Natera, Inc. — Q2 2016 Form 10-Q Summary
Reporting period: Three and six months ended June 30, 2016. Financial statements are unaudited; amounts below are in millions of dollars except per-share data and test volumes.
Business context
Natera provides genetic testing services, principally through its Panorama non-invasive prenatal test (NIPT), alongside Horizon carrier screening and other prenatal and reproductive tests. It also licenses technology through its cloud-based Constellation platform. Panorama represented 62% of first-half 2016 revenue, down from 76% a year earlier, as Horizon volumes grew.
Key financial results
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Total revenue | $52.0 | $45.1 | $113.9 | $92.5 |
| Cost of product revenue | $31.0 | $25.7 | $63.3 | $50.6 |
| Gross profit | $21.0 | $19.4 | $50.6 | $41.9 |
| Gross margin | 40.4% | 42.9% | 44.4% | 45.3% |
| Research and development | $10.3 | $6.7 | $19.1 | $12.4 |
| Selling, general and administrative | $33.2 | $28.1 | $63.6 | $51.3 |
| Operating loss | $(22.5) | $(15.5) | $(32.1) | $(21.7) |
| Net loss | $(23.2) | $(19.7) | $(31.8) | $(29.7) |
| Basic and diluted loss per share | $(0.46) | $(3.58) | $(0.63) | $(5.50) |
Revenue increased 15.3% in Q2 and 23.1% in the first half year over year. Q2 growth was led by Horizon, whose revenue rose $10.5 million; Panorama revenue declined $3.3 million, mainly because of lower insurance reimbursement. For the first half, Horizon revenue rose $21.7 million, while Panorama revenue increased only $0.5 million as higher volume was offset by lower reimbursement. The reported loss per share comparisons are affected by the substantially higher weighted-average share count following the 2015 IPO.
Cost of product revenue grew faster than revenue in both comparisons, compressing gross margin. Management cited higher test volume, materials and personnel costs, and the mix of Horizon and average-risk Panorama testing; it also said cost per test declined due to laboratory workflow efficiencies. Operating expenses increased with research investment, hiring and post-IPO public-company costs.
Cash flow, debt and liquidity
- Cash used in operating activities was $20.2 million in the first half of 2016, versus $15.9 million in the prior-year period. Capital spending, net of property-sale proceeds, was approximately $7.1 million; net investing cash use was $2.4 million.
- Cash and cash equivalents were $16.6 million at June 30, 2016, and short-term investments were $198.6 million. Restricted cash was $1.6 million. Cash plus short-term investments totaled approximately $215.2 million, before restricted cash.
- Short-term debt was $49.3 million, including accrued interest, against a $50 million UBS revolving credit line. The line is secured by the company’s money-market and marketable securities; UBS may demand repayment or terminate the facility at any time. The stated effective interest rate was 1.1%.
- Management said existing cash and marketable securities should meet anticipated cash requirements for at least the next 12 months, while warning that additional capital may be needed and may not be available on acceptable terms.
- Operating lease payments totaled $51.4 million in future minimum commitments as of June 30, 2016. Inventory purchase obligations were $11.9 million, with additional disclosed commitments of $2.2 million under a laboratory services agreement and $3.2 million under a four-year payer agreement.
Material changes, outlook and risks
- Test accessions exceeded 209,000 in the first half, versus more than 134,000 a year earlier; Panorama accessions exceeded 162,000. Management attributed the increase mainly to Panorama and Horizon growth.
- Most revenue is recognized when cash is received: 86% of first-half 2016 revenue, versus 81% in the first half of 2015. Consequently, revenue may lag test accessions, and some tests may not ultimately be reimbursed.
- Management expects operating losses to continue, with research and development and selling, general and administrative expenses increasing as the company develops products, expands sales and supports operations. It cautioned that revenue growth could return to lower levels in coming quarters. No numerical revenue or earnings guidance was provided.
- Average-risk NIPT and microdeletion reimbursement remain uncertain; most payers had negative coverage determinations for average-risk testing. In-network contracts can improve payment predictability but may reduce reimbursement per test and near-term margins.
- Major operating risks include dependence on Panorama, payer reimbursement and collections, competition and pricing pressure, reliance on Illumina for sequencing equipment and reagents, laboratory capacity and quality, and regulatory uncertainty for laboratory-developed tests and Constellation software.
- Litigation includes four purported class actions alleging misstatements in the IPO registration statement and prospectus, and a patient lawsuit alleging failure to perform an ordered carrier screen. The company recorded no loss contingency for these matters and said outcomes were uncertain. Separately, the Supreme Court denied Sequenom’s petition regarding the ‘540 patent on June 27, 2016, ending that litigation.
- A $3.2 million four-year agreement with an insurance carrier provides partial exclusivity and pricing benefits; $3.0 million of deferred costs was recorded as a long-term asset, with amortization reducing product revenue.
- Management concluded disclosure controls were effective at a reasonable assurance level and reported no material change in internal control over financial reporting during the period.
Most important facts for investors to verify
- Whether Horizon growth can continue and offset Panorama’s reimbursement-driven revenue pressure, while tracking product mix and gross margin.
- Collections, payer denials and refund exposure, particularly given the high cash-basis share of revenue and the time lag between accessions and recognized revenue.
- Cash burn and investment liquidity relative to the nearly fully drawn, callable UBS credit line and planned operating and facility commitments.
- Progress on average-risk and microdeletion coverage, in-network reimbursement rates, and regulatory requirements for tests and Constellation.
- Developments in IPO class actions and the carrier-screen patient lawsuit, including any change in the company’s ability to estimate potential losses.