Description

Thesis:

MiMedx creates Amniotic tissue grafts for wound healing and surgical applications. Their largest product (80% of revenue) is called EpiFix and looks like a piece of wax paper that doctors put on deep wounds to stimulate healing. The Company bought EpiFix in 2011 for $9m when it had $1m of revenue and has grown the product into a $180m revenue product with about a $1bn valuation (a 225% IRR over 4 years). We think that the product has very little competitive differentiation and their revenue growth was due to aggressively marketing a product with debatable efficacy and exploiting reimbursement loopholes / misaligned incentives in the U.S. healthcare system. EpiFix also benefited from a competitor’s issues leading to a one-time share gain that we view as unsustainable. We are seeing fundamentals start to deteriorate and an extremely challenging regulatory environment leading us to question the sustainability of the revenue growth and their ability to meet consensus expectations.

On October 28th, the FDA came out with a Draft Guidance which challenges the Company’s flagship product EpiFix. The FDA will make a decision at the end of 1H 2016 on how to proceed. In a worst case outcome for MiMedx, the FDA could decide to recall the Company’s products. Regardless of their decision, we feel comfortable the valuation does not reflect the inherent risks and the Company has meaningful risk to business fundamentals from here.

Table of Contents:

1. The Products

2. FDA Scrutiny

3. The Competitive Landscape

4. MiMedx's Revenue Growth

5. Deteriorating Fundamentals

6. Valuation

1. The Products: EpiFix (80% of Revs) & AmnioFix (20% of Revs)

1. Amniotic Tissue

MiMedx is a manufacturer of amniotic tissue products through its 2 largest categories: EpiFix for wound care and AmnioFix for Surgical use.

While a baby is in its mother’s uterus there is a membrane that surrounds the baby called an Amniotic Sack. The Amniotic Sack protects the baby and acts to retain amniotic fluid. During an elected C-Section the mother is cut open, the amniotic sack is popped and the baby is taken out of the in-utero environment. Historically, that sack was thrown away however there has been a push over the last several years to use the sack and other in-utero tissue for pharmaceutical purposes. MiMedx contracts with hospitals to procure amniotic membranes (free of charge!) and then dehydrates those membranes into a wax looking band-aid which is used as a “wound healing device.” The most common use for the product is a Podiatrist treating diabetic foot ulcers.

2. Commoditized and Unproven Product

None of MiMedx’s products have been proven to be efficacious by the FDA and there has been no clinical trial submitted to the FDA. This is because MiMedx is classified as a Human Cell Tissue Product under section 361 by the FDA. Because the product was classified as a Homologous Product (Take Human A’s Organ -> Put on Human B’s Organ) it does not require the strict protocols (clinical trials, stringent protocols, proof of efficacy and safety) included in a normal New Drug Applications. We believe this presents a loophole for companies like MiMedx to bring products to market and charge high prices without clinical trials.

As we will later discuss, the FDA has now clarified the definition to qualify for section 361 and we believe MiMedx does not qualify as a Human Cell Tissue product anymore. Should the Draft Guidance be unchanged once Final Guidance is published, the Company will likely have to prove their safety and efficacy through clinical trials.

While the company has not submitted clinical trial for FDA review, MiMedx has published a number of clinical trials for marketing purposes. All of their trials reference their first published trial which examines EpiFix’s efficacy vs. an untreated control group. We have examined the study and we do not believe the Company performed a fair and balanced trial. The diagram below is a screen shot taken from the published trial which analyzes the EpiFix group vs the control group:

The control group tended to be 5 years older, their wounds were 38% larger and they were 15% heavier. They only looked at 25 patients vs. competitor clinical publishings of 200+ patient trials. We doubt that any unbiased doctor would feel comfortable respecting the efficacy claims in this report. We believe the trail was created for marketing purposes to convince consumers and investors of the product’s differentiated competitive nature.

We understand that the existence of a weak clinical trial does not prove the lack of efficacy for the EpiFix product. However, after speaking with many doctors we feel comfortable that the product is viewed as clinically undifferentiated.

3. Least Economical Product

The Company sells the product to doctors who then use the product on patients and get reimbursed from the appropriate Payor. Until 2014, the Company has benefited from a special CMS reimbursement classification and other 1-time non-recurring changes to the competitive landscape that has allowed it to be a very economical choice for doctors. Because of a CMS change to “bundled” reimbursement EpiFix is now the least profitable product at almost every single wound size for doctors and hospitals. Prices in the industry are fairly opaque but their presence at the VA requires all VA players to publish their prices here. (http://www.va.gov/nac/index.cfm?cboContractNumbers=&cboBPAContractNumbers=&cboBOAContractNumbers=&cboContractorName=&cbo_SIN_Number=A-20C&cbo_SIN_Description=&cbo_fss_schedule_number=&cbo_Contract_Types=&txtCriteria1=EpiFix&Sort=1&Count=400&search=Search&template=Search_MedSurg_Catalog)

Screen shots from EpiFix and some of their competitors’ prices are referenced above. If you take each of the screen shots and look at the area covered for each graft relative to the price; EpiFix is almost always the most expensive product at every size wound. In fact, it is never the most economical choice for the doctor. If you include some of the other products which are not provided above (Puraply is reimbursed at 6% + cost [$109/cm^2]) and Dermagraft [$1,250 for a 37.5 cm^2 graft]) it really illustrates how uneconomical EpiFix really is.

We think the reimbursement landscape has evolved negatively for MiMedx prospectively and could impact market share / growth for MiMedx in the coming quarters and years as these changes flow through the system.

2. FDA Scrutiny

1. Untitled Letters

The Allograft space has had a cloud of regulatory scrutiny since August 2013 when MiMedx’s surgical product AmnioFix (20% of revenue) was the subject of an Untitled Letter. An Untitled Letter is the FDA’s initial correspondence with a regulated industry in which it cites violations that do not meet the threshold of a Warning Letter. In the last 18 months, the FDA biologics group has sent out 22 Untitled Letters; 5 of which have gone to players in the Amniotic tissue allograft space (http://www.fda.gov/BiologicsBloodVaccines/GuidanceComplianceRegulatoryInformation/ComplianceActivities/Enforcement/UntitledLetters/ucm091547.htm). We think this data point suggests that the FDA is taking serious actions for more regulations of this category.

The August 2013 Untitled Letter alleged that AmnioFix was more than minimally manipulated in its commercial form thus disqualifying the product’s status under section 361 as a Human Cell Tissue product. In order to regain its regulatory distinction the FDA ruled that the Company would be required to file a Biologic License Application (“BLA”) which takes years, costs millions of dollars and only leads to a 30% success rate at the end of the 36 month period. (http://www.fda.gov/aboutfda/reportsmanualsforms/reports/userfeereports/performancereports/ucm209349.htm).

During this time period the Company has not been allowed to market their AmnioFix product but they have been allowed to sell it. The marketing process is a key part of producing revenue for MiMedx and as the graph below illustrates, the BLA lead to a meaningful deceleration to AmnioFix’s revenue growth from 100% YoY to virtually no growth.

2. Draft Guidance

At the beginning of 2014, the FDA started addressing the industry broadly with the release of 3 Draft Guidance documents. The first Draft Guidance clarifies the FDA’s opinion on minimal manipulation and broadly challenges all AmnioFix like products. The more interesting Draft Guidance was released on October 28th, 2015 (http://www.regulations.gov/#!documentDetail;D=FDA-2015-D-3581-0002) and challenges the Company’s flagship product EpiFix.

The recent Draft Guidance clarifies the FDA’s opinion on Homologous use and contains the quote below:

“The basic functions of amniotic membrane include serving as a selective barrier for the movement of nutrients between the external and in utero and to retain fluid in utero. An amniotic membrane product is used for wound healing of dermal ulcers and defects. This is not homologous use because wound healing of dermal lesions is not a basic function of amniotic membrane.”

–FDA Draft Guidance - October 2015

Our read of the quote above is very clear and explicitly states that EpiFix (an amniotic membrane product) which is used for wound healing is not homologous. We don’t see much more room for interpretation and after reading many of the historical Untitled Letters we think that the most likely result will be a required BLA. As evidenced by the graph above, a BLA will likely limit the Company’s ability to market the product which will negatively impact revenue growth. Our view is that the market would not take kindly to a 0% revenue growth Company that is valued at 4x revenue and has revenue CAGR’d at 200% for the last 4 years. Further, a BLA is a 36 month very expensive process with a 30% approval rating which could create a meaningful overhang on the company.

The Company responded to the Draft Guidance with a White Paper on its IR page (http://phx.corporate-ir.net/phoenix.zhtml?c=213465&p=irol-irhome). In the White Paper the Company gives many examples of FDA published documents that define when using Amniotic tissue is Homologous. Only one of these examples state that using the tissue for wound healing is homologous. The 2005 OKTOS Untitled Letters states that the “FDA has recognized that amniotic membrane that has not been dehydrated or decellularized may be used for wound repair and wound healing”. Not all amniotic tissue products are dehydrated but EpiFix most definitely is. We see this as an opportunity for some of the other non-dehydrated cellular products to escape FDA scrutiny and begin to take significant share from MiMedx. Most importantly, we don’t think there is much room for interpretation and expect that the FDA will require MDXG to file a BLA in the near future.

The quote below from the FDA’s Tissue Reference Group (the group which provides a single reference point for product specific questions received by the FDA) gives us further confidence:

"A dehydrated amniotic membrane product for wound covering and healing for dermal ulcers and defects does not meet the criteria for regulation solely under section 361 of the PHS Act because healing of dermal ulcers and defects is a non-homologous use for amniotic membrane."

• - FDA Tissue Reference Group -2014 Annual Report

Finally, Apligraf and Dermagraft (EpiFix Competitors and the 2nd and 4th largest products in the category) are not regulated under section 361 but rather are classified as a device under a PMA. Should the FDA make a ruling on the product category these 2 products could be shielded and will benefit from a significant competitive advantage.

3. So What Happens Next?

When the FDA published their initially Draft Guidance which alleged that AmnioFix did not qualify under Section 361 the Company laid out 3 possibilities as a potential outcomes that we summarize as:

1. This is just a labelling / advertising issue: The Company will have to change its labelling and marketing practices and will not be able to claim that the product has healing properties.

2. BLA: If EpiFix takes the same path as AmnioFix this could eliminate growth using the AmnioFix precedent. Apligraf and Dermagraft are regulated as PMA’s and are not subject to this new scrutiny and have been proven to be safe and efficacious by the FDA.

3. Recall: ~80% of revenue would likely go to zero in this case…MiMedx should need to file an NDA and start from scratch which probably does not make economic sense

The Company has stated that they expect to have Final Guidance around July 2016.

3. The Competitive Landscape

1. The Players

The industry is generally divided according to the chart and descriptions below:

Today MiMedx is the largest player in this ~$800m market. We believe this is due to certain 1-time non-recurring competitive and regulatory events.

Given the Company’s commoditized product offering and their very high gross margins there has been a considerable amount of new entrants into the space which are not shown in the diagram above. Many of these products are very similar to MiMedx and MiMedx is currently in a patent dispute with 4 competitors including the non-profit Musculoskeletal Transplant Foundation. These competitors are gaining the necessary reimbursement codes and we estimate that in 6-12 months, many of the competitors will be fully reimbursed by Medicare and could start to compete for share and impact market prices for these products. Competitors should be able to underprice MiMedx’s products significantly given the Company’s very high gross margins.

2. The Wound Care Space: Aggressive Selling Accusations

Based on our work, we believe that wound care products are aggressively sold as evidenced by MiMedx spending 70% of revenues on SG&A. In fact, 4 Advanced BioHealing (“ABH”) formers were recently named in a plea deal alleging Kickbacks and Fraud related to their sale practices with VA Podiatrists and other doctors. A simple LinkedIn scrape of ABH formers shows a large number of salespeople left ABH for MDXG near the time of the alleged Kickbacks and fraud.

Around the departure of these ABH employees, MDXG was able to increase their VA revenues from 40% of total revenue in 2012 to 60% of total revenue in 2013. Further, there are some radical accusations related to sales practices on the CafePharma blogs (some of which we have provided below). We do not have any information in regards to a potential investigation of MiMedx but we point to the former aggressive ABH employees at MDXG and the CafePharma blogs to illustrate the sales culture in the industry and around MDXG.

http://cafepharma.com/boards/threads/mimedx-opportunity-on-the-surgery-side.577943/

http://cafepharma.com/boards/threads/mimedx-money-the-first-year.588854/

http://cafepharma.com/boards/threads/epifix-mimedx.517437/

4. MiMedx's Revenue Growth: 2 1-time Non-Recurring Events

MiMedx has benefited from a 260% 4-year revenue CAGR. We have identified two 1-time non-recurring events which the Company was able to take advantage of. We are not sure whether this was skillful or lucky however we don’t think it matters given the non-recurring nature of these events. The events include: The 2012 OIG investigation of Dermagraft and the 2014 CMS reimbursement change.

4.  

5. Deteriorating Fundamentals

Growth in 2015 has been decelerating dramatically as evidenced in the graph above. We have identified several competitors that have entered the space and are gaining MAC coverage (Medicare Administrative Contractor). The Companies include: Allowrap, AmnioBand, Guardian, AmnoGraft, BioDDryFlex, Neox, NuSheilf and Revitalon, just to name a few. Success in this market is generally based on Medicare and MAC reimbursement; which take 6 - 12 months to secure.

1. AR Days Spike

The Company has had a good track record of exceeding their quarterly revenue guidance. This past quarter, MiMedx barely made their revenue guidance registering a 0.0003% beat. Strangely AR days increased 35% YoY at the same time to a 7-quarter high. The decelerating revenue growth coupled with a spike in A/R days is a red flag worth considering.

2. Evidence of Share Loss at the VA

By tracking publicly available government data, we are also seeing evidence of smaller competitors starting to take significant share at the VA. The chart below illustrates the first signs of market share decline at the VA for MiMedx. Competitors like Grafix are rising quickly and may chip away further at EpiFix’s dominate position.

We believe that Osiris’ (OSIR) Grafix product is beginning to take significant share at the VA. We went through USSPENDING.GOV to get an understanding of how the competitive landscape has changed at the VA. We recognize that this is not a perfect data source as the numbers do not tie out to the stated VA revenues on MiMedx’s filings. This is most likely due to the various spellings that doctors input into the system. “Graffix”, “Osiris Graft”, “Osiris Graph”, “GRAFXA” are all examples of keywords that doctors had inputted into the system. As a result we were just looking for some kind of obvious relationship. The graph illustrates Grafix’s increasing share in the VA and we think this speaks generally to the increasing competitive landscape in the space.

6. Valuation

The Company is currently trading at FYE 2015 EV/ Revenue of 4.6x and 2016E P/E of 41.6x. OSIR, the maker of the amniotic tissue product Grafix, which faces the same competitive and regulatory hurdles is trading at 3.2x sales and Integra is trading at 3.4x sales. We view the multiple as not reflecting the inherent risks in the fundamentals of the business on a relative and absolute basis.

Risks:

• Continued Private Payor coverage

• The FDA says “Whoops…never mind we were wrong about everything”

Catalyst

• Short Term (Q1 2016) - Competition could continue to take more share and the Company exited last Q with very high levels on A/R days suggesting a potential pull forward of revenue.

• 30 - 90 Days after April 19th, 2016 – The industry has until April 19th to respond to the Draft Guidance. According to the Company, it may take the FDA 30 - 90 days to read all of the comments and respond with Final Guidance. We expect that the Final Guidance will require the Company to file a BLA or recall their product.

Disclaimer: The write up is not investment advice or a recommendation or solicitation for any fund or to buy or sell any securities now or at any time. The author and related persons may hold a position and make no representation that it will continue to hold long or short positions in the securities and disclaims any obligation to notify the market of any changes. The author and related persons may change its views about or its investment positions at any time, for any reason or no reason. This includes buying, selling, covering or otherwise changing the form or substance of its investment. The author disclaims any obligation to notify the market of any change. The information and analysis presented is based on publicly available information through filings, sell-side research, industry analysts and/or company or otherwise sourced. The author recognizes that there may be non-public information in the possession of the company or others that could lead the company or others to disagree with the author's analyses, conclusions and opinions. Any forecasts or estimates should not be relied upon (not the least due to the disclosure) and could turn out to be incorrect. While the author has tried to present the facts it believes are accurate, the author makes no representation or warranty, express or implied, as to the accuracy or completeness of the write up, and expressly disclaims any liability relating to the write up or such communications (or any inaccuracies or omissions therein). Thus one should conduct their own independent analysis before independently considering a position in securities. Except where otherwise indicated, the write up speaks as of the date, and the author undertakes no obligation to correct, update or revise the write up or to otherwise provide any additional materials.