OverviewFounded in 1993 with headquarters in California (108 employees), AVITA Medical currently sports enterprise value of ~$140M and Q3 cash position of $88M providing them operational runway for at least a couple years. There are ~25M common shares outstanding (I like the simple capital structure).
Late November's Piper Sandler webcast provides an excellent overview of the story, as CEO calls AVITA a regenerative tissue company that takes a tissue-sample, which is less than 20% of what's normally taken for a skin graft. Then, they disaggregate the cells, put them in a buffering solution (spray on) that enables accelerated healing where applied.
Currently, they have a burn indication approved and selling. Additionally, they have two indications going in for PMA supplemental filing (soft tissue repair and vitiligo).
Figure 2: Multiple applications to expand market opportunity for RECELL (Source: corporate slides)
Asked why new CEO James Corbett took the job, he responds it's fundamentally a new technology with a long history (used in Bali bombings for victims 20 years ago, even though it was not ready for the market at the time). When he joined the board 18 months ago, Corbett saw a great technology with approval in burns (relatively smaller market but performing quite well with great clinical data to back it in terms of healing and tissue sparing). Then, he saw the expanding market opportunity for vitiligo and soft tissue repair for the business (only in the US for the moment) along with strong balance sheet. Another positive aspect of the story is that reimbursement is already in place.
As for Q3 and why the burn business performed so well, CEO notes there are roughly 145 burn centers in the US. The company measures how often the burn centers use RECELL and adopt it. In Q3 they saw burn centers move from once a quarter to once a month to once a week pattern as they got more comfortable using RECELL. Fundamentally, this healing issue is a big deal because AVITA sells RECELL kit for ~$6,000 which is paid for in a DRG. Patients are healing so much faster it's working for the hospitals and obviously working for the patients (economic win for the hospital).
From a share-taking perspective, they are getting adoption but note that for relative share gain they don't know who the loser is. Physicians are gaining confidence, company provides an enormous amount of training and support and longer term they get more comfortable as pandemic-related staff turnover diminishes. AVITA treats big burns (but don't promote it as it can't be studied), and are seeing more in the way of small burns (sub 15% total body surface area category which is the majority of the market).
The last couple quarters the company has been hamstrung by getting into centers and getting clinicians trained. CEO responds that's not a headwind at all anymore and now have very good access. For Q4, they expect a continuation of current adoption rate (led to raising annual guidance). As for Japan (got the first order in Q3), for Q4 they still have a lot to learn about the adoption process over there. They shipped the first stocking order in September and in October they did dozens of cases (very encouraging because that rapidity of adoption behavior is uncommon). AVITA has a $30M to $40M burn business in the US and Japan is about a third the size of US market. CEO notes it could be a $10M+ business there (keep in mind it's shared with their Japan partner though and AVITA gets 40% of the reimbursement price but almost all of it goes to bottom line).
As for other markets, there is big international potential in 20+ countries and is a task for 2023. However, the real task in 2023 is launching in soft tissue repair where the growth will come from. Regulatory filings took place in December with approval expected in mid-2023. Soft tissue repair has Breakthrough Device Designation (expect a 180-day decision, suggesting July 1st approval if all goes well). With vitiligo, they have a separate Breakthrough Designation and expect approval in June. There is a different path to go for the latter indication, as they have to establish reimbursement for the physician office side of care (have it effective in January 2025). So, that market development will take place over the next 18 months or so following approval.
Focusing on soft tissue repair indication, management feels confident in approval time frame due to extraordinary performance on customer complaints (extraordinarily low) as well as solid clinical data (beat the p value of .025, healing definition). FDA response is likely to be consistent with prior communications and again expectation is to get approval on schedule. Economically, this opportunity is 3 to 4 times bigger than burn and sits in Level 1 to 2 trauma centers. Label is very broad for all sorts of related procedures.
Synergies are interesting because half of burn centers are also Level 1 to 2 trauma centers where they have reimbursement (25% of burn market they don't already call on also resides in these centers, where sales team will be able to exploit these synergies and hit the ground running after approval). In other words, 25% of burn market are patients who need skin grafting for burns are sub 30% total body surface area treated in level 1 and 2 trauma centers (salesforce does not currently call on them, so they will get expansion of opportunity). They will be adding to the salesforce for the trauma & burns combo (have not guided for precise number yet but will do so in February). It could be a complete doubling of the salesforce, which sounds quite aggressive!
As for guidance, they will have a lot of momentum in Q3 of 2023 which will ramp into 2024.
Moving on to vitiligo, focus is on getting reimbursement and will do cash pay in the meantime so they can optimize patient selection (want to be very successful in early cases while reimbursement is "cooking", actively developing the market). As for the size of vitiligo market, there are 3 to 4 million people in the US who have it and interestingly, most recent market research showed over 400,000 patients sought treatment for vitiligo last year (enormous market where no current treatments are effective). AVITA's trial was against active control and at 6 months where RECELL had responder group of 80%, the control had 0% responder to standard of care today at 6 months. This is a very divergent outcome and IF they get it right, it could be a big winner. From a dollar perspective, this is a couple billion-dollar market. Take those 400,000 patients and multiply them by $6,000 and you get over $2 billion. Even a slice of that would be massive for a company this size.
As a caveat, they are preparing for the unknown in terms of addressing new opportunities and ramping up sales efforts. Obstacles could occur, although CEO did not see specific ones that worry him, all the while noting that RECELL is differentiated and fully reimbursed with broad label, again an uncommon combination.
As for financial profile of this business, it has the potential to deliver strong profitable growth with soft tissue repair leading the way 2H 23 and vitiligo following in 2025. They have a strong team but need to build a bigger one. Balance sheet has $88M in cash and they plan to exit 2024 with sufficient cash (in other words, cash use in 2024 will be much less than 2023). They will exit 2024 with "very sufficient" cash along with steadily growing business (gives them flexibility in approaching vitiligo opportunity).
Other InformationFor the third quarter of 2022, the company reported cash and equivalents of $88M as compared to net loss of $5.6M (which decreased by $0.4M from the previous year). Total operating expenses rose by 16% or $2M to $14.2M, versus $12.3M for the prior year (due in part to higher pre-commercialization costs related to RECELL launches in soft tissue repair and vitiligo). Commercial revenue (excluding BARDA) increased by 30% to $9M, while gross profit margin decreased by 2% to 83%. The company boosted annual revenue guidance to $33M -$34M versus prior guidance of $30M (33% year over year increase). I note that accumulated deficit it just $257M, a reasonable sum for a company that's accomplished this much in terms of development for multiple indications and has been in operation for nearly 3 decades.
As for the conference call, for vitiligo opportunity CEO reminds us the goal is to get reimbursement in place by January 2025 (between now and then, penetration of burns and soft tissue repair opportunity could really drive growth).
As for competition, primary competitor in the burn market is current standard of care (split-thickness autografts). RECELL system is often complementary to autografts for the treatment of many burn injuries, but still faces competition from this traditional surgical procedure for many burn patients. Clinical trial data suggests RECELL has competitive clinical and economic advantages, but they are also facing competition from FDA-approved products such as Epicel (from Vericel Corporation) and Stratagraft (produced by Mallinckrodt). Focusing on Epicel from Vericel (VCEL), on the Q3 call the $1 billion company notes that it did $7.3M in Epicel revenue for Q3 (below 2021 quarterly run rate levels). Lower patient volumes had a significant impact on their highest volume centers and negatively impacted growth drivers, leading them to lower guidance (this seems quite the contrast to AVITA's Q3 call). To be clear, keep in mind Vericel's cartilage repair product accounts for the majority of its sales.
Figure 3: Vericel revenue details show Epicel accounted for 19% of Q3 sales (Source: VCEL Q3 slides)
Also, with EpiCel and its next product NexoBrid the company is primarily focused on the $200M addressable burn market in the US. The latter product is already approved in the EU and US pivotal phase 3 study met its primary endpoints. For the US market, back in 2021 it was the basis of a Complete Response Letter due to several CMC information requests including inspection of manufacturing facilities in Israel and Taiwan. It looks like with PDUFA date of January 1st, Vericel could finally launch this product 1H 23. For the reduced sales guidance, management noted that they saw continued decline in large burns (30%+ body surface area) in Q3. Again, investors in RECELL should keep an eye on the Vericel's efforts going forward as one potential gauge of competition.
On December 19th the company announced submission of Premarket Approval application to the FDA for the RECELL System in order to expand indication to the treatment of vitiligo. New CEO Jim Corbett notes that RECELL offers first-in-class repigmentation of vitiligo lesions through the transplantation of melanocytes. Approval would dramatically expand reach into a very large market with limited treatment options. On the con side, full launch is not expected until January 2025. Keep in mind under Breakthrough Device designation the company will receive prioritized review
As for institutional investors of note, Vanguard owns ~5% of shares outstanding while RTW Investments recently sold its remaining stake. As for insiders, I note former CEO Michael Perry continued to sell down his 300,000+ share position this year.
As for relevant leadership experience, it's reassuring to see that recently hired CEO James Corbett has 40+ years in the industry including at industry giants including Baxter Japan (General Manager) and GM of Boston Scientific International. That he would come on board to lead a company of this small size I see as a significant green flag. Chief Operating Officer Kathy McGee served prior as VP West Coast Operations at Shire Pharmaceuticals Regenerative Medicine Division (formerly Advanced BioHealing).
Moving on to executive compensation, cash portion of salaries looks very reasonable for a company of this size (including CEO at just $41,562 with majority of compensation in stock awards).
Figure 4: Executive compensation table (Source: Proxy filing)
The important thing is to avoid companies where the management team is potentially in it for self-enrichment instead of creating value for shareholders, and looking at compensation is one of several indicators in that regard.
Moving onto useful nuggets from members of ROTY Biotech Community, Manzil has been very helpful on this name and noted the following:
There are approximately 6.5M Americans with stable vitiligo. Clinical results for Recell showed re-pigmentation of more than 50% of treated area at 6 months at 56% vs 12% for SOC. Likewise, re-pigmentation of more than 80% of treated area at 6 months for Recell was 36% vs 0% for SOC. Management is projecting 18 months from time of approval to have reimbursements in place.
Investment thesis update: Recell commercial launch and sales ramp was heavily impacted by Covid restrictions and while burn center activity remains at subdued levels, current 30% YoY growth seems very healthy--especially given ongoing staffing challenges at burn and trauma centers. Recell's new high efficiency device should help to mitigate staffing issues as less time, personnel, and training are required for use of the device. I expect the burn indication to continue to ramp well, especially with the launch of the new high efficiency device. The big story should be launch of the soft-tissue indication in mid-2023 given the much larger TAM and patient population. As burn and trauma centers continue to become familiar with the Recell device in the burn indication, this should lead to faster ramp of sales in the soft tissue indication once FDA approval is secured. I expect this to be a solid growth driver in 2H 2023 and throughout 2024. In 2025, we should see launch of Recell in the vitiligo indication. Longer term, Avita is pursuing indications in regenerative dermatology and skin rejuvenation--though these are much further out.
At a current market capitalization of $137M and EV of $53M, with $84M in cash, no debt, low cash burn, and 30%+ YoY organic revenue growth, RCEL seems undervalued. RCEL's last capital raise was in Q1 of 2021 and management has no plans for further dilutive financing. While I do expect some increase in SG&A spend in 2023 with the launch of the soft tissue indication, I expect they should be able to ramp without raising capital--though I wouldn't rule out opportunistic financing if valuation supports it. Management seems conservative, fiscally responsible, and very focused on ramping sales organically.
While I expect RCEL to be mostly a 2H 2023 and 2024 story, I have been building a larger position for the past few months and plan to continue to add opportunistically on pullbacks.As for IP, the company has 56 granted patents and 26 pending applications worldwide. These cover methods of use, methods of evaluating therapeutic potential of Regenerative Epidermal Suspension, methods of preparing cell suspension with exogenous agents to promote wound healing, compositions of matter and more. In 2019, the company filed a Patent Term Extension application with the US Patent and Trademark Office requesting extension of a key patent (covering cell suspension preparation technique and device) which if approved would be extended to April 2024. Other patents have expiration dates ranging from 2022 to 2040.
As for other useful nuggets from the 10-K filing (you should always scan these in your due diligence as many companies like to sweep undesirable elements under the rug), it's heartening to see there's not a significant amount of concentration risk as for Q3 no single commercial customer accounted for over 10% of total net accounts receivable. Covid pandemic adversely affected operations in prior years, so renewed outbreaks of any kind would provide a headwind to growing sales. As noted prior, the company is competing in part against other enterprises such as Vericel and Mallinckrodt that are much larger and have greater resources to allocate to grow their franchises.
Final ThoughtsTo conclude, with market capitalization nearing $220M and EV of $140M, I continue to think this steadily growing medical-device type story is a great fit in our Core Biotech portfolio alongside other solid performers like TELA Bio and TransMedics.
It's apparent to my readers that recent losers I've sold have been due in part to management teams that fail to execute, even if science or value proposition is strong. I need to do a better job of finding leadership teams that continue to deliver across multiple fronts (balance sheet, clinical studies, commercial execution) and AVITA Medical with its highly experienced new CEO coupled with strong Q3 report appears to fit that definition.
For readers who are interested in the story and have done their due diligence, RCEL is a Buy and I suggest initiating a pilot position below $9. From there, I would accumulate desired exposure via dips during the next quarter or so.
Taking a long term perspective (3 to 5 years), value creation here should continue via steady sales growth in burn market with acceleration in 2H 2023 to 2024 and beyond via soft tissue repair opportunity. Vitiligo is the most attractive market (some estimates topping $5B TAM), but again this will become more of a factor in 2025 once reimbursement is obtained.
As for risk rating (1=low, 5= high), I will err on the side of caution and assign this one a 3 given how small the company is compared to much larger peers/competition. Key risks include dilution in the next year or so (could be merited to significantly grow the salesforce) and competition against much larger companies (primarily in burn) with greater resources they can employ to take market share. Pandemic related headwinds are always possible as well with subsequent waves that could occur.
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