Natera, Inc. — Q1 2017 Form 10-Q
Reporting period: Three months ended March 31, 2017. Financial statements are unaudited. Amounts are in millions of dollars unless stated otherwise.
Business context
Natera provides genetic testing and related services, principally prenatal testing. Panorama non-invasive prenatal testing (NIPT) was the largest revenue source, contributing $31.4 million, or 67% of quarterly revenue. The company also offers Horizon carrier screening and other tests, and licenses its technology through the cloud-based Constellation platform.
In Q1, Natera processed more than 121,000 tests, including more than 114,000 laboratory-accessioned tests and 6,300 Constellation units. More than 84,000 Panorama tests were accessioned. Natera reported over 195 million U.S. commercial covered lives under in-network contracts.
Financial results and liquidity
| Metric | Q1 2017 | Q1 2016 |
|---|---|---|
| Product revenue | $45.9 | $61.1 |
| Licensing and other revenue | $1.0 | $0.8 |
| Total revenue | $46.9 | $61.9 |
| Cost of product revenue | $33.1 | $32.3 |
| Operating loss | $(37.0) | $(9.6) |
| Net loss | $(36.0) | $(8.7) |
| Net loss per share, basic / diluted | $(0.68) / $(0.70) | $(0.17) / $(0.17) |
| Cash used in operating activities | $(24.3) | $0.5 provided |
Total gross profit was approximately $13.2 million, or 28.1% of revenue, compared with approximately $29.8 million, or 48.1%, a year earlier. Product gross margin fell to 27.9% from 47.1%. Research and development expense increased 44% to $12.7 million; selling, general and administrative expense rose 24% to $37.6 million.
At March 31, 2017, Natera had $9.1 million in cash and cash equivalents, $106.7 million in short-term investments, and $0.8 million in current restricted cash. Current assets were $140.2 million and current liabilities were $93.0 million. Debt, including accrued interest, was $49.8 million. The $50 million UBS credit line is secured by cash and marketable securities, bears interest at one-month LIBOR plus 0.65%, and may be called or terminated by UBS at its discretion.
Total assets were $176.0 million, total liabilities $102.4 million, and accumulated deficit $381.8 million. Cash declined $6.2 million during the quarter. Investing activities provided $17.7 million, mainly from net investment sales and maturities, partly offset by $6.3 million of property and equipment purchases. Natera reported $54.8 million of future minimum operating lease payments and $129.6 million in total contractual obligations, including debt and interest.
Material changes versus Q1 2016
- Revenue fell 24% to $46.9 million despite higher test volumes. Management attributed the decline mainly to lower average reimbursement per test as payers moved from out-of-network to lower-priced in-network arrangements. Panorama and Horizon revenue each declined by approximately $7.2 million.
- Processed test volume increased from more than 108,000 to more than 121,000; Panorama accessions rose from over 81,000 to over 84,000, and Constellation units from 3,800 to 6,300.
- Product costs were nearly flat in dollars while product revenue declined, driving product gross margin down to 27.9% from 47.1%. Higher outsourced Horizon processing, freight and overhead, and a $0.6 million equipment impairment and inventory adjustments offset Panorama processing savings.
- Operating expenses increased 17% overall, including higher R&D and SG&A, contributing to a substantially larger operating and net loss.
- Operating cash flow shifted from $0.5 million provided to $24.3 million used. Accounts receivable declined by $6.0 million, while inventory increased by $2.0 million and other accrued liabilities increased by $5.6 million.
Outlook, risks, contingencies, and unusual items
- Liquidity and losses: Management expects continued net losses and negative operating cash flows in the near term, but believes existing cash and marketable securities will cover anticipated needs for at least 12 months after May 9, 2017. Additional financing may be needed; availability and terms are uncertain.
- Reimbursement: Natera said it received no reimbursement for approximately 26,000 Panorama tests for average-risk patients and 40,000 Panorama microdeletions tests performed in the quarter. It reported low microdeletions reimbursement under the new CPT code effective January 1, 2017, and expects near-term pressure. A payer alleged overpayments and demanded recoupment; Natera disputes the allegation.
- Revenue recognition: Approximately 83% of Q1 revenue was recognized on a cash basis, so reported revenue can lag testing activity and collection outcomes remain uncertain. Natera’s preliminary assessment indicated adoption of the new revenue standard could materially affect results; planned adoption was Q1 2018.
- Products and execution: Management expects continued investment in sales, R&D, new products and cancer diagnostics. Evercord launched in April 2017; Vistara was launched on a targeted basis, with a broader launch planned later in 2017. Commercial success is uncertain. The company also cited sole-source and limited-supplier dependencies, especially Illumina sequencing equipment and reagents and Streck blood collection tubes.
- Legal and regulatory matters: Pending matters include IPO-related class actions, a patient lawsuit alleging failure to perform an ordered carrier screening test, and a Department of Justice civil investigative demand related to an understood qui tam billing matter. Natera had not recorded a loss contingency for these proceedings and could not estimate potential losses. Its dispute with Bio-Reference was resolved in February 2017. Regulatory uncertainty includes potential FDA oversight of laboratory-developed tests and Constellation software, as well as foreign-market requirements.
- Unusual item: A $0.6 million impairment charge was recorded for sequencing and automation equipment phased out during the transition to newer equipment. A $1.0 million warrant fair-value gain reduced reported loss, but was reversed in the diluted loss-per-share calculation.
Most important facts for investors to verify
- Whether test growth can translate into revenue growth and improved margins despite lower in-network reimbursement and unreimbursed average-risk and microdeletions testing.
- Cash burn, investment liquidity, and the terms and callable nature of the UBS credit line; assess funding needs against management’s 12-month liquidity statement.
- The trend in payer collections, refunds or recoupments, including the outcome of the payer’s overpayment demand and the DOJ inquiry.
- Progress on reimbursement evidence, the new microdeletions code, and adoption of the revenue-recognition standard.
- Execution and costs of the laboratory/equipment transition, product launches, Constellation adoption, and reliance on key suppliers and external laboratories.
- Developments in litigation and FDA or international regulatory matters that could affect operations, reimbursement, or cash requirements.