The large print giveth, but the small print taketh away.

AVITA Medical announced that its third-generation device has earned U.S. Food and Drug Administration (FDA) Breakthrough Device designation for acute wounds, such as burns and soft tissue repair. It will be an important driver for growth in the next few years with most of the benefit beginning to take effect in 2025.

The medical device company has also filed a shelf registration statement (Form S-3) with the U.S. Securities and Exchange Commission (SEC) allowing it to sell up to $200 million of common stock. This replenishes the shelf registration from October 2020 and suggests the business is likely to issue a public offering of common stock soon.

Throwing Elbows with ReCell Go

Investors shouldn't be too surprised to see AVITA Medical add to its collection of Breakthrough Device accolades. The unique nature of the technology platform allows it to treat emergency indications (burns, soft tissue repair) and dermatological conditions (stable vitiligo) that have limited or outdated treatment options.

The first-generation device, as well as three separate indications (acute thermal burns, soft tissue repair, and stable vitiligo), have also earned the designation. The label expedites the regulatory review process and shortens the time to market.

Investors might not realize that ReCell Go was instrumental in CEO Jim Corbett taking the reins and streamlining the growth strategy. Under the management of ex-CEO Dr. Michael Perry, the device now known as ReCell Go was only intended for use in the stable vitiligo indication. Dermatological surgeons operate differently than trauma centers, so automating sample preparation made sense for this user group.

However, automating sample preparation is valuable for any indication and any treatment setting. A key insight from Mr. Corbett is that the automated device could be used to reduce the training burden borne by AVITA Medical and mitigate challenges arising from staffing shortages experienced by trauma centers in recent years. It should also smooth the transition into higher volume outpatient treatment settings, such as emergency rooms, where training is trickier.

This difference in opinion on the strategic role of ReCell Go likely played a role in the CEO transition. It's paid off: AVITA Medical now expects to earn FDA approval for the third-generation system in January 2024 – more than six months ahead of the prior management team's timeline.

It helps to visualize the evolution of the ReCell System to see the value.

The first-generation device was a kit that required manual preparation of skin samples using two sets of hands (doctor and nurse) during certain steps. It also included a simple spray vessel that required manual pumping.

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The second-generation device currently in use is a nearly identical kit, although it reduces the number of preparation steps by 33% and only requires one set of hands. It still requires a simple spray vessel with manual pumping.

The third-generation device is a benchtop system that automates sample preparation in a sterile environment. My prior research suggested there was also a new spraying mechanism, although I cannot confirm that at this time.

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ReCell Go also allows the company to throw elbows in the competitive landscape. The intellectual property covering the first-generation (and most of the second-generation) device expired in 2022.

• In late 2021, AVITA Medical listed 56 granted patents and 26 pending patent applications on a global basis.
• By early 2022, that dropped to 18 granted patents and 24 pending patent applications on a global basis.

On paper, the loss of patent protection flattens the competitive landscape. Any company could make an exact replica of the first-generation device and undercut AVITA Medical on selling prices.

The reality is a little more complicated because the ReCell System is a Class III medical device. As a result, any would-be challengers would still need to conduct clinical trials and maintain special manufacturing certifications. Given the relatively small market sizes in acute wounds, the regulatory burden and costs are likely to keep competition at bay.

Transitioning the entire portfolio to ReCell Go makes concerns about intellectual property a moot point – and is expected to become a key driver for accelerating growth in the years ahead.

Shelf Registration Suggests Dilution is On the Horizon

AVITA Medical filed a shelf registration with the SEC on April 14, 2023, which allows the company to sell up to $200 million in common stock for fundraising purposes.

A $390 million company will not be able to raise $200 million in one transaction. Most shelf registrations are never fully exercised, but rather provide optionality to raise capital within an extended window. For example, AVITA Medical created a $200 million shelf in October 2020, which allowed it to raise $69 million in a public offering of common stock in March 2021. That was the only significant transaction for that specific shelf registration.

The new filing replenishes the shelf to $200 million. That suggests another capital raise is on the horizon, which would allow the company to wisely take advantage of a rising share price to extend its cash runway.

To reiterate our prior analysis of the cash runway (bold in original):

Importantly, Solt DB Invest modeling disagrees with CEO Jim Corbett's assertion that the business will end 2024 with more than $30 million in cash. AVITA Medical may have additional levers to pull to maintain gross margin in 2024 that I'm not accounting for, although increases in sales and marketing expenses and R&D expenses (for clinical trials) appear to dwarf any gross margin surprises.

Regardless, the business will likely seek to raise capital before the end of 2024 and ahead of the stable vitiligo launch in January 2025. A capital raise could include a stock offering, a debt offering, or grabbing a sizable upfront cash payment from a partner in stable vitiligo.

Solt DB Invest modeling includes another 15% dilution from the last reported share count. In other words, shares may tumble if AVITA Medical announces a public offering of common stock, but the dip is already accounted for in our Margin of Safety ranges.

I mean for the following to be helpful for our diverse member base, not patronizing.

• This is a good time to note that the models we build here at Solt DB Invest – risk-adjusted net present value (rNPV) models – are used to determine a valuation (or a range of valuations) for a business.
• The range of valuations can be converted into a range of share prices, which we communicate as the Margin of Safety range.
• Valuations are converted into stock prices by knowing or estimating the number of shares outstanding. If a business has a valuation of $100 million and has 10 million shares outstanding, then each share is worth $10 ($100 million / 10 million shares = $10 per share).

Due to the nature of living tech businesses, it's wise to account for dilution when determining the number of shares outstanding. That's why we communicate these figures when discussing the Margin of Safety.

This will all make much more sense on our new website in June, which communicates information more smoothly than is possible on Ko-fi.

Margin of Safety & Allocation

(No change.)

AVITA Medical is considered a Growth (Quality) position. The current Margin of Safety range for the company based on our 2023 model is below:

• Current Price (market close April 17): $15.43 per share
• Likely Undervalued:          <$8.89 per share
• Midpoint:                           $11.55 per share
• Likely Overvalued:            >$14.22 per share
• Allocation Range:              Up to 15%

The Margin of Safety range shared in the dashboard is based on our 2023 model. Here's how the Margin of Safety range would change if based on our 2024 model.

• Current Price (market close April 17): $15.43 per share
• Likely Undervalued:          <$13.34 per share
• Midpoint:                            $17.34 per share
• Likely Overvalued:           >$21.34 per share
• Allocation Range:              Up to 15%

AVITA Medical reported 25.296 million shares outstanding as of February 13, 2023. The Margin of Safety range above assumes 29.090 million shares outstanding, which accounts for another 15% dilution.

Further Reading

• April 2023 regulatory filing (S-3) for the shelf registration
• April 2023 press release announcing ReCell Go regulatory update
• February 2023 article discussing full-year 2022 results and full-year 2023 revenue guidance
• November 2022 article discussing FDA Breakthrough Device designations for soft tissue repair and stable vitiligo