AVITA Medical announced today that the U.S. Food and Drug Administration (FDA) requested more information during the regulatory review process of its third-generation device. Known as ReCell Go, the advanced version of the company's product platform will fully automate sample preparation for doctors and nurses. Importantly, it will enable higher margins and accelerate revenue growth due to higher consumables revenue potential.

The setback means the regulatory review will be paused for up to six months. This development essentially reverses the time advantage of the Breakthrough Device designation, which expedites regulatory review by six months. The delay means ReCell Go could potentially launch in May or July 2024 instead of January 2024.

As far as investors are concerned, the delay places the device on the original regulatory timeline. AVITA Medical previously expected the device to launch in the second half of 2024. Considering the sharp decline in shares today, Wall Street appears concerned the FDA will require a clinical trial for ReCell Go.

That remains a possibility. As we wrote in our first-quarter 2023 research note (bold in original):

The product candidate has Breakthrough Device designation, which means it could earn regulatory approval by the end of 2023 or early 2024. Approval is not guaranteed and might require an additional clinical trial (or more real-world data), which would negatively impact our 2024 model.

Although AVITA Medical will benefit from the efficiency gains of ReCell Go, the business has a solid growth trajectory in 2024 and 2025 with or without the device.

ReCell Go's Accelerated Timeline is a No-Go

ReCell Go is classified as a Class III medical device because it's used in serious, life-threatening applications. That means it must proceed through the strictest regulatory pathway, including a clinical trial and Pre-Market Approval (PMA) application.

AVITA Medical was able to file a PMA supplement (sPMA) (yes, a confusing acronym…) for the next-generation device. In other words, the FDA already accepted the safety and efficacy of the previous devices, so this essentially would be treated as an updated version. The sPMA also allowed ReCell Go to retain Breakthrough Therapy designation from the prior-generation device.

Analysts are thinking the FDA's request for more information could jeopardize the entire regulatory pathway, which could end with AVITA Medical being required to conduct a small clinical trial to prove ReCell Go is equivalent to the previous device. In other words, a delay of years instead of six months.

It's certainly possible. It helps to understand what specific components regulators are evaluating within the sPMA submission:

• ReCell Processing Unit (RPU) functional testing to ensure the device meets criteria for calibration, run sequence, and lock-out functionality. Temperature logs for the heating cycle are also evaluated.
• RPU environmental use conditions testing to verify the device operates acceptably within the specified limits, such as the temperature, humidity, and pressure of the room.
• Cell suspension characterization to understand if spraying cells onto wounds changed the cells significantly prior to and after spraying. Additionally, cell suspensions were testing to determine the proportion of non-viable (dead) cells.
• Cell suspension reproducibility to understand the similarity of one application to the next.

The existing ReCell product is a single-use medical device. ReCell Go is a benchtop device intended to be used up to 300 times before needing to be replaced. Although the FDA allowed AVITA Medical to submit a regulatory application through the supplemental pathway, perhaps that was a little ambitious considering the significant differences between ReCell Go and its predecessor.

Investors don't know what types of data were requested or whether the request pertained to the hardware, biology, or both.

A request for more data isn't necessarily a showstopper. AVITA Medical has time to submit a complete response to the FDA's concerns, which will then resume the regulatory review process under the previous timeline. That means the remaining review will still only take three months, there's just a four to six month pause in between.

If regulators aren't satisfied with the data provided, then the FDA may reject the sPMA and require AVITA Medical to conduct a small clinical trial before trying again. That would delay approval and market launch into 2025 or 2026. This scenario would be a bummer for the current emergency indications of ReCell in burns and tissue repair, but it would have a more severe impact on the stable vitiligo market opportunity (not expected to launch until 2025), as a fully-automated device is more important in a dermatology setting.

Lessons for Management

Shareholders rightfully exhaled when the board of directors of AVITA Medical removed the former CEO and appointed chairman Jim Corbett in his place in September 2022. The former CEO had the charisma of a cardboard box and set the company's growth trajectory on an uninspiring glacial pace.

One key example of that was the seemingly slow development and regulatory plan for ReCell Go. Jim Corbett made the device a core part of a reinvigorated pitch to investors. It worked. Existing business growth picked up just as the company prioritized its transition to ReCell Go.

But there are risks to putting products on a pedestal, especially when delays occur.

The new management team has succeeded in changing the story of AVITA Medical. It also made two regrettable missteps:

• AVITA Medical failed to take advantage of a rising share price and raise growth capital. The average share price in the last six months is over $15, while shares peaked at $21.70. A high(er) share price doesn't guarantee a public offering of common stock will be successful, but it makes the dilution less painful. A share offering seems unlikely, or more devastating, now.
• CEO Jim Corbett has held multiple investor webinars to hype the investment opportunity to retail investors. Maybe it's just a new way to connect with shareholders in 2023, but it seems unnecessary. I'm aware of multiple companies doing the same (Amyris, Bionano Genomics, and so on), but I can't name any that have ended up being successful investments. Investor webinars are meant to create buzz and attract attention, but having more eyeballs and recognition can backfire when bad news drops.

Forecast & Modeling Insights

(Removed full impact of ReCell Go.)

Solt DB Invest is reducing its full-year 2024 estimates for revenue, gross margin, and operating margin. We're making a conservative adjustment to remove any impact from ReCell Go in 2024.

The third-generation device was projected to have a relatively small impact on 2024 operations, as it would take time for trauma centers to adopt ReCell Go and exhaust inventory of prior-generation devices.

Additionally, the value of a benchtop device such as ReCell Go is the ability to create high-margin consumable pull-through, which builds over time. A benchtop device is sold once (these devices will technically need to be repurchased every few years), whereas the kits and panels needed to operate a benchtop device must be repurchased with every use.

That means 2024 is (was) about getting ReCell Go into the hands of customers, but a significant acceleration of revenue likely wouldn't have been observed in burns and tissue repair until 2025. That's also true for stable vitiligo, although the next-generation device is more critical to the overall market opportunity. Burns and tissue repair can largely carry on without it.

A summary of our updated 2024 model:

• Full-year 2024 revenue of approximately $77.59 million (vs. $82.81 million previously), gross margin of 84% (vs. 85.5% previously), and an operating loss of $24.2 million (vs. $18.5 million previously).
• Our 2024 model doesn't include the impact of international expansion, which is expected to be announced on the November 2023 earnings conference call.
• Our 2024 model doesn't include the impact of a potential new procurement agreement with the U.S. Biomedical Advanced Research and Development Authority (BARDA) to adjust the Strategic National Stockpile (SNS) inventory following the approval in tissue repair. This could add an additional $7.5 million to $15 million in revenue during a 12- to 36-month contract.
• Our 2024 model doesn't include the impact of a potential licensing agreement for the stable vitiligo indication. This could generate an upfront cash payment of over $100 million depending on how much downstream value is retained by AVITA Medical.

Investors are reminded of the existing growth trajectory in burns and tissue repair without ReCell Go:

• AVITA Medical's latest full-year 2023 revenue guidance expects at least $51 million, representing year-over-year growth of at least 48%.
• The business will only generate revenue from tissue repair indications for approximately half of 2023 (it launched mid year). Solt DB Invest expects the product to ramp significantly in 2024 with minimal acceleration attributed to ReCell Go.
• AVITA Medical expects to achieve third-quarter 2023 revenue of roughly $13.5 million, representing year-over-year growth of 50%.
• To meet guidance the business would need to achieve fourth-quarter 2023 revenue of at least $15.9 million, representing year-over-year growth of 70%. That would put the business on an exit rate of at least $64 million in revenue heading into 2024.

Investors need to watch developments for ReCell Go, which is important for the long-term trajectory of the business. But it very much remains a 2025+ catalyst. Importantly, the existing business is capable of delivering AVITA Medical to between $85 million and $100 million in full-year 2025 revenue -- and profitability.

Margin of Safety & Allocation

(Removed full impact of ReCell Go.)

AVITA Medical is considered a Growth (Quality) position. The current modeled fair valuation for the company based on our 2024 model is below:

• Market close October 2, 2023:  $10.81 per share
• Midpoint:                            $17.21 per share
• Allocation Range:              Up to 15%

AVITA Medical reported 25.478 million shares outstanding as of August 2, 2023. The Margin of Safety range above assumes 29.300 million shares outstanding, which prices in 15% dilution.

Further Reading

• October 2023 regulatory filing (8-K) announcing the FDA's request for more data
• May 2023 research note providing the latest of analysis on ReCell Go
• April 2023 research note discussing ReCell Go in depth compared to the prior-generation device