Pacific Edge — Operating revenue up 46% on strong US growth

Pacific Edge recently published H1 FY21 results with operating revenue growth of 46% to NZ$3.3m from NZ$2.3m in the same period a year ago. The US segment saw operating revenue increase 46% to NZ$2.9m while it increased 40% in the rest of world (primarily Australia, New Zealand and Singapore) to NZ$0.4m. Importantly, for July to September, the company saw a 117% year-on-year increase in US operating revenue (and reported record sales for the month of October). Total laboratory throughput decreased 16% globally while commercial test volume (81% of the total) fell 15% to 5,591 tests mainly due to the COVID-19 pandemic. In the US, commercial test volumes fell 25% while they grew by 18% in the rest of world. However, due to easing COVID-19 restrictions and the in-home sampling option, volumes recovered in the latter parts of the period and commercial test throughput was up 11% year-on-year in September.

The reason US operating revenues were still up 46% despite this decline in test volumes can be explained by the achievement of LCD inclusion, enabling reimbursement in the US by CMS. Before CMS reimbursement, approximately 43% of US Cxbladder commercial test volume was for CMS patients and those tests were typically not included in revenues as they were not reimbursed. Now they are reimbursed (with payment occurring within 30 days), they are being included in revenues and accounted for 67% of US commercial test volume in H1 FY21. Pacific Edge is negotiating the payment terms for the 22,634 tests previously billed but not paid (as of 30 June 2020). The revenue for these tests will be recognised if payment is obtained for these tests that were performed before CMS reimbursement was effective.

Outside of CMS, US private payers often base their own coverage decisions and reimbursement levels on the coverage listed in an LCD, so the success here with LCD inclusion is expected to lead to faster growth for the company and improves the prospects for coverage with other healthcare coverage providers. Pacific Edge is also seeking a positive shift in guideline inclusion language in bladder cancer, which may assist with obtaining additional private reimbursement.

Operating expenses for H1 FY21 were reported as NZ$11.2m, an 8% decrease compared to the prior year. This decrease is due to less expense from laboratory operations (due to lower throughput) and lower SG&A. Net operating cash flow loss decreased slightly from NZ$7.4m to NZ$7.6m in H1 FY21.

In June, Pacific Edge announced it reached an agreement with Kaiser Permanente, one of the largest non-profit health providers in the US, on the commercial use of Cxbladder by its urologists in patients being evaluated for bladder cancer. Kaiser Permanente has more than 12 million members (approximately 3.6% of the US population), operates 39 hospitals and employs 23,000 physicians, so this commercial agreement is a major milestone for the company, which we expect should provide a meaningful increase in revenues now commercial orders have begun (in November). Of note, more than 95% of Kaiser Permanente’s medical consultations are now telehealth, highlighting the importance of Pacific Edge’s in-home sampling system.

Our DCF-based valuation has increased to NZ$1,064m (NZ$1.46/share) from NZ$538m (NZ$0.78/share). This increase is mainly due to increasing our long-term revenue assumptions, as we are increasingly confident in the company’s market opportunity and competitive positioning despite the current temporary challenges related to COVID-19. Pacific Edge is investing heavily in the US business to maximize its ability to capitalise on the recent LCD inclusion as well as the validation from Kaiser Permanente. The company is adding frontline sales representatives, medical affairs experts and a dedicated team of specialists focusing on contract negotiations with private payers to gain greater coverage and inclusion in reimbursement networks. We previously estimated 2025 peak sales of NZ$228.5m with growth essentially being flat after that point. Our 2025 estimate is essentially unchanged, but we now expect meaningful growth to continue past that year, reaching over NZ$730m in 2030.

To put these estimates into perspective, EY-Parthenon has previously estimated the size of the addressable market in the US (see Exhibit 1). It includes seven million patients who present with haematuria each year and would be candidates for Cxbladder Triage. A further 3.4 million potential patients can then be evaluated for urothelial cancer by Cxbladder Triage or Cxbladder Detect. 81,000 patients who are diagnosed with urothelial cancer can then have their cancer graded by Cxbladder Resolve. Finally, there is the surveillance segment of 800,000 patients who are candidates for Cxbladder Monitor, who are monitored three to four times per year for recurrence for five years (2.4–3.2m tests for this segment). From end to end, this is a potential end-user market covering more than 13m tests. Using the current CMS reimbursement rate of US$760 per test, this indicates a total potential addressable market of approximately US$10bn (over NZ$14bn). The urology market alone (which is the initial focus for the company), with its more than 6m potential tests per year, has a total potential addressable market of just less than US$5bn (around NZ$7bn).

Rolling forward our DCF and higher net cash also helped increase the valuation for the company. This was partially offset by more conservative near-term revenue estimates as a second wave of closures are occurring in the US. Additionally, we have increased our estimates for cost of goods (as it will take some time to recognize economies of scale) and operating expenses (as the company invests more for US growth). The per share value was also affected by share issuance related to a NZ$22m placement in July.

Following the results for H1 FY21, we are decreasing our FY21 revenue estimate to NZ$13.2m from NZ$20.2m and our FY22 estimate from NZ$44.1m to NZ$34.3m as the second wave of closures in the US due to COVID-19 may further affect test volumes in the near term as well as the growth trajectory in FY22 (we expect any impact from COVID-19 past this point to be minimal due to the recent vaccine announcements). Hence, it appears prudent in our view to err on the side of caution. Additionally, Kaiser Permanente commercial orders are just getting started and the ramp-up is unknown. In our previous note we calculated Kaiser Permanente as a NZ$33.4m annual opportunity for Pacific Edge, although that could take some time to achieve. We have also increased our estimate for operating expenses by NZ$2.8m in FY21 despite a lower-than-expected run rate in the first half as the company has stated its intention to invest in the US business by adding to commercial personnel. We have also increased our operating expense estimate for FY22 by NZ$10.0m mainly due to the increased cost of laboratory operations (which are a direct function of increased test volumes) and increased SG&A.

The company reported NZ$29.3m in cash, cash equivalents and short-term deposits as of 30 September 2020. It has NZ$0.8m in debt, which is due to a loan from the US Paycheck Protection Program, a COVID-19 related business support scheme. The loan may potentially be forgiven without repayment but if not, it will need to be repaid by April 2022.

Pacific Edge raised NZ$22m in July from ANZ New Zealand Investments, one of New Zealand’s largest asset managers with NZ$33bn under management. These 33.8m shares were purchased at NZ$0.65 per share, which at the time was a 14% premium over the volume weighted average price over the preceding five days.

We now expect profitability in FY23 (formerly FY22, although it would be still cash flow positive in that financial year) due to the more conservative near-term estimates and do not forecast any additional financing needs for the company.