Veracyte, Inc. — Q3 2016 Form 10-Q Summary
Reporting period: Three and nine months ended September 30, 2016. Financial amounts below are in U.S. dollars; “millions” is used unless otherwise stated.
Business context
Veracyte is a molecular diagnostics company. Through September 30, 2016, all revenue came from Afirma, its thyroid nodule diagnostic solution. Percepta, a lung cancer diagnostic test, was launched in April 2015. Envisia, designed to aid diagnosis of idiopathic pulmonary fibrosis, was introduced in October 2016, after the reporting period.
Financial results and liquidity
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Revenue | $18.6m | $12.3m | $46.8m | $35.5m |
| Revenue growth | 51% | 32% | ||
| Gross profit and gross margin | $12.2m; 65.8% | $6.7m; 54.4% | $27.9m; 59.5% | $20.1m; 56.8% |
| Operating loss | $(4.9)m | $(8.9)m | $(25.1)m | $(25.5)m |
| Net loss | $(5.6)m | $(8.9)m | $(27.0)m | $(25.7)m |
| Basic and diluted loss per share | $(0.20) | $(0.32) | $(0.97) | $(1.01) |
Gross margins are calculated from reported revenue and cost of revenue. Q3 revenue growth reflected increased Afirma adoption and newly accrued revenue from additional payers. The company reported 5,740 GEC tests in Q3, up 14%, and 16,924 for the nine-month period, up 23%.
Revenue recognized on an accrual basis was $13.9m, or 75% of Q3 revenue, compared with $7.0m, or 57%, in Q3 2015. For the nine months, accrual revenue was $31.5m, or 67%, versus $19.0m, or 53%. The company recorded $3.5m of incremental Q3 revenue after concluding it could reasonably estimate reimbursement for additional payers; this reduced Q3 operating and net losses by $3.5m, or $0.13 per share. The corresponding nine-month incremental accrual was $4.0m.
- Cash and liquidity: Cash and cash equivalents were $31.7m at September 30, 2016, down from $39.1m at December 31, 2015. Current assets were $43.0m and current liabilities $10.3m, implying working capital of approximately $32.7m.
- Cash flows, nine months: Operating activities used $23.8m; investing activities used $3.8m, primarily for facility and laboratory build-out; financing activities provided $20.1m. Cash and cash equivalents declined by $7.4m.
- Debt: Net debt was $24.9m, against $25.4m principal, under a 12% fixed-rate credit agreement maturing in 2022. Principal is interest-only through March 2020, with repayment in eight installments during the final two years. The company elected to pay 3% of the rate in kind for Q3 and reported $0.4m of such accrued interest. Debt is secured by substantially all assets; the company reported covenant compliance at quarter-end.
- Commitments: Operating lease obligations totaled $20.8m and non-cancelable supplies purchase commitments approximately $1.5m at September 30, 2016. The company reported no material pending litigation and no off-balance-sheet arrangements.
Material changes versus the prior comparable period
- Q3 revenue rose 51%, while operating loss narrowed by $4.0m. For the first nine months, revenue rose 32%, but net loss increased by $1.3m, largely reflecting substantially higher interest expense after the March 2016 borrowing.
- Q3 operating expenses increased 11% to $23.5m; nine-month operating expenses increased 18% to $72.0m. Higher sales and marketing, R&D and cost of revenue reflected increased staffing, test volumes, and product development and commercialization activity.
- Q3 interest expense was $0.8m versus $0.1m in 2015; nine-month interest expense was $2.0m versus $0.3m. The increase followed the $25.0m term loan and repayment of the prior loan in March 2016.
- The U.S. Genzyme co-promotion agreement terminated effective September 9, 2016. Veracyte had expanded its internal sales and marketing team in preparation; the company expected elimination of the U.S. co-promotion fee to offset some ongoing internal costs.
Outlook, commentary and key risks
- Management expected existing cash, available term-loan capacity and revenue to meet anticipated cash requirements for at least the next 12 months. It also expected further losses and said it might never achieve profitability. No numerical revenue or earnings guidance was provided.
- Growth depends on Afirma test volume, payer coverage and reimbursement, collections, and the successful commercialization and reimbursement of Percepta and Envisia. Management expected continued investment in R&D and selling and marketing.
- CMS set the 2017 Afirma GEC gapfill rate at $2,864, below the then-current $3,200 rate. Veracyte requested reconsideration; the outcome was uncertain. Average GEC reimbursement was approximately $2,200 in Q3 2016 versus $2,300 in Q3 2015. Medicare accounted for approximately 20% of GEC volume.
- Revenue estimates involve significant judgment and can change as payer experience develops. The company disclosed approximately $163.1m of cumulative billed amounts for tests not recognized as revenue and not yet paid, written off or otherwise resolved; it gave no assurance as to the timing or amount, if any, that would be collected.
- Other highlighted risks include dependence on Afirma and a limited number of payers, reimbursement reductions or denials, complex billing and collections, reliance on single-source suppliers and TCP for cytopathology services, clinical and commercialization risks for newer tests, regulatory uncertainty including possible FDA oversight of laboratory-developed tests, and the ability to raise additional capital.
- Subsequent event: On November 1, 2016, the company entered into an underwriting agreement for a public offering of 5.0m shares at $6.00 per share; underwriters exercised an option for 0.75m additional shares. Expected gross proceeds were approximately $34.3m, subject to customary closing conditions. The company intended to use net proceeds for working capital and general corporate purposes, with possible complementary acquisitions or investments.
- Management concluded disclosure controls were effective at the reasonable-assurance level and reported no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- How much of reported growth reflects recurring test volume and collections versus the new payer accrual estimates, and whether those estimates ultimately match cash reimbursement.
- The outcome of the CMS reconsideration request and the effect of the 2017 GEC rate and any payer-linked rate changes on realized reimbursement.
- Whether Afirma adoption and cash collections continue to grow after the U.S. Genzyme agreement ended, and whether internal sales costs are offset by avoided co-promotion fees.
- Whether the November 2016 offering closed on the disclosed terms, including net proceeds and share dilution.
- Cash burn, liquidity, debt service and covenant compliance, including the terms and availability of the optional second loan.
- Evidence of payer coverage, reimbursement and commercial adoption for Percepta and Envisia, which did not generate reported revenue through September 30, 2016.