Business context and reporting period
Natera, Inc. filed this unaudited Form 10-Q for the three months ended March 31, 2018. The company develops and commercializes genetic testing services, principally prenatal tests Panorama NIPT and Horizon Carrier Screening (HCS), alongside licensing, cord-blood storage and research-use oncology offerings. Comparative 2017 figures are revised for retrospective adoption of ASC 606 revenue accounting.
Financial performance and position
| Metric | Q1 2018 | Q1 2017 |
|---|---|---|
| Total revenue | $62.3 million | $49.4 million |
| Product revenue | $54.3 million | $48.4 million |
| Licensing and other revenue | $8.1 million | $1.0 million |
| Gross profit and gross margin | $21.7 million; 34.9% | $15.7 million; 31.8% |
| Operating loss | $(30.5) million | $(34.6) million |
| Net loss | $(32.9) million | $(33.5) million |
| Operating cash flow | $1.0 million provided | $24.6 million used |
At March 31, 2018, cash and cash equivalents were $33.7 million and short-term investments were $80.0 million; restricted cash was an additional $6.0 million. Accounts receivable was $50.3 million. Total debt was approximately $125.1 million including accrued interest: a $50.1 million UBS credit-line balance and a $73.1 million net carrying amount for the OrbiMed term loan. Total liabilities of $222.5 million exceeded total assets of $218.7 million, leaving a $3.9 million stockholders’ deficit. The company reported an accumulated deficit of $479.2 million.
Operating cash flow turned positive primarily because deferred revenue increased $35.5 million, largely from the Qiagen agreement; it also reflected $6.3 million of cash use from increased receivables and $3.0 million from inventory growth. Investing activities provided $25.1 million, mainly from investment sales and maturities. Cash, cash equivalents and restricted cash increased $26.7 million to $39.7 million.
Material changes versus the prior comparable period
- Revenue increased 26.2%. Product revenue rose 12.1%; Panorama revenue increased $0.7 million and HCS revenue $5.3 million. HCS tests accessioned grew approximately 54% and Panorama tests approximately 27% year over year.
- Licensing and other revenue rose to $8.1 million, including $5.5 million recognized on delivery of the Qiagen technology license and revenue from Evercord. The Qiagen agreement provides for $40.0 million of upfront license fees and prepaid royalties, but the company initially included $15.0 million in transaction price and reported $34.5 million of long-term deferred revenue at quarter-end.
- Gross margin improved overall, but cost of product revenue rose faster than product revenue: 72.0% of product revenue versus 68.4% in Q1 2017. Management cited volume-related costs and expected a new HCS automation workflow to reduce costs later in 2018.
- Operating loss narrowed by $4.0 million, while net loss improved by $0.6 million. Higher interest expense, mainly from the 2017 term loan, and lower interest and other income partly offset operating improvement.
- ASC 606 adoption increased Q1 2017 reported revenue by $2.5 million. The filing reports a $41.6 million cumulative adjustment to accumulated deficit as of January 1, 2016 in the accounting note, but MD&A elsewhere states a $37.0 million adjustment as of January 1, 2017; investors should verify the applicable reconciliation.
Outlook, risks, contingencies and unusual items
- Management expects continued losses and negative operating cash flows in the near future. Based on its current business plan, it believes cash and marketable securities will cover anticipated cash requirements for at least 12 months after May 10, 2018. It may need additional financing; availability and terms are uncertain.
- Management identifies payer coverage, reimbursement rates and collections as key uncertainties. Average-risk Panorama and microdeletions reimbursement remains limited; prior-authorization requirements have affected collections and results. A new expanded-carrier-screening CPT code was expected to take effect in 2019 and could reduce Horizon reimbursement.
- The company depends heavily on Panorama, third-party payers, and sole-source suppliers including Illumina and Streck. The filing highlights risks from reimbursement audits, test performance, regulatory changes, competition, operational scaling, and cybersecurity and laboratory continuity.
- In March 2018, Illumina sued, alleging Panorama infringes a patent; Natera said it would defend the matter and could not estimate potential loss. The company also reported three payer overpayment demands and several other legal matters, including an IPO-related class action.
- The company agreed in March 2018 to pay approximately $11.4 million to resolve a Department of Justice qui tam matter concerning past reimbursement submissions, without admission of liability and without a corporate integrity agreement. The charge was recorded in 2017; the filing says the first installment of approximately $5.3 million had been paid by March 31, 2018.
- A $1.6 million impairment charge in research and development related to project development costs written off after the company terminated a cell-free DNA extraction automation project. The UBS credit line is payable on demand at UBS’s discretion; the OrbiMed loan is secured by substantially all assets, including intellectual property, and carries financial and other covenants. The company reported covenant compliance at quarter-end.
- No formal revenue or earnings guidance is provided. Management reported effective disclosure controls as of March 31, 2018 and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Reconcile the conflicting ASC 606 cumulative-adjustment amounts and confirm how the revised comparative figures affect trend analysis.
- Assess how much of operating cash flow depends on Qiagen-related deferred revenue and whether this source recurs as services are delivered.
- Track payer collection trends, prior-authorization denials, refund reserves, and the outcome of the three payer recoupment demands.
- Review the timing and cash impact of the DOJ settlement installments, and developments in the Illumina patent suit and IPO-related litigation.
- Monitor liquidity against continuing losses, debt service and covenants, including UBS’s demand rights and the term loan’s maturity and collateral provisions.
- Evaluate whether HCS automation improves unit costs and whether revenue growth and reimbursement can support a path toward profitability.