Natera, Inc. — Q2 2017 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2017. Unaudited consolidated financial statements. Amounts below are in U.S. dollars; financial statement figures are in millions unless stated otherwise.
Business context and reporting period
Natera provides genetic testing services, principally prenatal testing. Panorama, its non-invasive prenatal test, generated 64% of revenue in the first half of 2017. Other offerings include Horizon carrier screening, Constellation cloud-based software, and the newly launched Evercord cord blood and tissue service and Vistara single-gene screening test.
In the first half, the company processed approximately 247,100 tests, including 233,700 tests accessioned in its laboratory and 13,400 Constellation units. Total volume increased from approximately 216,600 in the comparable 2016 period.
Financial performance and liquidity
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Total revenue | $53.6 | $52.0 | $100.5 | $113.9 |
| Operating loss | $(27.0) | $(22.5) | $(64.1) | $(32.1) |
| Net loss | $(27.7) | $(23.2) | $(63.7) | $(31.8) |
| Basic and diluted loss per share | $(0.52) | $(0.46) | $(1.20) | $(0.63) |
| Gross profit and gross margin | $19.1; 35.5% | $21.0; 40.4% | $32.3; 32.1% | $50.6; 44.4% |
First-half product revenue was $98.2 million, down 12.6%; licensing and other revenue rose 53.3% to $2.3 million. First-half Panorama revenue was $64.3 million, down from $70.7 million, and Horizon revenue was $27.8 million, down from $34.7 million.
Cash used in operating activities was $38.1 million in the first half, versus $20.2 million a year earlier. Investing activities provided $27.5 million, primarily from net investment proceeds; financing activities provided $2.4 million. Cash and cash equivalents declined to $7.1 million from $15.3 million at year-end 2016.
At June 30, 2017, Natera had $95.0 million in short-term investments, $0.8 million in current restricted cash, and $50.0 million of short-term debt including accrued interest. Current assets were $123.1 million and current liabilities $98.3 million. The UBS credit line was secured by investments and could be called for repayment at UBS’s discretion.
Material changes versus the prior comparable period
- Q2 revenue increased 3.1%, but first-half revenue fell 11.7% year over year despite higher test volumes. Management attributed the first-half decline mainly to lower average reimbursement as insurers shifted from out-of-network to in-network pricing.
- First-half operating loss nearly doubled, and net loss increased to $63.7 million from $31.8 million. Cost of product revenue rose while revenue declined; product gross margin fell to 32.0% for the first half from 43.7% (product cost as a share of product revenue increased to 68.0% from 56.3%).
- Research and development expense increased 28.2% to $24.4 million, and selling, general and administrative expense increased 13.0% to $71.9 million.
- Cash used in operations increased by $17.9 million year over year. Short-term investments declined to $95.0 million from $130.9 million at December 31, 2016.
Outlook, commentary, risks, and unusual items
- Management expects continuing net losses and negative operating cash flows in the near term and says additional revenue is needed to reach profitability. It stated that, based on its business plan, cash and marketable securities should cover anticipated cash needs for at least 12 months after August 9, 2017.
- After quarter-end, on August 8, Natera closed a senior secured term loan with $75.0 million available at closing and up to $25.0 million more available through December 31, 2018, subject to a minimum net revenue condition. The loan bears interest at 8.75% plus the higher of 1.00% or LIBOR, matures in August 2024, requires interest payments during the term and repayment of principal at maturity, and is secured by substantially all assets, including intellectual property. Natera also agreed to issue 300,000 shares as a funding-commitment fee.
- The company said approximately 83% of first-half revenue was recognized on a cash basis. It expected adoption of the new revenue standard in 2018 to have a material impact, with the potential for some revenue to be recognized earlier.
- Reimbursement remains a central risk: coverage for average-risk pregnancies and microdeletions was limited, and the company reported low reimbursement under the new microdeletions CPT code. It did not expect reimbursement for approximately 26,000 average-risk Panorama tests and 40,000 Panorama microdeletions tests performed in Q2.
- In March 2017, a third-party payer alleged overpayments and demanded recoupment; Natera disputed the claim. The filing also describes IPO-related securities class actions, a patient lawsuit, and a Department of Justice civil investigative demand relating to a former employee’s qui tam billing allegations. No loss contingency accrual was recorded; outcomes and potential losses were not estimable.
- First-half cost of product revenue included a $0.6 million impairment charge related to sequencing and automation equipment phased out during a transition to newer equipment. Management cited temporary qualification costs during Panorama process changes and cost savings from the new process.
- Management reported disclosure controls and procedures were effective at the reasonable-assurance level as of June 30, 2017, with no material change in internal control over financial reporting identified during the quarter.
Most important facts for investors to verify
- Whether reimbursement rates, payer coverage, and collections improve enough to offset lower in-network pricing and support revenue growth.
- The pace of cash burn and whether the post-quarter $75.0 million loan, its interest burden, security package, and potential additional borrowing provide adequate liquidity.
- The progress and financial exposure of the payer recoupment demand, the DOJ inquiry, and pending litigation, including whether any loss becomes estimable.
- Whether the new Panorama workflow delivers expected savings without disrupting test quality, turnaround, or volumes, and whether product gross margins recover.
- The eventual financial-statement impact and adoption method for the revenue recognition standard, given the substantial use of cash-basis recognition.