected to increase by around $15 million in 2012 due to increased spending in clinical activities. Cost of goods sold is expected to be in the 50% range by the end of 2012.

Related to the Provenge disappointment, Dendreon also announced the departure of its chief operating officer, Hans Bishop, and appointment of John Osborn as executive vice president, general counsel, and secretary.

Our Recommendation

We currently have a Neutral recommendation on Merck. The stock carries a Zacks #3 Rank (Hold rating) in the short run.

The successful commercialization of Provenge is crucial for the financial performance of Dendreon as it can drive the company to profitability. Though we still believe in the long-term prospects of Provenge, following the second quarter developments, our visibility on the performance of the drug for the next few quarters has become clouded. We believe the stock will remain range bound for some time and prefer to remain on the sidelines until visibility on Provenge’s performance improves. Moreover, in the long run, we remain concerned about the company’s dependence on Provenge and the lack of a robust pipeline. We believe Dendreon has little to fall back on if Provenge fails to keep its promise.

Besides, the competitive milieu is intensifying with Johnson and Johnson’s (JNJ - Analyst Report) Zytiga, launched in the second quarter in the US, posing competition to Provenge. Moreover, there are products currently under development for the treatment of prostate cancer like Medivation’s (MDVN - Analyst Report) MDV3100, which is in late-stage trials. If these products are successful, the prostate cancer market will become more crowded and competitive.

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