Pacific Edge — Anticipating commercial growth

Pacific Edge Ltd. (PEB) was formed in August 2001 to develop molecular diagnostic and prognostic tools, in cancer. It is headquartered in Dunedin, New Zealand, and has two wholly owned subsidiaries commercialising Cxbladder, Pacific Edge Diagnostics NZ Ltd. in Dunedin and Pacific Edge Diagnostics USA Ltd. (PED USA) in Hershey, Pennsylvania. The company also has laboratories in both locales with Dunedin being CLIA-certified and IANZ accredited, while Hershey is CLIA-certified and CAP accredited. Pacific Edge joined the NZX in February 2002 and has raised total funds of over NZ$100m to date. Its first product was approved in New Zealand in 2011.

Cxbladder Detect, the first of the company’s four products, is a non-invasive urine-based test that detects bladder cancer in people presenting with hematuria (blood in urine). It was rolled out initially in New Zealand and Australia, and subsequently launched in the US in July 2013. The company has since launched additional bladder cancer tests focusing on differing value propositions identified by physicians and clinicians to provide a comprehensive diagnostic toolkit. In December 2016, Cxbladder Monitor was launched in the US while its fourth product, Cxbladder Resolve, was launched in New Zealand. Pacific Edge runs its own product development programmes and has first rights to any new discoveries from the University of Otago’s Cancer Genetics Laboratory.

Using a DCF methodology, we value Pacific Edge at NZ$434m (NZ$0.93/share). We forecast overall peak sales of NZ$256m for the Cxbladder franchise in 2025. In the midst of a somewhat protracted global roll out for its initial products, we note there is still some uncertainty as to the full sales potential of the group, particularly given the complexities and vast size of its target market.

Pacific Edge is now ramping up sales efforts in the commercialisation of its Cxbladder franchise in the US. The company completed a capital raise of NZ$21.3m in November 2017 and had net cash of NZ$4.0m at 30 September 2017 (which does not include cash from the November raise). We forecast profitability in FY20, which is a delay from FY19 previously due to a slower than expected sales ramp in the US. We note that a large portion of the company’s remaining cost base is variable as it outsources manufacturing, billing and reimbursement. Current laboratory facilities have the capacity to accommodate our forecast sales to 2031.

Pacific Edge has made considerable inroads on its way to full commercialisation in the crucial US market. Wider acceptance of its Cxbladder products in the US will be driven by the rate of conversion of ongoing User Programmes into fee-paying customers. Cxbladder products are now undergoing evaluation by a number of clinicians and key opinion leaders. Negotiations are proceeding with key organisations including the Centres for Medicare and Medicaid Services (CMS) (which covers c 35% of the US population) and other large private healthcare providers, which may take longer than expected. We do not see a near-term competitive threat to the Cxbladder portfolio of products. Further out, the company runs the risk of potential competition from new diagnostics tests. However, clinical validation will be critical for new competitive technologies and the long lead time to commercial adoption for Pacific Edge as well as their portfolio of products serves as a formidable, high barrier to entry.

Pacific Edge develops and commercialises molecular tests for the detection and better management of urothelial cancers (UC) and is the only company worldwide to offer multiple molecular diagnostic tests for bladder cancer. The company has created a franchise of products that can be commercialised through the same channels under the Cxbladder banner to meet a series of unmet needs along the same clinical pathway. The underlying aims are to meet the clinical needs of urologists, notably a reduction in the length of current, repetitive and invasive diagnostic testing for UC, and an improvement in accuracy over those tests currently in the market. The first test in the range, Cxbladder Detect, has been shown in clinical studies to be more accurate than benchmark tests at all stages and grades.

Pacific Edge is working towards fully commercialising its bladder cancer testing, reporting a 68% increase in US sales for the year ended 31 March 2017, albeit off a low base and including healthcare organisations’ testing through User Programmes. A number of these User Programmes are underway in the US, most notably a large-scale testing by Kaiser Permanente, which concluded in November 2016 and demonstrated positive results. In Singapore, three hospitals, including Tan Tock Seng Hospital and Singapore General Hospital, have commenced User Programmes and are trialling the potential for Cxbladder products in South-East Asia (SEA) for patients needing testing for bladder cancer as well as those coming to SEA for routine medical check-ups. Sales in the smaller New Zealand market are building steadily. In August of this year, Pacific Edge announced its third commercial contract in New Zealand with the MidCentral District Health Board to integrate the entire suite of Cxbladder tests into the standard of care for UC diagnosis and monitoring.

Pacific Edge’s Cxbladder products are regulated in the US as laboratory-developed tests that can be used for detecting bladder cancer in patients who present with hematuria in conjunction with standard urological work-up, a patient population of around seven million annually in the US. The Cxbladder technology is gene based and can be used as a non-invasive adjunct to cystoscopy or to replace other urine-based tests to identify more accurately those patients who should go on for more invasive testing. In New Zealand, Cxbladder has replaced the use of cystoscopy for some of the low risk patients. It is more accurate, faster, less invasive and more cost-effective than standard methods that include cytology, NMP22 BladderChek (Alere), NMP22 ELISA (Fisher Scientific) and UroVysion FISH (Abbot).1 Cxbladder Detect quantitatively measures the expression of five mRNA biomarkers in a small sample of the patient’s urine that has been collected non-invasively. Pacific Edge has developed a set of algorithms that combine cancer biomarkers into a single score to detect and characterise bladder cancer. The urine sample is screened using a quantitative polymerase chain reaction validation, a process that amplifies a small RNA sample. This system indicates a score-based probability of urothelial carcinoma: 0-0.12 normal; 0.12-0.23 elevated; and 0.23-1.0 high based on gene expression; the company’s newest test, Cxbladder Resolve, can be used to classify existing tumours by grade and was launched in New Zealand in December 2016.

Its second product, Cxbladder Triage, was first launched in New Zealand in December 2014 and targets physicians in the primary and secondary care of patients who present with hematuria in New Zealand and Australia and urologists in the United States. Cxbladder Triage includes the same five genomic biomarkers as Cxbladder Detect adding four phenotypic variables to give a new algorithm. Cxbladder Triage is used to rule out cancer by its high sensitivity and high negative predictive value. Follow on tests Cxbladder Monitor and Cxbladder Resolve (formerly Predict) are aimed at different value propositions in the evaluation and monitoring of UCs detailed below.

Bladder cancer is the sixth most common cancer worldwide and has the highest per patient medical scost of any cancer.2 There will be an estimated 79,000 new cases diagnosed in the US in 2017. Patients who present with non-muscle-invasive bladder cancer experience high recurrence rates of 15-61% and 31-78% after one and five years, respectively.3 Consequently, the American Urological Association (AUA), National Comprehensive Cancer Network (NCCN), and European Association of Urology (EAU) guidelines suggest intensive surveillance procedures involving cytology (manual examination of a urine sample under a microscope), which tends to have low sensitivity (true positives), particularly at the earlier stages of cancer, and is subject to user variability, as well as cystoscopy (insertion of a flexible scope into the urinary tract) every few months for several years after primary treatment.4

Cxbladder Detect is clinically validated by a multicentre clinical study in 485 patients in Australasia, which compared the test to the benchmark urine tests. Pacific Edge has also completed a further blinded user study in 178 patients, which showed an equivalent rate of performance. Voided urine samples were analysed using Cxbladder, NMP22 ELISA and NMP22 BladderChek, and urine cytology and sensitivity (true positives) and specificity (true negatives) compared to cystoscopy as a reference.

The study showed Cxbladder Detect to be more accurate than cytology and NMP22 tests across all stages and grades at a pre-specified specificity of 85% including stage Ta, which is a potential advantage given the low sensitivity of other tests for early-stage bladder cancer. Furthermore, Cxbladder Detect identified five UCs that had not been diagnosed by cystoscopy, but were subsequently confirmed in a 12-month follow-up. The results were published in the International Journal of Urology in September 2012.

Cxbladder Detect also compares favourably against Abbott’s UroVysion looking at separate large-scale clinical trials, each with over 400 patients. UroVysion was launched 2001 as an aid in monitoring bladder cancer and in 2005 to aid diagnosis. The test uses Abbott’s FISH fluorescence technology to detect chromosomal abnormalities. In a trial conducted by Abbott, UroVysion showed an overall sensitivity of 68.6% and specificity of 77.7% in detecting bladder cancer in 479 patients presenting with hematuria. This compared with a sensitivity of 82% and specificity of 85% for Cxbladder Detect in the separate study detailed above. We note some caution must be used with the comparisons given tests were not compared head to head.

In 2017, Pacific Edge published two clinical studies evaluating Cxbladder Monitor. Cxbladder Monitor for UC recurrence is internally clinically validated by a multicentre US study, which analysed 1,036 voided urine samples from 763 patients undergoing routine surveillance, including cystoscopy, from October 2012 to November 2015. The independent clinical validation of Cxbladder Monitor showed a validated sensitivity of 93%, a negative predictive value (NPV; true negative) of 97%, and a test negative rate of 34%. For all high-grade disease and low-grade stage T1 or greater, sensitivity was 95%, while sensitivity was 85% for low-grade Ta disease. Furthermore, of the 1,036 individual samples used in the development and validation of Cxbladder Monitor, 1,016 samples (from 748 patients) collected were used for clinical comparison to non-invasive tests that include cytology, NMP22 ELISA (Fischer Scientific), and NMP22 BladderChek (Alere) for ruling out recurrent UC. The study showed Cxbladder Monitor to be more accurate than cytology and NMP22 tests across all stages and grades as demonstrated by high sensitivity and high NPV, which is essential to an effective rule-out test.

Additionally, Abbott’s UroVysion FISH was performed on 145 samples because of either atypical local cytology, physician request, or performed independently of cytology analysis. UroVysion FISH demonstrated a sensitivity of 33% and an NPV of 92%, consecutive cytology and UroVysion FISH yielded a sensitivity of 38% and an NPV 93%, in comparison to Cxbladder Monitor, which showed a sensitivity and NPV of 93% and 98%, respectively. However, the UroVysion FISH test was not part of principal pathologic review and the data was obtained from a comparatively low sample size.

There are a number of commercially available in-vitro diagnostic (IVD) tests to detect and monitor bladder cancer in hematuria patients, although the specificity and sensitivity of such tests is variable. NMP22 has been widely adopted as an adjunct to cytology. However, no other test is being used as standard, as none has been shown to be more accurate than the existing benchmark.

Of the many diagnostic tests currently in development for detecting and monitoring UCs, all are in early stages of development, and none, as yet, has shown equivalent or better overall accuracy. Given the long lead time for the commercialisation of UC tests, which can span a number of years, we believe that Pacific Edge has a considerable leg-up on would-be competitors.

The Cxbladder portfolio is being developed as laboratory-developed tests (LDTs). The CMS regulates clinical laboratories that carry out diagnostic testing through the authority of CLIA (Clinical Laboratory Improvement Amendments), which establishes quality standards for clinical lab testing and a certification programme for labs that perform testing using IVD devices. The company has also received the CAP (College of American Pathologists) signification approval in the US. Pacific Edge management continues to explore the pathway to full FDA approval for the Cxbladder portfolio, which would enable the company to directly market to consumers. However, CLIA certification is sufficient for direct selling to physicians given the tests are processed in the company’s own lab.

Pacific Edge management intends to focus on bladder cancer diagnostics in the short to medium term. Further out, the company may pursue other portfolio opportunities that include gastric, colorectal and endometrial cancers and melanoma. However, the company plans to first concentrate on building on the current momentum of the Cxbladder products and franchise.

Pacific Edge’s US operations are run through its wholly owned subsidiary, Pacific Edge Diagnostics USA Ltd., in Hershey, Pennsylvania. The company’s cancer testing technology is steadily gaining recognition in the field as it has completed critical User Programmes with the Veterans Administration (VA), which provides healthcare to veterans; TRICARE, which provides healthcare to members of the armed services and their families; the Centres for Medicare and Medicaid Services (CMS), which covers 35% of Americans; and Kaiser Permanente (KP), an integrated healthcare provider that serves 11.8 million members.

The US market for hematuria testing and monitoring represents a noteworthy commercial opportunity. According to Pacific Edge, an estimated US$1bn is spent investigating hematuria each year, with approximately 1.5 million people presenting to their healthcare provider a year in the US.5 A high recurrence rate means continual monitoring at an estimated extra cost of US$1-2bn for those requiring regular follow-on testing.

Pacific Edge’s sales organisation in the US includes an MSL (medical scientific liaison) for technical support and an experienced sales executive specialising in deal closing. All members of the sales staff have experience in selling high technology medical products including molecular diagnostics products. Pacific Edge has continued to expand its commercialisation efforts in the US, with a total of 18 sales executives canvasing 19 earmarked regions clustered around metro centres. The salesforce actively markets its tests to private paying integrated healthcare providers and urologists (c 11,000 in the US) as well as public payers including CMS and the VA. The company has made good headway in establishing sales channels and building relationships with payers and clinicians. However, the sales cycle is relatively long for the new technology, as for most molecular diagnostic tests, and the main challenge remains converting those clinicians trialling the tests on User Programmes into fee-paying customers. A number of User Programmes are underway in the US and most comprise large prospective customer groups of up to 100 urologists.

Drivers of healthcare decisions by clinicians in the US include the avoidance of malpractice suits on missed tumours, the clinical utility of the product and minimising co-payments to the patients, thereby boosting patient retention rates. Cxbladder Detect directly covers the first two and, more indirectly, the third. Urologists need a large number of tools for the clinical work-up of patients presenting with hematuria. The sales team has therefore placed much emphasis on the end-user: the urologists. Its User Programmes offer clinicians the opportunity to trial the product in clinical settings by trying it out on their patients. This process serves to garner a sufficient comfort level with the test to reduce the high level of pre-purchase dissonance. Pacific Edge management reports those specialists who are introduced to Cxbladder tests recognise the potential value in the technology and are interested in trialling the product before entry into commercial relationships.

Key decision makers driving sales in the US are described below.

Large urology group practices (LUGs) comprise approximately 15% of US urologists and Pacific Edge has made positive inroads with a number of select LUGs. Selling to these organisations began in mid-2013, as with other significant but smaller urology practices. Several LUGs have successfully completed User Programmes and are placing commercial orders.

US public healthcare groups most notably include the Veterans Administration (VA)6, TRICARE7, and the Centres for Medicare and Medicaid Services (CMS)8, with potentially significant volumes. In March 2016, its dossier for Cxbladder Detect was approved for addition to the Federal Supply Schedule (VA FSS)9 enabling commercial access to the VA urologists and expedited payment following a lengthy review process. The government-funded VA, one of the largest healthcare programmes in the US, is an organisation that represents a considerable market providing care to approximately 20 million veterans and their families in a network of clinics, hospitals and healthcare centres across the US. The company is currently targeting five large VA clinics and early sales have already begun in two of them. It also expects to set up User Programmes at larger sites so that healthcare providers can trial the tests. In October 2016, Pacific Edge was approved as a provider and negotiated a contract price for tests with TRICARE. TRICARE covers 9.4 million beneficiaries who accounted for 70.5 million outpatient visits in 2015 in 55 military hospitals and 373 military medical centres. The company is currently leveraging existing relationships with high-volume sites in key areas. As in other areas, it anticipates User Programmes at the larger sites so that healthcare providers can trial the tests. CMS provides healthcare services to the elderly and those on a lower income in the US, and, according to Pacific Edge, represents a notable 40% of its total target market. Progress has been made in the negotiation process with the CMS and management expects the conclusion of discussion on approval and reimbursement to provide a significant lift in revenue/lab throughput for Cxbladder tests, though exact timing is uncertain as the process is long and iterative.

Integrated healthcare providers (IHPs) combine insurance, hospital and medical group functions into a coordinated healthcare model. Pacific Edge is targeting IHPs such as Kaiser Permanente (KP), which serves over 11.8 million members. In the large User Programme with KP, patients presenting with hematuria for the evaluation of the Cxbladder Triage were enrolled in a large, blinded study. With the successful conclusion of the programme, the previously published Cxbladder Triage data (sensitivity of 95.1%, specificity of 45%, and a negative predictive value of 98.5% according to the BioMed Central Urology journal) has been validated in a real-world clinical setting, based on the company’s analysis. The company is now in final discussions with Kaiser regarding a commercial relationship. Commercial adoption by KP could provide a significant ramp in sales.

National provider networks (NPNs) provide a contracted price network that links providers and payers. The NPNs consist of clinicians, hospitals, laboratories and other specialists that contract with the provider to offer services to the patients of their clients, which are private insurers, large employers and third-party administrators. In addition to a negotiated price, approved coverage of a product or service by the NPN encourages its acceptance and adoption by clinicians. To date, Pacific Edge has signed agreements with four networks in the US – FedMed, ACPN, Stratos and MultiPlan – thereby establishing a fixed retail price to patients insured by NPN clients.

In addition to the US, Pacific Edge is dedicated to the commercialisation of Cxbladder in its home market of New Zealand and in Australia while also pursuing other worldwide opportunities. The markets in New Zealand and Australia are measurably smaller, with 300 urologists in both countries together, which is less than 3% of the c 11,000 in the US. The CLIA-certified New Zealand facility services these territories and can also serve as backup to the US. Annual capacity for tests is 35,000 and scalable, and on our base-case forecasts is sufficient to accommodate Pacific Edge sales through to 2031.

In New Zealand, Pacific Edge is seeing steadily increasing adoption of Cxbladder products by publicly and privately funded health organisations. Launched in 2011 in New Zealand, the sales effort there has focused primarily on the district health boards (DHBs). In August of this year, the company signed its third commercial agreement with MidCentral District Health Board, joining Canterbury and Waitemata DHBs, to incorporate Cxbladder testing into the standard of care across the bladder cancer pathway from initial diagnosis to post-treatment observation for patients throughout the Manawatu-Whanganui region. Among private health insurance providers, nib Health Insurance and Sovereign Health have approved reimbursement for Cxbladder diagnostic tests. The company’s latest test, Cxbladder Resolve, was launched in New Zealand in December 2016.

In Australia, Pacific Edge partnered with Tolmar Australia in February 2016; Tolmar is a specialist uro-oncology company that provides healthcare to men with advanced prostate cancer. It has a specialist salesforce of nine people with strong relationships with urologists throughout Australia who will encourage the use of Cxbladder tests through User Programmes, replicating the marketing approach in the US and New Zealand.

Pacific Edge is evaluating the South-East Asian market opportunity and has set up Singapore as a base to do so. In early June 2015, the company announced its first entry into South-East Asia with the commencement of a User Programme agreement with Tan Tock Seng Hospital (TTSH) in Singapore. TTSH is one of Singapore’s largest hospitals with 40 clinical and allied health departments and a more than 7,000 strong staff, which tends to over 2,000 patients per day. In November 2016 a User Programme agreement with Singapore General Hospital (SGH), the country’s largest hospital, was signed. SGH has a team of 10,000 staff and serves over one million patients a year. According to Pacific Edge, 1.3 million medical tourists are projected to visit Singapore in 2018. This tourist patient population regularly pays out of pocket, thereby lowering any reimbursement hurdles.

A third User Programme has recently commenced in Singapore and the company anticipates additional User Programmes in hospitals and clinics in South-East Asia will commence in the second half of the year. Additionally, one of the three User Programmes in Singapore is expected to transition into a commercial agreement in the near future. The company is also employing sales and marketing staff in the region to pursue commercial rollouts in Bangkok and Taipei. Financial support for the programme will be provided by a grant from New Zealand Trade and Enterprise (NZTE). The three-year NZ$600,000 grant to aid the evaluation of the South-East Asian market opportunity will be dispersed on the basis of milestones and Pacific Edge will match NZTE funding.

While we believe that the signing of three User Programmes in Singapore represents a significant milestone, we do not yet include potential sales in the South-East Asian region. We await the completion of Pacific Edge’s evaluation and clarity on sales potential, particularly that stemming from the potentially large medical tourist community.

First acceptance of Cxbladder products has confirmed the utility of the technology associated with the franchise. The diagnostic test has been validated through various User Programmes and is now seeing its first sales in New Zealand, Australia and the US. However, execution risk remains an important hurdle as the Cxbladder tests have yet to be proven on a full commercial scale. The US accounts for more than 95% of our projected sales in 2020. Healthcare specialists in the US (and worldwide) are typically highly conservative in their adoption of new technologies and the selling process for molecular diagnostics is normally protracted. It will be critical for the company to continue to convert those organisations with current User Programmes to fee-paying customers.

We believe Pacific Edge is on the tipping point of potential meaningful conversions in the US. The nod of approval from the VA for Pacific Edge to sell to VA urologists is a considerable stepping stone towards wider acceptance by the greater medical community. Additionally, management reports early interest and willingness to explore the potential of the products from numerous clinicians. We expect the successful negotiation of contracts with four national provider networks to provide additional support. While Pacific Edge runs the risk of potential competitive products from those known diagnostic tests that have not yet published data and those not yet in the public domain, we do not expect a near-term competitive threat to the Cxbladder technology. Clinical validation will be critical for would-be new tests, while the long lead time to commercial adoption serves as a high barrier to entry.

Our DCF-based valuation has been reduced to NZ$434m (NZ$0.93/share) from NZ$449m (NZ$1.12/share). This is mainly due to a more conservative view of the sales ramp for the Cxbladder franchise in the US following a slower than expected first half of the year. We have also pushed back profitability to FY20 from FY19. The impact on a per-share basis was more pronounced than on the absolute valuation due to the dilution related to the NZ$21.3m November 2017 capital raise. The effect of these reductions was mitigated by lower operating expense estimates due to lower than expected spending on R&D and SG&A. With the recent capital raise, we expect that no additional capital will be required to fund operations into forecast profitability.

We derive our valuation by applying our standard 12.5% discount rate to our estimates, which include the sales of the Cxbladder Detect, Triage and Monitor in the US, New Zealand and Australia. We do not include forecasts for potential additional product launches in the Cxbladder franchise (including Cxbladder Resolve), tests in the pipeline for follow-on cancer indications and sales in additional regions, including South-East Asia where Cxbladder is in beta testing in Singapore.

The company recently published interim (half-year) results. Pacific Edge reported operating revenue of NZ$4.2m, up 41% compared to the first half of the prior year, although this is down 17% compared to the sequential half-year due to summer seasonal weakness in the US. Laboratory throughput (which includes both User Programmes and commercial tests) rose 26% compared to last year, though this is a slight deceleration from the 35% growth seen in the previous full year. R&D expenses were NZ$1.8m, down 29% compared to the first half of the prior year. SG&A expenses were NZ$7.7m, down 8% compared to the prior year as that period included expenses related to winding up the incentive scheme for employees. Due to these results, we have made changes to our financial forecasts (see Exhibit 6).

The company completed a capital raise of NZ$21.3m in November 2017 and had net cash of NZ$4.0m at 30 September 2017 (which does not include cash from the November raise). We forecast profitability in FY20, which is a delay from FY19 previously due to a slower than expected sales ramp in the US.