Invitae: This Turnaround Could Be Painful (NYSE:NVTA)

Investment Thesis

Invitae Corporation (NYSE:NVTA) has one chance to leverage itself into profitability in the next 12 months. The market, which has long been its primary funding source, is unlikely to recover any time soon. As long as interest rates remain high and the stock market continues to trade at depressed levels, there is limited upside for Invitae unless it becomes a self-funding enterprise.

At this point, earnings visibility remains low, providing little confidence in the ticker. The short squeeze and “tactical opportunity” discussed in the previous article have now played themselves out. In my view, Invitae Corporation shares will continue to trade sideways, offering little value to investors. A rating upgrade is conditional on the company demonstrating meaningful progress in its turnaround efforts and reducing its cash burn rate. Such actions would unlock additional value for existing shareholders. On the other hand, a rating downgrade is likely if the company fails to deliver on its turnaround plans or if it becomes dependent on dilutive sources for future financing.

Third-Quarter Results

NVTA reported topline sales of $133 million in Q3, up $19 million (17%) year-over-year, driven by a 9% increase in testing samples (324,000 units vs. 296,000 a year ago) and an increase in average selling prices ($398 per test vs. $377 per test a year ago) due to variances in payor and product mix (different payors are charged differently). These are solid numbers under the circumstances, especially given the July 2022 cliff, when management announced a “realignment plan,” which saw a leadership change, layoffs, and discontinuation of certain businesses and products.

Gross margins were suppressed this quarter, down significantly to 12.4% from 23.3% a year ago due to a mix of cash and non-cash extraordinary expenditures, namely an inventory write-down of its shutdown business segments, summing to $16 million in aggregate and $14 million in amortization expense. Excluding these items, the gross margin would have been up to 46%, compared to 35% a year ago. Most restructuring expenses, however, were recorded as operating expenses, namely severance packages for the 1000 or so employees made redundant in the past few months, as discussed in the previous article. Employee severance cost the company $58 million in Q3, in addition to $49 million in asset disposals (other than inventory disposals), such as equipment and building lease terminations.

Shares rebounded on Q3 results, perhaps due to a short squeeze (short interest is 19%), but what is certain is that earnings were less than Wall Street expected. The $128 million operating cash loss is painful and raises total cash burn to nearly half a billion dollars this year. What remains in the company’s coffers is $586 million in cash, cash equivalents, and marketable securities, leaving little room for errors in management’s turnaround plan and cash burn projections (between $325 million cash burn reduction target and $245, representing realized annual run rate based on Q3 results), especially given that management expects an additional $170 million in restructuring expenses in the next 12 months, on top of operating expenses. Thus, dilution risk remains high. From experience, turnaround plans can be tricky, and in my view, execution risk remains high.

The reduction in cash burn to $108 million represents an annualized run-rate reduction of approximately $245 million from Q1 and reinforces that we are on track to deliver the $326 million in cash burn reduction fully realized in 2023. – Ken Knight, Q3 conference call.

Market Position

NVTA has a unique market position, with strong brand recognition, supported by strong relationships with commercial insurance payors. The company is one of the first gene testing labs to enter the UnitedHealth provider network. For most of NVTA’s peers, the commercialization process starts with Medicare, not insurance companies. NVTA, however, started selling its products before Key Opinion Leaders “KOLs” adopted gene diagnostics in the standard-of-care guidelines, as mirrored in its negative gross margins in 2013 -2016. The company’s entrepreneurial spirit, combined with its commitment to democratizing the gene testing market through a low-cost, high-volume model, attracted the likes of SoftBank and Ark Invest, but now, with a solid alternative in the bond market, NVTA isn’t attractive anymore.

The company’s focus on hereditary cancer risk screening, with established clinical utility, allowed it to quickly penetrate the market with minimal investment in clinical validity and trial studies. When NVTA started selling its BRCA1 and BRCA2 screening tests, the medical community already understood the connection between these two genes and the risks of breast and ovarian cancers.

In recent years, NVTA did ramp up its R&D, namely for its Minimal Residual Disease market, but the expense account also includes activities tied to its customer accounts. This, from my understanding of management’s comments, limits its ability to reduce total expenses through R&D cost reduction initiatives.

And those people start out in R&D and over time as we’ve have launched more content a portion of their time than sort of transfers over to the cost of goods, because what they are now doing is spending increasing amounts of their time actually interpreting the results of particular tasks and assisting in the classification of variance for individual patient reports. So basically that portion of our R&D line over time migrates out of R&D and into COGS and that’s some of what you saw it’s to some degree a function of expansion of our test menu and the commercialization of a broader test menu, and to some degree it’s a function of volume growth that basically migrate some of the R&D expense over in the COGS. – Randy Scott, Q2 2016

Because we are aggregating large numbers of genetic tests into a single service, our near-term offering will in most cases replace an existing test already offered by a third party. Where our test is replacing an existing test already offered by a third party, the clinical utility of the tests that our service might replace is generally well established and accepted in medical practice. SEC Filings.

What is notable is the company’s decision to exit its Cytogenetic analysis business, including CMA, FISH, and Karyotyping, among other segments. This leaves its market share to NeoGenomics (NEO), with an established position in this market. Its decision to also seek divestiture or sale of its Kitted business is bad news to OncoCyte (OCX), which is also desperately looking to divest the same business line, creating two options on the market for any potential buyer.

Summary

The era of free money is over, and I don’t believe it is coming back anytime soon. Companies such as NVTA, which for long relied solely on equity financing to fund growth, must now rely mainly on cash and potentially debt financing, given the realities of the stock market and the dilutive impact of new equity offerings from suppressed ticker prices.

Invitae Corporation’s current cash balance is barely enough to cover operations in the short term (12 -18 months) even if management achieves cash burn targets, leaving little room for error. The execution of management’s “realignment plan” needs to be flawless for Invitae Corporation to improve shareholder value meaningfully.