Veracyte Third Quarter Results: Good Execution; Sustainable Rally

Veracyte Third Quarter Results: Good Execution;  Sustainable Rally

Scientist in the lab using microscope

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investment thesis

In previous articles, I have discussed a paradigm shift in the genetic testing industry from a “growth at all costs” market approach to “profitable growth” primarily driven by rising costs of capital such as the era of free money. . comes to an end. Genetic diagnostics is a new field, and market participants adopted an aggressive marketing strategy that incorporated significant spending on clinical validity studies and product awareness campaigns. This was intended to influence key opinion leaders “KOLs” to change the standard of care practice guidelines and payers to expand insurance coverage to their products to achieve rapid growth.

This historical pattern has been widely adopted by market participants (as reflected in anemic profitability numbers across the board), but to varying degrees. For example, smaller market participants such as Veracyte (NASDAQ:VCYT) and CareDx (cDna), have less cash consumption compared to their peers like Natera (OUR) and Invite (NVTA), allowing them to more easily pivot to profitability in response to new market dynamics.

I envisioned this paradigm shift as a combination of higher profitability at the expense of lower revenue. While I noted VCYT’s low cash burn in the previous article, I wasn’t expecting the magnitude of its change.

Veracyte is not as far in the red in terms of cash burn compared to its peers, making it easier to leverage trades for profitability.

I see VCYT in a favorable position to pivot to profitability, given its stronger balance sheet and better cost structure relative to its competitors – the FDA is stepping in, October 2022

Yesterday the company announced the results of the third quarter, showing significant revenue growth and cash flow improvements driven by strong demand for its diagnostic products. Here are some highlights from the company’s earnings release.

  • Revenue grew 25% year over year to $75 million
  • Gross margin improved to 66% compared to 64% a year ago.
  • Operating loss decreased 30% despite increased revenue
  • Positive operating cash flow of $7 million, compared to a cash burn of $1.4 million a year ago

These numbers are a model example of profitable growth, raising the bar for the entire sector. Other companies should take note of VCYT’s success, as the industry now focuses on improving margins and returns to generate sustainable returns for investors.

Spectacular Third Quarter Results

VCYT reported strong quarterly numbers, with revenue reaching $75 million, up 25% from the previous quarter. Basic diagnostic tests, which account for 85% of total sales, grew 27%, driven by higher test volumes, namely the Afirma Thyroid and Decipher Prostate tests. VCYT showed fantastic financial discipline, with operating losses reduced by a third, despite increased revenue. Operating cash flows were $7 million, compared to a cash burn of $1.4 million in the same period last year.

As mentioned in previous articles, higher capital costs made profitability the top priority for shareholders. This quarter, VCYT significantly reduced operating expenses as a percentage of revenue while continuing to grow the business at an impressive rate. This is a notable departure from past trends where revenue growth outpaced profitability, resulting in an unsustainable business model. Genetic testing companies, such as VCYT, have traditionally spent significant amounts of capital on marketing, product awareness campaigns, and validity studies, all with the goal of changing standard-of-care practice guidelines to drive growth. This quarter, the company managed to do both, a positive surprise from the lesser-known genetic testing company.

How did VCYT achieve such positive results? This is primarily due to continued focus on operational efficiency, low-cost platforms to drive international growth, and increased collaboration between the company’s various business units to deliver better value to its customers. For example, the company continues to leverage its NanoString (NSTG) nCounter Analysis System (where VCYT has an exclusive global license outside the US) to take advantage of Europe’s renewed interest in genetic diagnostic testing, an area where I believe the continent lags behind the US USA for a few years. For example, while UnitedHealth (UNH), the largest health insurer in the US. started covering prenatal screening for medium-risk pregnancies in 2020, it wasn’t until latest month the UK NHS adopted a similar programme. In November 2021, Sweden expanded coverage for the Prosigna breast cancer test, after the UK and Germany. This unique exposure to the international market is an important tailwind in the coming years. Another engine of growth was that of August 2021 acquisition from HalioDx, a provider of non-invasive imaging technologies for the diagnosis and monitoring of patients undergoing cancer treatment, namely its flagship product Decipher Prostate. This added some inorganic growth, but management’s success in improving the performance of acquired assets has been equally important in driving results. For example, the European Society for Medical Oncology adopted Halio’s Immunoscore Colon Cancer Test in Practice Guidance for Asian-tailored versions of its Clinical Practice Guidelines in November 2021, after acquisition. Decipher Prostate is now the second most popular test in the company’s portfolio after Decipher Prostate Cancer. In general, I think the international exposure is now between 15% and 20%

The accumulation of literature on VCYT products in the last year should be acknowledged, which hastened the adoption of their tests into standard of care practice guidelines. For example, in September 2021, the National Comprehensive Cancer Network (NCCN) Incorporated Decipher Prostate in its guidelines. The Envisia genomic classifier for IPF was highlighted in updated practice guidelines published in the American Journal of Respiratory and Critical Care Medicine (AJRCCM). These developments contributed to the exemplary performance this quarter.

Reassessment of regulatory risks

In a previous article, we highlighted the regulatory risks associated with FDA initiatives to regular the LDT market. However, the evolving political landscape forces me to revise my assessment in light of the possibility that the 2014-2016 policy and regulatory pattern for LDT supervision will be repeated this year.

In 2014, the FDA provided guidance to regulate the LDT market, supported by the Obama administration in the same way it announced earlier this year. However, in 2015, Republicans won Congress, emphasizing in their platform less regulation and more business-friendly health policies, such as reflected in the 21 Century Cares Act of July 2015, aimed at speeding up the drug approval process. In 2016, the Trump administration archived the proposal indefinitely.

Early last month, Congress temporarily decided hold the VALID law that would have given the FDA new powers to regulate LDTs, perhaps until the results of the midterm elections come out. In light of the current political landscape, I see less political risk for the genetic testing market, as Republicans appear to have a lead in the polls ahead of the election period.

Summary

Now that the era of free money is over, investors are demanding profitability rather than inflated revenues and low operating profits. Yesterday, VCYT exceeded investor expectations, combining strong revenue growth with higher profitability. Revenue grew a solid 25%, while operating loss decreased 30%.

The company’s product menu managed to secure significant market shares, namely Afirma Thyroid and Decipher Prostate, without falling into the red in terms of cash flow, unlike its competitors. I am encouraged by the economy of scale and the fact that this company is generating strong cash flow with room to grow given the rapid demand for genetic testing in Europe and the US Given recent developments this article updates the VCYT rating from holding to buying.

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