Natera, Inc. — Q2 2015 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2015. Financial statements are unaudited. Amounts below are in millions of dollars unless otherwise noted.
Business context
Natera develops and sells genetic diagnostic tests, principally Panorama, its non-invasive prenatal test (NIPT). Panorama generated 79% of Q2 revenue and 76% of first-half revenue. The company is expanding its U.S. direct sales force and developing a cloud-based distribution model and additional tests, including cancer diagnostics.
Financial performance and liquidity
| Metric | Q2 2015 | Q2 2014 | First half 2015 | First half 2014 |
|---|---|---|---|---|
| Total revenue | $45.1 | $35.8 | $92.5 | $63.1 |
| Gross profit | $19.4 | $16.8 | $42.0 | $28.2 |
| Gross margin | 42.9% | 46.9% | 45.3% | 44.7% |
| Operating loss | $(15.5) | $(1.2) | $(21.7) | $(8.5) |
| Net loss | $(19.7) | $(0.5) | $(29.7) | $(10.1) |
| Net loss per share, basic and diluted | $(3.58) | $(0.11) | $(5.50) | $(2.17) |
- First-half revenue rose 46.6%, primarily on Panorama growth; Panorama revenue was $70.3 million, up from $47.4 million. Test accessions increased to more than 134,000 from more than 99,000.
- First-half operating expenses grew 59.6%. Selling, general and administrative expense rose 81.5% to $51.3 million, reflecting sales-force and support growth; research and development expense rose 46.9% to $12.4 million.
- Q2 gross margin declined year over year. Management attributed pressure to the microdeletions panel’s costs, lower average Panorama reimbursement following new CPT codes, and costs incurred before related revenue was recognized. First-half gross margin improved slightly year over year.
- Cash used in operations was $15.9 million in the first half, versus $5.5 million in 2014. Capital expenditures were $6.0 million; cash declined $24.9 million to $62.2 million. Restricted cash was an additional $1.6 million.
- At June 30, current assets were $85.8 million and current liabilities $38.5 million. The balance sheet reported $23.1 million of senior secured term debt at fair value and $4.7 million of equipment financing, including $2.3 million current. The senior loan’s $20.0 million principal is due in 2019; its terms include a revenue royalty and security over substantially all assets.
- After quarter-end, the July IPO and August over-allotment sale generated approximately $178.5 million net proceeds from 10.9 million shares sold at $18 per share. Preferred shares converted to common stock at the IPO. These transactions are not reflected in the June 30 balance sheet.
Material changes, outlook and notable items
- Revenue mix shifted substantially toward direct U.S. sales: 78% of first-half revenue came from the direct sales force, versus 43% a year earlier; U.S. laboratory partners accounted for 8%, versus 42%. The company’s greater direct-billing exposure contributed to cash-basis revenue recognition of 81% of first-half revenue, versus 52% in 2014.
- Management expected operating losses to continue and research and development and selling, general and administrative costs to increase as the company expands sales, develops products and operates as a public company. Before the IPO, management said cash and anticipated operating cash were expected to cover requirements for at least 12 months; the subsequent IPO materially changed the funding position.
- Management reported more than 11 cloud-based licensing and service arrangements at June 30, but recognized revenue from only one such arrangement in the first half. Cloud-based tests may generate lower revenue and gross profit per test than tests processed in Natera’s laboratory.
- The company recorded a $1.18 million second-quarter revenue charge for settlement of a payer audit that had alleged $1.88 million of overpayments. It also extended the estimated useful lives of certain equipment from three to five years, reducing Q2 and first-half operating and net loss by $0.6 million in each period.
- Non-cash fair-value losses affected results: first-half warrant remeasurement was $3.9 million and senior secured term-loan remeasurement was $2.1 million. Q2 other expense also reflected warrant valuation changes.
- The Court of Appeals for the Federal Circuit affirmed invalidity of the Sequenom patent claims on June 12, 2015; further appeal remained possible. A separate former-employee case concluded with a verdict in Natera’s favor on the employee’s claims.
- Key risks include reliance on Panorama, reimbursement uncertainty and payer recoupments, competition and pricing pressure, loss of laboratory partners, dependence on Illumina for sequencers and reagents, regulatory uncertainty over laboratory-developed tests and cloud software, and execution and scaling risks. ACOG and SMFM guidance did not recommend routine microdeletion screening and retained conventional screening as the preferred first-line option for average-risk pregnancies.
- The company reported compliance with debt covenants, effective disclosure controls, and no material change in internal control over financial reporting during the quarter. It reported no off-balance-sheet arrangements.
Important facts for investors to verify
- Whether Panorama volume growth translates into collected revenue, given the high share of cash-basis recognition and delays or failures in payer reimbursement.
- Whether reimbursement rates and coverage—especially for average-risk pregnancies and microdeletions—support margins after CPT-code changes and payer policy developments.
- Whether rising operating costs, direct-sales expansion and product development can be sustained while reducing losses and operating cash burn.
- Whether supplier commitments, reliance on Illumina, debt covenants and the secured lender’s royalty terms constrain operations or future cash generation.
- How the IPO proceeds are deployed, and whether the cloud model, international partnerships and planned new tests produce meaningful revenue at acceptable margins.