Rockwell Medical Overvalued Based On Significant Risk

| About: Rockwell Medical, (RMTI)

Rockwell Medical Technologies, Inc. (NASDAQ:RMTI), headquartered in Wixom, Michigan, is one of the largest manufacturers and providers of hemodialysis concentrates. The company's base business, hemodialysis concentrate solutions and dialysis kits, still generates almost $50 million in revenue but has recently been slipping on the top-line and in margins, largely as a result of adverse changes to healthcare reimbursement.

Rockwell's focus for growth lies in two pipeline products, both of which target the hemodialysis market and, assuming eventual regulatory approval, could potentially be seamlessly integrated into their already well-established sales, marketing and delivery infrastructure and sold to their existing customer base. Both of Rockwell's pipeline candidates, soluble ferric pyrophosphate (SFP) and Calcitriol, could benefit from recently implemented changes by Medicare for hemodialysis reimbursement which should increase demand for lower cost hemodialysis services, drugs and supplies. Management has high hopes for both product candidates but particularly SFP, a novel late-stage soluble iron supplement which aims to replace intravenous iron (IV iron) as the industry standard therapy for anemic hemodialysis patients.

Based on the potential for SFP to reduce dialysis costs (thereby maximizing profit for providers) and lower the adverse event risk compared to IV iron therapy, management expects strong demand for SFP at the outset of commercialization. This, coupled with being able to leverage their established distribution and customer base, offers the possibility of rapid revenue growth and almost immediate margin expansion. Rockwell hopes to launch SFP in the U.S. by sometime in 2014 but first must gain FDA approval. While SFP phase II clinical data, which was first announced in early 2010, showed a very strong safety profile, efficacy was, in our opinion, less than compelling. Rockwell subsequently moved the candidate into phase III trials, which consist of two identical 300-patient studies (CRUISE I and CRUISE II) which will support the FDA regulatory filing and PRIME, a (non-FDA) 100-patient marketing study powered to demonstrate that SFP can reduce the amount of ESA required to maintain hemoglobin in patients undergoing hemodialysis. Management expects CRUISE I/II to complete in mid-2013 and hopes to file an NDA in Q4 2013. Assuming all goes to plan and a ~12-month turnaround by FDA, this could put SFP on the U.S. market sometime in late 2014.

Rockwell believes their other pipeline candidate, Calcitriol, a generic injectable vitamin D analogue which also targets the chronic renal failure market, could launch in Q1 2013. As the drug is already FDA-approved, RMTI only needs manufacturing stability data approved by the agency in order to begin commercialization. Rockwell expects their Calcitriol product to receive a warm welcome given its lower price-point relative to branded vitamin D analogues in the face of the recent Medicare reimbursement changes.


§ Weak Phase IIb Efficacy Data

The primary endpoint of the phase IIb dosing study, efficacy of SFP in maintaining iron levels as measured by the percentage of subjects whose hemoglobin decreases by 1.0 g/dL or more from baseline on each of two successive measurements (for up to 26 weeks), was not met. This is also the primary efficacy endpoint in the ongoing phase III CRUISE studies. In addition and in contrast to management's implications, we do not believe the phase IIb data showed a clear dose response of SFP on change in hemoglobin levels.

While a secondary endpoint, a change in Hgb from baseline to the final evaluation, was hit, it was just barely statistically significant and at only one dose, with all other doses handily missing. Again, there was no clear dose-dependent response. Assuming Dr. Yokum's allegations are legitimate, the FDA may have significant concerns about the phase IIb efficacy data. CRUISE studies are relatively long (12 months) and costly which, coupled with potentially questionable phase II efficacy data and allegations of managerial misconduct, introduce what we believe is meaningful risk that shareholder value could end up being impaired.

§ ESA Sparing Not Overly Compelling

While the limited data that was released relative to ESA sparing in phase IIb indicated that SFP may have utility in reducing ESA dosage, we would characterize the results as inconclusive given the lack of a dose-dependent response of SFP on ESA dosing. While ESA reduction will not be required for FDA approval, RMTI clearly views it as the major selling point for SFP as it would require the use of less ESA (compared to IV iron) and would therefore offer relief to the margin squeeze providers will experience from bundled reimbursement and the high cost of ESA.

In addition, SFP, if approved, will directly compete with long-acting erythropoietin receptor activators (CERA) which also have utility in reducing the amount of ESA. Mircera (methoxy PEG-epoetin B), Roche's CERA drug, is FDA approved and is expected to be available in the U.S. in mid-2014 (which we think is likely to be ahead of SFP).

§ Standard of Care Headwind

Even with accepting the premise that the phase IIb primary endpoint would have been met had protocol violations and other potential extenuating circumstances (RE block from too high of an SFP dose) been controlled for, this might only indicate that SFP is more effective than no iron supplementation. The phase III trials' control arm, similar to phase II, are patients receiving no iron supplement, which will reveal nothing about SFP's effectiveness compared to IV iron (the current standard of care) in maintaining Hgb or in ESA sparing. While SFP's safety profile looks to be excellent, in general IV iron is relatively safe. And despite certain risks of IV iron, its use in CKD dialysis patients has been rising, partly due to recent studies showing effectiveness at increasing Hgb levels and reducing required ESA doses. As such, in the absence of compelling ESA sparing data, we think SFP may face significant headwinds against IV iron given the latter's established position and the "we know what to expect from the standard of care" mentality and related risk aversion to novel products common with health care providers.

§ Development / Commercialization Delays

There's been a regular pattern of management pushing back commercialization timelines for SFP and, given that enrollment just completed in July, we think it's highly probable that the CRUISE studies will not complete by mid-2013, which is management's most recent guidance. Timelines for commercialization of Calcitriol, which was acquired just barely over one year ago, have also already been pushed back. While optimistic projections relative to development and commercialization timelines are common among life sciences companies, regular and ongoing delays are often indicative of future setbacks that end up being costly and damaging shareholder value.

In early 2010 RMTI had guided towards an SFP launch date in 2013. Management reiterated this 2013 guidance in May 2011. RMTI is now guiding towards mid-2013 for the CRUISE studies to wrap up. However, we think current best-case scenario is that the CRUISE studies complete in the Summer of 2013, an NDA is filed in late-2013 and SFP launches in late 2014. Again, that's a best-case scenario and assumes no delays during the treatment phase of the studies, with data analysis, with the regulatory filing and with an FDA decision and regulatory turn-around (most importantly it assumes SFP is approved). Best-case scenarios often don't happen, however, and we would be surprised if SFP launches by the end of 2014.

Calcitriol was acquired in July 2011. At that time, management guided towards a launch in Q2 2012 and expected the purchase to be accretive in 2012. By late 2011, the launch guidance was pushed back to the second half of 2012. The most recent guidance, provided on the Q2 call (August 2012), has the Calcitriol launch again pushed back - which is now expected in Q1 2013.

§ Lawsuit Contributes Meaningful Risk

Investors seem to have inexplicably (our opinion) largely shrugged off the revelation of a wrongful termination lawsuit[1] filed in early March 2012 by Rockwell's former V.P. of Drug Development and Medical Affairs (Dr. Richard Yocum who was in charge of the SFP development program) which alleges severe misconduct by company leaders including mischaracterizing the SFP phase IIb clinical trial results as "positive" and failing to disclose RMTI's discord with the FDA on the phase III trial design. While the validity of the allegations is currently unknown, given the relative strength in the stock price since the suit was filed, it seems investors are either unaware of the lawsuit or else have mostly dismissed any potential risk (including significant delays to SFP commercialization, handicapped approvability of SFP, handicapped demand for SFP - any of which we think are real possibilities and could negatively impact the stock price) posed by the accusations being made. Given the severity of the allegations and potential negative outcomes if they are legitimate (particularly that the FDA may not be in agreement with the CRUISE trial designs), we feel it's prudent to make sure investors are aware of the lawsuit and the possibility that this could be a real cause for concern. RMTI's motion to dismiss the lawsuit was denied by the court on June 27.[2]

While we are taking no position on the validity of Dr. Yocum's claims, we highlight several allegations made in the lawsuit8 that, if legitimate, could be of particular concern. These are;

o Aside from showing an absence of safety issues, the phase IIb study was a failure (Zacks' note: this is in direct contrast to RMTI's February 2010 press release which was titled, "Rockwell Medical Announces Positive Phase IIb Clinical Data")

o Yocum and other clinical experts warned RMTI's CEO, Robert Chioni that the results of the phase IIb study did not provide adequate efficacy data or dose ranging information to proceed directly to phase III trials

o Due to the inadequate dose-selection data and lack of confirmation of efficacy in phase II, Yocum urged RMTI to conduct additional phase II studies before proceeding to phase III

o In early July 2011, FDA indicated agreement with Yocum's assessment, stating "It appears that no dose response pattern was identified among the dose groups for SFP in your completed Phase II study"

o In early December 2010, FDA sent RMTI a "No Agreement" letter and rejected RMTI's proposed phase III trial design

o The parties met in February 2011 to discuss the phase III trial design but the FDA maintained numerous substantive points of disagreement with the proposed phase III trial design, with the agency noting "we are concerned that it will not be possible to reach agreement on the specific features of the study design to ensure its acceptability to support the indication are seeking" (Zacks' note: this bullet-point seems to contradict RMTI's October 20, 2010 press release which notes, "We are pleased that our positive dialogue with the FDA led to what we believe to be a robust Phase III program" and "We are very encouraged that the FDA supports our Phase III primary efficacy endpoint…"[3] as well as the company's November 10, 2010 press release where they announced that they had, "Finalized Phase III trial design with FDA"[4])

o Yocum further alleges that the disagreement was not resolved (Zacks' note: if valid, this is of particular concern as the CRUISE findings, no matter how compellingly positive, may not be acceptable by the FDA as support for approvability of SFP. This means the CRUISE studies could be a very costly mistake.)

o Dr. Yocum claims his termination from RMTI (in September 2011) was a result of his "opposition to fraudulent, unlawful, and unethical acts"

§ Optimistic Calcitriol Projections

Management's expectations for their Calcitriol (generic injectable vitamin D analogue) product may be highly optimistic. Management believes Calcitriol can generate $50 million in revenue with implied gross margins of ~50% in the first full year on the market (which they think could be 2013). RMTI says revenue will be driven by bundled reimbursement causing widespread switching by healthcare providers from higher-priced competing branded products (namely Zemplar and Hectorol) to their lower-cost generic product. While bundling may cause some switching, given the proven efficacy advantages of competing vitamin D analogues (including Zemplar, Hectorol and Sensipar) and the potential that competitors reduce their prices (particularly with the introduction of generic Zemplar by 2014), we think that $50 million (or ~ 14% market share of the ~$350 market for ESRD vitamin D) in the first year on the market is probably highly optimistic. This also assumes that RMTI first gains FDA approval to market Calcitriol - the company has recently noted that they are currently in the process of getting their manufacturing facility approved - although the expected launch has been delayed from initial expectations (cited in July 2011) of early 2012 (with the acquisition also initially expected to be accretive by mid-2012, obviously neither of which happened).

Something else that brings into question management's expectations for Calcitriol is the relatively meager acquisition price (i.e. - would the (unnamed) seller sell the ANDA this cheap if they, or another company, thought it could claim double-digit market share in year 1?). Notwithstanding the unique advantage RMTI has with being able to leverage their already established customer base and sales/distribution infrastructure to facilitate sales of Calcitriol, it seems that either management's expectations of the product are highly optimistic or they got the deal of the century. Terms of the purchase were not disclosed but based on RMTI's balance sheet and cash flow statement prior to and following the July 2011 acquisition date, the purchase price looks to be immaterial. RMTI had to pay an additional $550k by July 13, 2012, but all-in, the total acquisition price looks to be approximately $700k. While RMTI will incur additional expenses related to getting their manufacturing facility approved by the FDA, those expenses are not expected to be overly significant. Even if we ballpark $2MM (we think it's actually closer to $1MM) in acquisition and regulatory/facility expenses compared to the ~$50 million in revenue (with implied gross margin expectations of ~50%) management says they expect their Calictriol product to generate in the first full year on the market (which they think could be 2013), it seems that either RMTI got an absolutely tremendous deal (i.e. - purchase price ~ equal to 2% of first-year sales or 4% of gross profit) or management's expectations may be highly optimistic. While fire sale prices are not unheard of in pharma/biotech, especially in the case of a larger pharma purging legacy and off-patent assets that don't fit with a sales force and marketing heavy business model, an implied 2% of first-year sales purchase price should raise some eyebrows.

§ Base Business May Have Peaked

Base business (hemodialysis concentrates) revenue may have peaked in 2010 at $59.6 million. Revenue fell 18% in 2011 and through the first six months of 2012 was down 4% y-o-y (although Q2 was up 3%). The base business is also relatively low margin (12% - 15% gross margins) and has provided only one quarter (Q2 2010) of positive operating income over the last several years (and that was partially due to relatively low R&D expenses in that quarter). While RMTI's newer powdered concentrates are higher margin due to lower shipping costs, bundled reimbursement which has put downward pricing pressure on all dialysis concentrate products, puts a limit on gross margin expansion. We do not believe that RMTI's base business will be able to generate positive operating income or cash flow. As such, any delays in commercializing the pipeline will be magnified on the bottom line and stress the balance sheet.


Given our aforementioned concerns, we feel there is significant risk that Rockwell's revenue remains relatively flat to only slightly positive through 2015. The company's base-business, hemodialysis concentrates, may have already peaked and we expect this to show continued erosion from here on out. We currently model Calcitriol to launch next year but believe management's sales expectations for their vitamin D analogue product may prove to be wildly optimistic. Our model incorporates the assumption that SFP launches in 2015. Our ~$4 million in modeled SFP revenue in 2015 is already risk-adjusted for what we believe to be material aggregate risk encompassing potential for; delays in the clinical trials/data analysis/regulatory filing/FDA turnaround, failure to hit efficacy endpoints, failure to gain FDA approval, less than compelling ESA sparing, and (assuming approved and launched) a strong competitive headwind.

R&D expense is running $8MM - $10MM per quarter and the company is burning about $9 million of cash per quarter. Given the meager margins and top-line erosion of the company's base-business, if this substantial R&D spend does not produce positive ROI in relatively short-order, shareholder value could be significantly impaired. At the current burn rate, the cash balance at 6/30/2012 represented about 7 months worth of operating capital. Based on our current model, we do not believe RMTI will generate positive net income or cash flow for the foreseeable future and expect that RMTI will need to continue to raise a significant amount of additional operating capital through at least 2017 (and potentially longer) which could be highly dilutive to the existing shareholder base.

RMTI Looks Overvalued Based On DFC and Comparable Valuation …

Based on our DCF model which goes out to year 2022 and uses a 9.3% discount rate (based on CAPM) and 2% terminal growth rate, RTMI is valued at approximately $4.20/share.

Based on a near-term P/S metric (P/E isn't applicable given that we model negative net income through 2018) and using Fresenius (NYSE:FMS) (P/S: 1.6x 2012, 1.5x 2013) and DaVita (NYSE:DVA) (P/S: 1.2x 2012, 1.1x 2013) as comps, RMTI is valued at between $2.55/share and $3.80/share.

As we feel near-term P/S under-represents the value of RMTI's pipeline, we think DCF provides a better gauge of the company's intrinsic worth and feel $4.00/share is reasonable fair value of RMTI. The stock currently trades near $8.50/share, which we think significantly overvalues RMTI. We recommend selling the shares down towards our $4.00 target price. We are initiating coverage of RMTI with an Underperform rating and $4.00/share price target.

[1]United States District Court Southern District of California, Case #3:2012cv00568: Richard Yocum, MD vs. Rockwell Medical Technologies, Inc. and DOES 1 through 25

[2]United States District Court Southern District of California, Yocum v. Rockwell Medical Technologies Inc. Case No. 12-CV-568-MMA (MDD). June 27, 2012. Order Denying Motion To Dismiss And For Transfer of Venue.

[3]Rockwell Medical Technologies Inc. Company Plans to Start Phase III Within 90 Days. October 20, 2010

[4]Rockwell Medical Technologies Inc. Rockwell Reports Third Quarter Results. November 4, 2010

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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