4 Small-Cap Medical Device Stocks with Healthy Prospects for Growth

The Life Sciences Report |

In the U.S., the medical device and diagnostics industry has been burdened with conflicting regulations that have delayed commercialization and complicated reimbursement. In this interview, Brian Marckx, senior medical device/diagnostics analyst with Zacks Investment Research, tells The Life Sciences Report how that situation is changing and identifies some innovative companies poised to make the most of the situation.

The Life Sciences Report: What trends are you seeing in terms of regulatory approval for medical devices and diagnostics, and what's driving them?

Brian Marckx: There are recent developments from federal regulatory agencies on potential changes to regulation of both medical devices and diagnostics—some good, and some maybe not so good, for manufacturers. These regulatory changes are largely being driven by technological advances in the medical device and diagnostic spaces.

In the U.S., the FDA has borne a substantial amount of criticism for what many in the medical device sector believe are policies, standards and a framework that are antiquated and too static to sufficiently serve an industry that is much more dynamic, and is evolving much more quickly than the regulatory guidelines currently in place to oversee it. Much of this disconnect—and I think regulators in general would agree, at least to a certain extent, that changes are needed—relates to the quick pace of technological advances in medical devices and how the current FDA approval process is not structured so that regulators can efficiently and effectively make approval decisions, particularly for class 3, or high-risk, devices. This disconnect and related inefficiency has meant that, in many cases, effective and safe novel devices that addressed unmet medical needs lingered way too long in the regulatory black hole, and patients suffered for it.

So, to the FDA's credit, earlier this year the agency issued guidance documents for two new programs related to how certain devices are reviewed and approved. These guidance documents have the potential to accelerate time-to-market for products that could have a real positive benefit on patients' lives.

One of these initiatives, which the FDA first proposed in 2014, is called the Expedited Access Pathway program, or EAP. EAP is designed to get high-risk devices that address unmet medical needs for serious diseases on the market faster than would have been the case under the typical Premarket Approval (PMA) pathway. A manufacturer can request the EAP pathway—which, in a nutshell, accelerates the approval decision. The EAP framework includes priority review and earlier and more involved interaction between a device company and FDA regulators.

It's important to understand that the FDA's main concern is to ensure that it doesn't approve a product—whether it be a device, diagnostic or a drug—that will cause significant harm, or where the benefit is outweighed by the risk. With novel devices that address the unmet needs of life-threatening or serious diseases, the safety hurdle is essentially lower than it would be for, say, a follow-on insulin meter. The FDA recognizes this, and as part of the EAP, the agency also released guidance for a program called Balancing Premarket and Postmarket Data Collection for Devices Subject to Premarket Approval. A draft of this program was released concurrent with the EAP.

This second program allows for more of the clinical trial data collection to occur post-approval. Clinical trial data collection can be costly and very time-consuming, and allowing more of this to happen post-approval could be a significant step toward speeding device approvals, which benefits manufacturers but, more importantly, benefits patients.

Since we're on the topic of FDA regulation, let's talk about diagnostics for a minute, and a fairly recent development related to laboratory developed tests, or LDTs. These diagnostic tests are essentially home-brews that are developed by a single lab and that can only be processed by that lab. FDA has always maintained discretion to regulate LDTs but has historically chosen not to. There are probably 10,000—12,000 LDTs in existence, so these are an important part of the diagnostics industry.

In the summer of 2014, the FDA threw the industry for a loop when it issued a guidance document notifying Congress that it now intends to regulate these tests. The agency cited technological advances and the growing complexity of the tests as part of the reason for the increased oversight. What exactly the oversight will encompass is still unknown. The draft guidance, which has now gone through a public comment period, includes premarket review for what the agency will classify as higher-risk tests that already compete against FDA-approved companion diagnostics, and a potential phase-in over time of premarket review for other high-risk and moderate-risk LDTs.

What is known is that LDT manufacturers will have to notify the FDA that they are currently making and using these tests, and will have to provide information about the tests. The guidance recommends that premarket review begin 12 months after the guidance is finalized for the highest-risk LDTs, and for the guidance to phase in over four years for the remaining high-risk devices. Premarket review would begin five years after the guidance is finalized for moderate-risk devices.

This has some diagnostic companies nervous, particularly those that rely on LDTs for much of their revenue. While I suspect the agency will pursue any oversight cautiously, I can't believe the FDA will implement policies so onerous they could be devastating to the industry and the patients it serves. But it is something to be aware of and keep an eye on.

TLSR: The European Union (EU) is expected to tighten regulatory restrictions on medical devices and in vitro diagnostics. Final debate begins this fall. What are the implications for companies and their investors?

BM: In Europe, medical device regulation is much different than in the U.S. Instead of a unified body charged with approval and oversight, such as the FDA, in Europe device approval follows a route that includes separate organizations and member states, which can differ depending on the type of device. It's been no secret that the process suffers from inefficiencies, inconsistencies and a certain lack of faith over whether the oversight is sufficient, particularly when it comes to safety. This really came to light in 2011, when it was discovered that Poly Implant Prothèse (PIP), a French company and one of the largest producers of breast implants, had been using industrial, instead of medical, silicone in its breast implants. This resulted in a massive recall.

To avoid similar issues the EU is implementing significant changes to oversight of medical devices. The proposal covers certain devices differently, differentiating between implantables, diagnostics and just general medical devices. But the crux is that oversight will be stricter, and there may be a requirement that all marketed devices be CE marked. CE marking is EU's stamp of approval.

One of the major changes will likely include expanded oversight of certain devices, particularly in vitro diagnostics (IVD), the majority of which are currently largely unregulated. This could have a real negative impact on IVD manufacturers. Other potential changes may require manufacturers to provide additional safety and efficacy data and, possibly, a device identification requirement. The device ID requirement relates to the PIP implant issue, as many of women who received the implants didn't know whether they received those with the potentially harmful industrial silicone.

The potential implication for investors, particularly those looking at or already invested in companies that sell medical devices in Europe, is that regulatory oversight will almost certainly become more strict. This has the potential to add cost and slow down future regulatory submissions, and may even affect products already on the market—particularly IVD products.

TLSR: The House voted to repealed the medical device tax in June, but Senate acquiescence is not assured. How is this tax affecting investment in the medical device and diagnostics market? For example, are investors turning to other sectors, disregarding the tax or willing to accept lower returns?

BM: From my viewpoint, the medical device tax has been a real impediment to growth in the medtech space, and that's particularly been the case for smaller companies. Many of the companies that I cover are fairly early-revenue stage, and the 2.3% bite from the medical device tax has been, for lack of a better word, very taxing.

Unlike income tax, which is a tax on operating income, the medical device tax is a tax on revenue. This can be a huge burden on companies that may be years away from generating positive income or cash flow, and that need every cent to be able just to stay afloat—and to pump back into research and development (R&D) and manufacturing to stay competitive and grow. I don't know that President Obama understood, or maybe didn't consider, how much more difficult it would be for small companies to innovate, or even survive, with implementation of this tax. With much of the technological innovation in the space coming from smaller companies, this tax has been a disaster to R&D budgets, and has directly negatively impacted development of new technologies in the medical device sector. Needless to say, I have not been a fan of the tax, and I urge Congress to do everything it can to repeal it.

AdvaMed (Advanced Medical Technology Association), the leading medical device trade association, conducted a recent survey of its members. Results were that the medical device tax may have contributed to almost 200,000 job losses. More than half of respondents reduced R&D, and most canceled capital investment projects. And almost all said that if the tax were to be repealed that they would likely increase hiring and R&D budgets.

TLSR: If the medical device tax is repealed, how you do believe the market will respond?

BM: I don't have a clear enough view to know whether investors have looked elsewhere, but given there's no doubt the tax has negatively affected bottom lines and product development, which affects future income, it would be surprising if it has not influenced investors' decision-making. If the tax were repealed, it makes sense that the medical device space would become more attractive—it would have to.

I can tell you that I model the tax into my financial forecasts of the companies that I cover, and if and when it's repealed, my forecasted numbers immediately improve—which, all else being equal, makes investment in those companies more attractive.

TLSR: In terms of market dynamics and regulatory constraints, what do you consider the key differences between the medical devices and diagnostics sectors?

BM: There are certainly major differences in the regulatory approaches to devices and diagnostics. One of the biggest components has to do with the respective extent of safety risks. Diagnostics, by and large, don't have the same potential safety risks that devices might—particularly implantables, such as coronary stents, artificial hips or pacemakers, for example. And that explains the FDA's historic hands-off approach to LDTs.

In terms of market dynamics between devices and diagnostics, I assume you're asking where to find the best opportunity for investment returns. It's a great question, but tough to give a general answer to. My coverage universe encompasses very small companies and so, by default, these are usually companies with novel products. When I look at opportunity for outsize returns, I don't necessarily differentiate between diagnostics and devices, but am more interested in finding an unmet need, and the company developing a product to address that need.

There's a lot going on in the diagnostics space that is new and interesting, and that could have a lot of room to run. Molecular diagnostics and genetic analysis are exploding; this growth has been fueled, in large part, due to the human genome project. In terms of disease areas, cancer is the hottest of the hot and not likely to decelerate anytime soon—this is true for both diagnostics and devices. New biological markers are being discovered on a regular basis, and it isn't just big pharma making these discoveries. Much of the innovation in cancer diagnosis is being done by companies you've probably never heard of—but you very possibly might in the future, as development is moving at very rapid pace.

In the med device and medtech space, growth is kind of all over the place. Some is being driven by new products that are more effective or less costly than other products already on the market addressing the same condition. Obamacare has shifted the competitive landscape a bit in the med-device space, in terms of placing a greater focus on cost and reimbursement based on pay for performance, not fee for service.

I certainly see companies looking to leverage those changes in their product development decisions. In terms of novelty, again, it mostly comes down to developing products that will improve the outcomes of diseases or conditions. Areas such as cancer, infectious disease and critical care illnesses are all very attractive from an investment standpoint, as the associated morbidity and mortality is so great.

But I'm also seeing innovation in information technology areas. Wireless technology has recently become hot. This includes being able to wirelessly control, or get readouts from, implanted devices or sensors. Bioprinting, or 3-D printing of organs and tissue, has been a recent headline-grabber, although I think full-scale commercialization of this, particularly for major organs, is likely to be many years off. And I'd suggest looking at companies within the manufacturing channel, including those that make components for medical devices undergoing greater innovation.

TLSR: Which companies are at the forefront of the tools and diagnostics fields, and why should investors be interested?

BM: Aethlon Medical Inc. (AEMD), a device company that I cover, has a product called Hemopurifier, an extracorporeal blood filter used with typical blood circulatory equipment, such as dialysis machines. Initially the company developed the device to remove the hepatitis C virus (HCV) from the blood, and it has shown some success in that regard. In fact, a small, U.S.-based clinical study with HCV patients recently started.

But it may have more utility than in just HCV. In fact, Hemopurifier was used with an Ebola patient who became infected during the recent outbreak in West Africa. The patient, a Ugandan doctor, received standard of care and was treated with the Hemopurifier. After about three weeks he was found to have no detectable levels of Ebola and was subsequently released from the hospital. Prior to Hemopurifier administration, the patient had multiple organ failure, was unconscious and had a viral load of 400,000 (400K) virus copies/ml. Following a 6.5-hour treatment with Hemopurifier viral load was 1K virus copies/ml. Hemopurifier captured 253 million copies of Ebola. Of course, there's no way to definitely know whether Hemopurifier treatment was ultimately responsible for the patient's recovery, but the fact that it captured a significant amount of the virus certainly seems encouraging.

Aethlon is now seeking Humanitarian Device Exemption from the FDA, which would allow use of Hemopurifier for Ebola in emergency situations. The company is also considering initiation of Ebola studies in both the U.S. and Canada, although patient recruitment is an obvious challenge.

Aethlon's Hemopurifier has also been used with cancer, and successfully demonstrated the removal of circulating exosomes from the blood that are believed to be associated with the spread of cancer throughout the body. There's recently been increased research surrounding the role of exosomes in cancer. This was documented in an article written by researchers at Harvard Medical School and Oxford University, and published in 2014 in the journal "Trends in Molecular Medicine." The authors pointed specifically to Hemopurifier as having potential as a cancer therapy. Aethlon recently announced an agreement with the University of California Irvine to conduct an investigator-initiated study using Hemopurifier in various solid tumors.

While we don't anticipate FDA approval for any particular indication in the near term, development continues to ramp up, and results to date look very encouraging. We think additional supportive data from these new studies in HCV and cancer, and possibly a study in Ebola, could make Aethlon even more interesting.

Aethlon has other projects in the pipeline as well. This includes work on development of an assay to identify the presence of chronic traumatic encephalopathy, or CTE. CTE has received a lot of mainstream media attention, as it has been associated with head injuries and resultant depression, which has led to some suicides. Currently, the only way to definitely diagnose CTE is through an autopsy. Last year Aethlon's wholly-owned subsidiary, Exosome Sciences, entered into a collaboration with Boston University's CTE Center for development of a blood-based diagnostic to identify CTE. Boston University is on the leading edge of CTE research, so this is a big deal for Aethlon.

TLSR: Is there another company you'd like to talk about?

BM: Zecotek Photonics Inc. (ZMS:CA) (ZMSPF) is not a typical medical device company, as it does not make end products but instead makes components that go into the manufacture of the end products.

The company's main focus is on scintillation crystals, which are an important component used in medical scanners. Scintillation crystals create a burst of light that is then captured by photo detectors in the scanner, and is then multiplied and produces an image. All scintillation crystals are not created equal, and there are only a few manufacturers: Technically the crystals are grown, not manufactured. We won't get into all the technicalities of the crystals, but performance is based on certain characteristics including light yield, density and decay time. LYSO crystals, manufactured by Saint-Gobain S.A. (SGO:EN Paris) and Crystal Photonics Inc. (private) and used in high-end, time-of-flight positron emission tomography (PET) scanners, have been considered the highest performing crystals on the market.

Zecotek, through experiments that performed comparing their LFS crystals to LYSO, believed its crystals were superior. Until recently there was no solid third-party validation of this, however. But last month, CERN announced results of its experiment comparing LFS to LYSO, and the results showed that LFS outperformed LYSO. CERN stands for the European Organization for Nuclear Research, which is a world-renowned institution run by 20 European member states and is on the cutting edge of scientific research. CERN led the rebuild of the Large Hadron Collider, which has been credited with recently discovering the existence of Higgs boson, also known as the God particle. I encourage anyone who is not familiar with the Large Hadron Collider to do an Internet search about it. It is an incredibly impressive instrument. Validation of the superior performance of Zecotek's crystals over LYSO by CERN is a meaningful vote of confidence.

There has been substantial interest from PET manufacturers and from CERN, the latter for certain experiments to use Zecotek's crystals, including rebuilding the Large Hadron Collider. Zecotek has received more than $2 million ($2M) worth of orders for its crystals, although it has only booked a fraction of that as revenue so far. This head-to-head study may help facilitate even greater interest.

TLSR: Is there another company you'd like to discuss?

BM: I'll mention Chembio Diagnostic Systems Inc. (CEMI). The most significant news relative to Chembio's DPP HIV assays came in late 2013, when the company received a CLIA waiver in the U.S., which allows it to sell the tests to the point-of-care facilities, such as clinics and physician offices. Chembio is now in the early stages of rollout, and I think this could be a real needle-mover over time.

The DPP technology can be used with saliva or whole blood, which makes it more convenient than other blood-only HIV tests. It will compete with OraSure Technologies Inc.'s (OSUR) OraQuick test, which, while also capable of using saliva and blood samples, may not be quite as accurate as Chembio's DPP HIV assay. Chembio is now supporting the U.S. rollout of its DPP HIV test, along with its legacy, lateral-flow HIV tests, with its own sales force and hand-picked distributors—which is a change, as the company had utilized Alere Inc. (ALR) for U.S. distribution for years.

As you noted relative to Europe, Chembio received a CE Mark for the DPP HIV test, which came last month. The company expects to begin rolling it out to the point-of-care channel in Q4/15. While we see this as an important milestone, and something we think will provide incremental financial contribution, the European point-of-care market probably does not hold the type of opportunity that the U.S. does. That's because Europe has lower HIV prevalence and a much greater reliance on clinical lab testing as compared to the U.S.

But we think the DPP product can do well in Europe. And certainly the self-testing initiative with BioSure Ltd. (United Kingdom) and AAZ (France), which relates to Chembio's lateral-flow HIV tests, not the DPP products, could spark greater uptake of personalized self-testing for HIV. If so, it's possible this could benefit demand for the DPP products.

While we're on the topic of Chembio, investors may not know that the company has recently branched out its development portfolio, which has historically focused on HIV, HCV and syphilis, along with a few other infectious diseases. More recently Chembio has initiated work on assays for a wider array of disease areas, including Ebola, febrile illness, malaria, and even cancer and traumatic brain injury. Management has indicated, on recent conference calls, that some of these new programs are moving along fairly rapidly, with some potentially culminating in a commercial product in the not-too-distant future. Stay tuned to Chembio, as it has a lot of potential growth catalysts that could make an impact very soon.

TLSR: Is there one last company you'd like to bring to readers' attention?

BM: CytoSorbents Corp.'s (CTSO) flagship product is called CytoSorb, another blood filtration device. It is a cartridge filled with highly porous, adsorbent polymer beads that connects to an extracorporeal circuit in a standard blood pump machine. These beads filter the blood as it is pumped through, removing excessive and harmful cytokines and other toxic substances. It is designed to treat people who are very sick with critical care illnesses such as sepsis, acute respiratory distress syndrome and acute pancreatitis, all of which can lead to massive organ failure and death.

CytoSorb was shown to be safe and to effectively remove key cytokines in a clinical study in Europe. It has a CE Mark and has been commercialized in Europe for the last few years. Commercialization is following a very structured approach, and is supported by getting the device in front of key opinion leaders and incorporating it in investigator-initiated studies. The company is demonstrating that the product works, that it's efficacious and safe, and this is how CytoSorbents has been able to grow sales and interest.

The company has used a combination of a small in-house sales force and third-party distribution, and has ramped up its geographic footprint fairly rapidly, with distribution now covering more than 30 countries. Distribution partners include some "majors," including Fresenius, the world leader in dialysis, and Biocon, the largest biotechnology company in India. CytoSorbents also recently announced a partnership with an unnamed "top four" medical device company for use of CytoSorb in France for cardiac surgery. Distribution is already substantial and continues to grow.

Revenue grew from about $800,000 in 2013 to $3.1M in 2014. While revenue disappointed somewhat in the first quarter of 2014, it still showed growth. Management attributed the softer-than-expected results to a restructuring of the sales force, which is anticipated to be worked out in the second half of the year. Importantly, there's no indication that demand, adoption or interest in the device is waning. In fact, management has noted seeing demand for the product in various indications, including cardiac surgery.

And this is interesting. Initially the company expected to seek FDA approval in a sepsis indication and had talked about designing a sepsis trial. But then the device was used more in cardiac surgery, and successfully so. Results of a study done in Germany were recently published—the study indicated that CytoSorb reduced cardiac surgery-related inflammation, and the investigators concluded that CytoSorb, pending further validation, may have utility as a routine measure in heart surgery procedures. The thinking is that a cardiac surgery indication may be easier, faster and lower cost to market than sepsis.

So CytoSorb shifted focus from sepsis to cardiac surgery as an initial indication for the U.S. market. An investigational device exemption (IDE) was recently approved for a 20-patient U.S. study in cardiac surgery, which is expected to commence shortly. And CytoSorbents has applied to follow the EAP pathway, the benefits of which we discussed earlier. Assuming eventual FDA approval, CytoSorbents would then look to expand the label to critical care illnesses, which would likely include sepsis.

The beauty of CytoSorb is that it targets an enormous market—critical care illnesses—which aggregate to a multibillion-dollar market that is not sufficiently addressed by current therapies. There's an awful lot to like about CytoSorbents.

The stock price took a beating following the disappointing Q1/15 numbers, but I see this as a short-term thing and not representative of the long-term fundamentals. The dip offers an attractive entry point for anyone looking to buy the stock cheap.

TLSR: Brian, thanks for your time.

Brian Marckx is the senior medical device/diagnostics analyst with Zacks Small-Cap Research. He covers small- and micro-cap medical device and diagnostic companies with a focus on development-stage companies with novel and emerging technologies, as well as already established names still flying under the radar. Prior to joining Zacks, Marckx worked as a high-yield bond analyst on Wachovia Securities' institutional trading desks, where he specialized in the healthcare and industrials industries. Prior to that he was an analyst in corporate finance at First Union National Bank. Marckx has been quoted in The Wall Street Journal, Barron's, Bloomberg Businessweek and Kiplinger. His work has also been cited in various market studies and working papers including those from Massachusetts Institute of Technology, Deloitte & Touche, and Pharmaceutical Manufacturing. He graduated with a bachelor's degree in finance from St. John Fisher College, and received his master's degree in business administration from Wake Forest University. Marckx is also a Chartered Financial Analyst.

Source: Staff of The Life Sciences Report 

Want to read more Life Sciences Report interviews like this? Sign up for our free e-newsletter, and you'll learn when new articles have been published. To see recent interviews with industry analysts and commentators, visit our Streetwise Interviews page.

DISCLOSURE:
1) Staff conducted this interview for Streetwise Reports LLC, publisher of The Gold Report, The Energy Report and The Life Sciences Report, and provides services to Streetwise Reports as independent contractors/employees. They own, or their families own, shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of Streetwise Reports: Aethlon Medical Inc. The companies mentioned in this interview were not involved in any aspect of the interview preparation or post-interview editing so the expert could speak independently about the sector. Streetwise Reports does not accept stock in exchange for its services.
3) Brian Marckx: I own, or my family owns, shares of the following companies mentioned in this interview: None. I personally am, or my family is, paid by the following companies mentioned in this interview: None. My company has a financial relationship with the following companies mentioned in this interview: Zecotek Photonics Inc., CytoSorbents Corp., Aethlon Medical Inc. and Chembio Diagnostic Systems Inc. I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I determined and had final say over which companies would be included in the interview based on my research, understanding of the sector and interview theme. I had the opportunity to review the interview for accuracy as of the date of the interview and am responsible for the content of the interview.
4) Interviews are edited for clarity. Streetwise Reports does not make editorial comments or change experts' statements without their consent.
5) The interview does not constitute investment advice. Each reader is encouraged to consult with his or her individual financial professional and any action a reader takes as a result of information presented here is his or her own responsibility. By opening this page, each reader accepts and agrees to Streetwise Reports' terms of use and full legal disclaimer.
6) From time to time, Streetwise Reports LLC and its directors, officers, employees or members of their families, as well as persons interviewed for articles and interviews on the site, may have a long or short position in securities mentioned. Directors, officers, employees or members of their families are prohibited from making purchases and/or sales of those securities in the open market or otherwise during the up-to-four-week interval from the time of the interview until after it publishes.

Streetwise – The Life Sciences Report is Copyright © 2014 by Streetwise Reports LLC. All rights are reserved. Streetwise Reports LLC hereby grants an unrestricted license to use or disseminate this copyrighted material (i) only in whole (and always including this disclaimer), but (ii) never in part..

Streetwise Reports LLC does not guarantee the accuracy or thoroughness of the information reported.

Streetwise Reports LLC receives a fee from companies that are listed on the home page in the In This Issue section. Their sponsor pages may be considered advertising for the purposes of 18 U.S.C. 1734.

Participating companies provide the logos used in The Life Sciences Report. These logos are trademarks and are the property of the individual companies.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer

Companies

Symbol Name Price Change % Volume
AEMD Aethlon Medical Inc. 4.81 0.01 0.21 5,686
OSUR OraSure Technologies Inc. 8.98 0.19 2.10 138,230
CTSO Cytosorbents Corporation 5.38 0.18 3.37 27,939
ALR Alere Inc. 37.28 0.61 1.66 766,792
CEMI Chembio Diagnostics Inc. 6.95 0.00 0.00 13,168

Comments

Emerging Growth

Taranis Resources Inc.

Taranis Resources Inc is an exploration stage company. The Company along with its subsidiaries is engaged in the acquisition and exploration of mineral properties. Its projects include Thor Property in…

Private Markets

GoCoin

Blockchain currencies (e.g. Bitcoin) provide a new disruptive way to transfer value between parties over the internet as opposed to going through banks. GoCoin provides online merchants with a suite…

8tracks

Our mission is to be the best place for people who care about music to create and discover thoughtfully curated playlists. In essence, 8tracks is a platform for online mixtapes.