Natera, Inc. — Q3 2017 Form 10-Q
Reporting period: Three and nine months ended September 30, 2017. Financial statements are unaudited; amounts below are in millions of dollars unless stated otherwise.
Business context and reporting period
Natera provides genetic testing services, principally Panorama non-invasive prenatal testing (NIPT). Other offerings include Horizon carrier screening, Constellation cloud-based licensing, and newly launched Evercord, Vistara and research-use-only Signatera. Panorama represented 64% of nine-month revenue. The company processed approximately 377,500 tests in the first nine months, up from 330,100 in the comparable 2016 period; Panorama accessions were approximately 253,100 versus 247,100.
Financial performance and liquidity
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Total revenue | $56.7 | $53.9 | $157.2 | $167.8 |
| Gross profit and margin | $22.0; 38.9% | $19.6; 36.4% | $54.3; 34.6% | $70.2; 41.8% |
| Operating loss | $(25.0) | $(26.7) | $(89.1) | $(58.8) |
| Net loss | $(27.1) | $(26.0) | $(90.8) | $(57.9) |
| Net loss per share | $(0.51) | $(0.50) | $(1.71) | $(1.13) |
| Operating cash flow | Not presented quarterly | Not presented quarterly | $(68.6) | $(44.4) |
At September 30, cash and cash equivalents were $11.2 and short-term investments were $135.0, compared with $15.3 and $130.9, respectively, at December 31, 2016. Current assets were $169.2 and current liabilities $91.5. Debt included $50.1 outstanding on the UBS credit line, including accrued interest, and a $73.2 net carrying amount on the OrbiMed term loan; management reported gross debt of $125.1 including accrued interest. Accumulated deficit was $436.7.
Material changes versus the prior comparable period
- Q3 revenue rose 5.1%, primarily from higher test volume, including Horizon growth; nine-month revenue fell 6.3%, as product revenue declined 7.2%. For the nine months, Panorama revenue was $100.0 versus $108.7 and Horizon revenue was $44.7 versus $46.9.
- Despite higher nine-month test volume, revenue declined as in-network reimbursement rates were lower, microdeletion collections were weak, and the Bio-Reference distribution agreement had been terminated. Licensing and other revenue increased to $3.7 from $2.3, including Constellation and Evercord.
- Nine-month cost of product revenue increased 3.4% while product revenue declined; product gross margin fell to 34.6% from 41.3% (product revenue less product cost). Company-wide gross margin, including licensing and other costs, was 34.6% versus 41.8%.
- Nine-month R&D increased 21.8% and SG&A increased 7.9%, contributing to the larger operating and net losses. Q3 operating loss narrowed, but higher interest expense and less favorable other income/expense left net loss slightly higher.
Outlook, management commentary, risks and unusual items
- Management expects continued losses and negative operating cash flows in the near term. It believes existing cash and marketable securities will fund anticipated needs for at least 12 months after November 8, 2017; additional financing may be needed, with potential dilution or restrictive debt terms. No numerical revenue or earnings guidance is provided.
- In August 2017, Natera borrowed $75.0 under a $100.0 OrbiMed senior secured facility; a further $25.0 is available through December 31, 2018, subject to conditions. The loan bears interest at 8.75% plus the higher of 1.00% or LIBOR, matures in August 2024, and is secured by substantially all assets, including intellectual property. It has financial and other covenants; the company reported compliance at quarter-end. The UBS credit line is callable at the lender’s discretion.
- Revenue depends heavily on payer reimbursement. Approximately 84% of nine-month revenue was recognized on a cash basis. Natera cited limited or low reimbursement for average-risk NIPT and microdeletions; it did not expect reimbursement for approximately 28,000 average-risk Panorama tests and 41,000 microdeletion tests performed in Q3.
- Q3 revenue included a $3.7 release from payer refund reserves. Nine-month results included a $0.6 asset impairment charge and $0.4 inventory excess adjustments, primarily associated with phasing out prior-generation sequencing and automation equipment.
- Contingencies include three payer overpayment/recoupment demands, a DOJ civil investigative demand concerning a qui tam matter related to test billing, a patient lawsuit scheduled for trial in March 2018, and IPO-related securities litigation. No loss accrual was recorded for the legal proceedings; outcomes and potential losses were not estimable. The IPO court dismissed certain claims in October 2017, with leave to refile the remaining Section 11 claim.
- Other key risks include dependence on Panorama, reimbursement and pricing pressure, reliance on Illumina and other limited or sole-source suppliers, no backup facility for Panorama testing, third-party laboratory dependencies, regulatory uncertainty for laboratory-developed tests and Constellation, and execution risks for newly launched products.
Most important facts for investors to verify
- Whether Panorama and Horizon volume growth can translate into improved realized reimbursement and revenue, particularly for average-risk and microdeletion testing.
- Cash burn, marketable-security availability, debt service and covenant compliance, including the callable UBS facility and OrbiMed loan terms.
- Whether gross margins recover as automation changes mature and product mix, payer rates and testing costs evolve.
- Developments in payer audits and recoupment demands, the DOJ inquiry, and the patient and securities litigation.
- Commercial adoption, economics and regulatory status of Constellation, Evercord, Vistara and Signatera, and continued access to critical suppliers and laboratory capacity.