NVTA at CML

On 9-15-2020, I submitted my official estimates for Invitae (NVTA) to Thomson First Call / Refinitiv as an analyst of record.

The end of this dossier includes my one-on-one CEO and CFO interview, so this is a lengthy dossier in that it houses what is normally two separate reports.

We added Invitae (NVTA) to Top Picks on July 4, 2016 for $7.42.

As of this writing it is trading at $44.76, up 503%.

This entry date and price has been verified by the third-party audit firm Krost. Please feel free to visit their website.

Earnings
In short, all of these numbers are, and have been, trampled on by COVID-19, but to see the company return to growth so quickly has been encouraging.

This chart they shared is nicely illustrative of the COVID impact and recovery

A longer-term perspective reminds us that as of the close of the Archer acquisition on October 2nd, 2020, the company has guided to 50%-60% compounded annual growth for 3-5 years, putting the company at about $2 billion in revenue in five years, up from $217 million for 2019.

As we have said many times, in terms of a growth trajectory, there is no other Top Pick with a larger total addressable market growing as quickly as the what Invitae has in front of it.

This company will fail or succeed on execution, not on market size, and while we have seen the stock rise more than five-fold since being added to Top Picks, if we’re right — and it’s not a guarantee that we are — this company has the potential to rise even now, from a $5 billion market to over $50 billion in the next five to ten years.

While we discuss the opportunity, we also equally discuss the risks, because the upside is unmatched in Top Picks, but so is the downside risk unmatched.

* Revenue: $68.7 million, up 21% year-over-year, versus analyst expectations of $59.80 million.
This is a beat.

(My official estimates called for $62.15 million.)

* Adjusted EPS: -$0.62 versus analyst expectations of -$0.66 (but nobody cares about this, yet).
This is a beat.

* Adjusted GAAP Gross Margin: $26.8 million.

Snapshot
We believe Invitae, in the long-term, will be a substantial winner in the genomics testing and bio-informatics space, and one of the most powerful network driven data companies in all of health sciences.

We further believe it will generate material portions of its revenue, in a few years, as on going recurring revenue through lifetime subscriptions to genomic screening through its somatic offerings from Archer DX combined (necessarily so) with its core germline business.

In short, if an individual is found to have a germline variant that is potentially pathogenic, their inherited gene profile will determine their personal path as to frequency of somatic testing and health monitoring.

Equally, if someone is found to have a pathogenic variant in a somatic test, so too they will then have their inherited genes mapped, and a personal life long plan will be scripted to minimize risk of disease and maximize positive outcomes that go beyond survival and toward a thriving life.

We see Invitae not just as a genetic testing company, but rather a company that employs the science of information and the engineering of information systems developed hand-in-hand (informatics), with the power of network effects to create a dominant role in the genomic and personalized medicine thematics.

We see improved SG&A margins, long-term, resulting from the digital transformation which has thrust Invitae’s automated AI channel (with the acquisition of Clear Genetics) into the spotlight.

We unofficially echo the company’s guidance for 50%-60% compounded annual revenue growth for the next five years with higher gross margins (guidance raised to 50%-60% from 50%), yielding an entity with $2 billion in sales in five years.

With a growth rate expected to reach over 50% compounded every year for the next 5-years and improving margins, we believe the company is in the early stages of growth and has not yet reached its potential.

Broadly speaking, we see the thematic of genetic testing and personalized medicine expanding rapidly, acting as a tailwind to the industry at large.

The thematics for genomics are likely the largest single secular trend in any industry in any place in the world.

If you have enough of a mountain top view, you should be able to see a world where virtually every living person and unborn person will have their genes mapped in order to produce optimal health outcomes.

Further, those with at risk profiles for any rare disease, will then me monitored on a schedule specifically and personally designed for them based on their genetic profile.

“Everyone” is a big word, so we can look out to the next ten years, and we’ll get a graphic that looks like this:

First the march into 2017:

 

And then the march forward (this is done to scale):

 

And, as I noted prior, genetic testing is not like a normal blood test — not even close. And it took a visit to Invitae headquarters to fully grasp the company’s competitive edge.

The global next generation sequencing market is forecast to grow from $4.15 billion in 2016 to $11.93 billion by 2024, or fully 187%.

But that chart is not even half the market. In total, the global genomics market is expected to reach $27.6 billion by 2025.

In fact, if we look at the totality of personalized medicine, that market is forecast to hit nearly $3 trillion dollars by 2022 and fully $340 billion for personalized medicine therapeutics and personalized medicine diagnostics.

All of this scratches the surface. According to a United States Harris Poll taken in the middle of 2018, only 36% of U.S. adults were likely to use genetic testing to determine cancer risk.

This science is just now reaching cognition for the populace and doctors.

That number, in our opinion, will top 90% within a decade, and it won’t just be for cancer, but all chronic diseases and even general health care and preemptive care for healthy people.

Invitae is going to be the dominant market force in genomics and personalized medicine within that realm — we see a very bright future.

We firmly believe that Invitae is not a test-by-test genomics company, an industry which CEO Sean George has openly said is dead.

Invitae is a network genomics company, with some of the most impressive technology in the industry and a clear competitive advantage which, at least for now, seems quite defensible to competition.

Now it has added somatic capabilities that are also industry leading technology.

It has diversified the risk of a centralized laboratory approach by acquiring a gorgeous apparatus for a decentralize approach.

This is the bullish thesis for Invitae and it goes much further than a quarter, or a year.

Stock gyrations and quarter by quarter histrionics are just conversation and not a conversation we are interested in having.

Having said all of that, please be aware of the risk inherent in a company with such a large and growing cash burn relative to cash balances, debt burden, and overall revenue.

One-on-One with the CEO and CFO
A few takeaways I had from the call that are updates from our prior views:

* The recovery out of COVID has been so strong, or if you prefer, Invitae’s markets are growing so fast, that the company has decided it press back on the accelerator for growth and eschew it prior conservative approach.

* The once touted 50%-60% growth margin goal with the addition of Archer has been brought down to its former goal of 50% gross margin in an aim to grow faster.

* For the first time in four years — that is, sine I have ever spoken with the company — it is outwardly noting that two other competitors will be surging with it, and that competition will mean faster growth but also more cash burn.

Here are some statements we’d like to call out:

— With regard to profitability, growth, and the medium-term trade-off:

CEO: “Growth is going to become front and center here much more than the concern about when we become profitable, as it were.”

CEO: “In the long run, it’s just not going to matter. It’s going to be like asking, “Did Amazon break even in 2006 or 2012?” I forget. Nobody knows, nobody cares. I think that’s where our head is right now.”

CEO: “We’ve seen this in our investor base, you have a top 70% of our holders are very much interested in the TAM, the development of it and our growth into it. They don’t really care about profitability, per se, but that does change from time to time.”

CEO: “When you look two and three years out, do you believe that we’re putting all the pieces together to have that incredible growth early in the first quarter before COVID hit middle of March? That’s the thing that you really have to focus on. We’ve stitched all of these things together. Business model is working.”

CFO: “The investment world has really changed the way that they’re looking at this, which is everybody’s coming to get involved. Genetics matters. Genetics is super important, and there are only going to be a few winners. Growth is on, but also the race is on. It’s like finally people understanding what the potential is. And the diagnostics really, really matters.”

CFO: “we’ll pull the levers we have to pull to be prudent in our business, but we just urge you to think about what it is that we’re doing to change the genetics. As you said, to really change the name of the game.”

— With regard to the impact of COVID in the immediate -term:

CEO: “We have zero interest in trying to convince people that our stock should be higher than it is now in the next couple quarters, because we’re really going to fare well with this winter.”

Please enjoy the transcription of my conversation.

Ophir Gottlieb:
I’m going to start with the most pressing question, which surrounds Archer. Are you now able to give us some detail on guidance for Q4 and onwards with respect to margins, revenue, cash burn, samples? In other words, can you help analysts model the Archer piece yet? Or are we not there yet?

Shelley Guyer (CFO):
No. And I’d say the best thing that you can use is going to be, we’re going to file the 9-30 numbers. So we have filed their June 30th numbers with the prior S4 and then we’re going to file their 9-30 numbers with another amendment.

So, you’ll see those numbers as part of a proforma. And so I think that’s probably your best… Just look at what they did first quarter, second quarter, third quarter, and you make your own guesstimate on the fourth quarter.

OG:
Got it.

Sh G:
We never give quarterly guidance and we give our annual guidance at JP Morgan. So that’s sort of why, at that point, we’ll also have a better idea.

We didn’t even close it in the quarter. We closed it after the quarter. So we’ll have a better view by the JP Morgan conference and really be able to talk with more authority at that time.

OG:
Okay. Got it. Thank you. I appreciate that.

Question number two: when the Archer acquisition was announced, Invitae gave some loose guidance, which was 50% to 60% compounded annual growth in revenue for the next three to five years.

But what I want to focus on is that the prior Invitae long-term gross margin goal of 50% had essentially been lifted to the 50 to 60% range with the addition of Archer DX.

But on the call yesterday, it appeared to me that Invitae has reversed course on that gross margin percent guide, and rather stated that the goal was going to remain 50% company-wide and not this sort of elevated 50 to 60%. Is that right?

Sean George (CEO):
I think it just might be a misunderstanding or difference in timeframes. In the call, in the conversation about Archer’s margins are 60% to 70% of our 55% to 65%, you guys are just below 50 with you think you can get to 50 by the end of the year.

When people said, “Okay, what is your forecast margin for next year, people were looking at 21.” And we said, well, we’re not going to immediately bring down Archer’s margins and ours are going to kind of improve to the 50% point, maybe a little higher.

So yeah, in the next year or two, it might float higher than our long-term target 50%, but make no mistake, our long-term target is 50% gross margin.

We just, in the context of the Archer business immediately coming on at a higher margin, it’s not like we’re not going to drive it down just to drive it down.

So, it’ll pull up on the overall gross margin, but long-term, three to five years out, we’re still going to be expecting to head to the 50% gross margin level.

OG:
Okay. So, the higher gross margin percent from Archer is essentially going to be consumed into the entire entity and spent down rather than reaching for a higher long-term goal.

SG:
That’s right. That’s right. And we’ll either do more market building in cancer, or we’ll take those gross profits and invest them in pediatric or rare diseases or et cetera, et cetera.

OG:
Okay. And I assume still no change to the original loose guidance of the revenue growth forecast. I know 2021 in January is going to be a much bigger release, but not no change there?

SG:
Yeah, that’s right. We’re saying we’ll do the formal guidance in January, but there’s nothing that we see to change the way that we thought about it back when they announced the deal.

OG:
Okay. So, when the Archer deal was announced, I think all of us actually talked on June 23rd about the financing and how Invitae, in consultation with your largest shareholders and also your largest stakeholders, decided to raise an extra 50 to a hundred million dollars in financing.

Some was through a PIPE [Private Investment in Public Equity], but some was just an additional raise.

And at the time, the messaging I heard was that the extra amount, this additional amount that was raised, was to end the questions, per se, about cashflow break-even.

So that with those funds in total, while cashflow break-even was going to be two or even three years away, that the capital raises were done with the one caveat, of course, that there could be unforeseen new acquisitions, right?

So we have to take that off the table. So, I think I heard differently on the call too, and I want to straighten it out, is Invitae’s position the same or has it changed in the last several months?

So that is, is the cash flow break-even goal with no more outside funding still on? And again, free pass on acquisitions.

SG:
Yeah. So, it’s interesting. I think what we’re trying to message is we are still in that position, but now that COVID is kind of… We know the COVID landscape and growth is coming back and… Basically, our thesis is being validated.

The TAM is being understood by more and more people every week to be massive. And all that really matters is our growth into it.

And that’s where then what I would say is, we’re not changing where we are on our ability to get the cash flow positivity.

I do think that as we think about guidance heading in January, I think we’re going to be talking to investors more about like, hey, yes, we’ve got a ton of cash on the balance sheet. We’ve got enough to get the business profitability.

So, we are looking at growth and we are looking at growth by way of organic growth, investment in R&D [research and development].

Our investment horizon tends to be pretty close to it. It’s two years, 18 months to three years kind of range.

Nothing like… We’re not investing a decade out ahead of things, for example, but we are looking at organic investment and it’s just obvious that the M&A [mergers and acquisition] train is just going to keep running.

So, we’re just kind of like forecasting the people.

We’re never going to be in a position where we need capital to get the company profitable, but we also want to be able to understand, we think this is kind of game on, as far as we can tell.

Obviously, COVID not withstanding, elections causing this massive global turmoil into the world’s market scenarios, at which point… It’s why we’ll always have enough cash on the balance sheet, but we’re…

Yeah, it’s roughly the same, but I think you’re detecting what we intend, which is… We think growth is going to become front and center here much more than the concern about when we become profitable, as it were.

Nonetheless, we’ll always be ahead of it… and we’ll be able to get the company profitability if we need to.

Sh G:
I think some of that is driven by the investment community saying, wow, this is a pretty interesting space.

Illumina has decided for $9 billion to buy Grail.

EXACT Sciences has come in at $2.8 billion to buy Thrive. Neither of those companies has a real operating company.

So. the investment world has really changed the way that they’re looking at this, which is everybody’s coming to get involved. Genetics matters. Genetics is super important, and there are only going to be a few winners.

And so, as Sean said, growth is on, but also the race is on. It’s like finally people understanding what the potential is. And the diagnostics really, really matters.

I think we talked about that before. COVID has made people understand that diagnostics are important.

And so, I think that overlay is important to understand that we’re very different than we were on March 31st, March 15th, in the way the world is feeling now, and the race is on.

OG:
I think we all know each other well enough that I can ask this next question and no one will get upset… At least, I hope not.

As a member of the human race, I want Invitae to spend as much money as needed and raise as much money as needed to further the science. Right?

So, as we discussed, Sean, you just said it so wonderfully. The idea that today, we identify cancer when it literally shows up in an image is totally absurd, given the science that is available to us now, not to speak of the science that’s coming soon.

And that’s just cancer.

SG:
That’s right.

OG:
And Invitae has clearly been a spender and a maker of a market.

I don’t know that cognition would have been reached if Invitae hadn’t done it.

I don’t want to give the company too much credit, but I also don’t want to dismiss the fact I’ve seen companies raise the bar of cognition and Invitae is that to me.

So, in that sense, Invitae is the purveyor of greater health and health outcomes.

That’s one thing. That’s what I want for my life. That’s what I want for everyone’s life, but I’m here to ask questions for investors.

And as an investor, it still isn’t apparent to me that cashflow break-even is clearly a goal. So let’s just go myopic.

Q3 saw substantial and clearly factual reduction in cash break, right? We can’t argue it. I think there was… You can correct me if I get the numbers wrong. I think it was about $60 million burn on $170 million in revenue.

And then you can see the sequential decline, no doubt.

But I mean, I’m getting from investors, that that’s not really evidence that cashflow break-even is possible.

It’s just evidence of a short-term and intentional reduction. It’s nothing less and it’s nothing more.

What can you say to investors in that realm?

SG:
Yeah. And they’re right.

What I would say is, it’s just like we did in ’18, you can see… We know the levels on cash flow in the business. We pulled back on investment in future cash flows.
All op ex leverage starts going up.

And if we were to continue doing that for four or five more quarters, I think it’s hard not to draw the line and go, we would we get there. You could argue, is it Q3 next year? Is it Q1 22? But I think it’s hard to argue that if you see that pitch, we just made… Just like in 18, when we went from 36 to 16 or something like that, in a matter of five or six months.

That’s what I would say is that we certainly know we can do it.

Every time we say we’re going to reduce burn, we demonstrate very, very quickly that we can reduce burn.

If the question was well, okay, so you can reduce burn, but can you actually get it to zero?

I would just say, well, it’s pretty hard not to draw those lines. We know with that reduced burn, we can still grow significantly. Maybe not 70, 80%, but we can grow at 30 to 40%, which is still industry leading growth, and get the cash flow break-even.

And that’s where I would say, since we know we can do it, we’re not too concerned about it, but I totally understand if you’re sitting there and you’re concerned about cash flow positivity. That’s the question that’s going through your mind and you kind of just have to… I get it.

You got to kind of take management’s word for it now that I’ve said, but we’ve now demonstrated twice that when we say we can reduce it, we do.

But no, I get it, I think the thing that I would focus most on is… In the long-term, we do believe that total return to shareholder will be greater the way that we’re currently…

Where the now, or kind of average to the last many years, we think the total return to shareholders will be greater with that positional attitude than concerning ourselves too much if cash flow break-even in 2020, 21, 22, 23, 24, 25.

In the long run, it’s just not going to matter.

It’s going to be like asking, “Did Amazon break even in 2006 or 2012?” I forget. Nobody knows, nobody cares. I think that’s where our head is right now.

OG:
Yeah. And then of course you have the evidence that when I started covering the stock, it was $7 and it ain’t $7 anymore. So, that’s the other one.

SG:
Yeah. Yeah. That’s right. And I think that’s… And we’ve seen this in our investor base, you have a top 70% of our holders are very much interested in the TAM, the development of it and our growth into it.

They don’t really care about profitability, per se, but that does change from time to time.

Like, for example, when COVID hit, then it becomes front and center question, right?

If there was global market disruption, that would immediately become front and center conversation, which is again why we… And we have in the past lock[ed] ourselves without the flexibility, but we’re not there.

We’ve got more than 400 million on the balance sheet. We can execute and accelerate just fine.

OG:
I appreciate that answer. My last question, this is also a weird one.

The earnings call was an interesting one. You guys were incredibly transparent.

I thought the questions were lacking in some of detail, just in particular about Q4. So, I’m going to some questions about Q4, just because I have to, and if you say we can’t talk about it, then no offense.

It appeared to me from what was being said on the call that, okay, I’m just going to caveat, you have no idea what’s going to happen with COVID during winter.

For now, it looks like you’ve figured out what the impact of COVID is in the short term on your business.

And you’re feeling much more comfortable with it. It may be getting kind of mushed around because growth is so high that you can’t necessarily see the direct, absolute impact, but we definitely would not have said that in March.

SG:
That’s exactly where we are. Exactly what you see is… We know there’s an impact there.

There’s big growth. Not quite sure. And we know something’s going to happen in the winter if we can, and spring next year. We just don’t know what. Yep. That’s right.

OG:
Okay. So, with that backdrop, it feels to me that Q4 is kind of on track to be an Invitae Q4, which is your largest quarter of the year, substantial year over year growth.

So, I’m trying to… This is not including Archer. I’m trying to put rails around my forecast.

So, what can you tell me about your vision of Q4 as of this moment, with knowing so many things can go weird?

I don’t want to put a number on it because then you have to comment on the number, so I’ll just leave it really bland. What can you tell me about how you see this Q4 relative to other Q4s?

SG:
Yeah, I think we obviously made a point of, hey, September was a record September.

And then people said, “Well, do you see anything different in October? Is that what’s giving you pause?”

The answer is no.

We don’t see any change in business.

With that said, December’s always a seasonality month for us, with just this last week or so of stage three shutting down, countries re-shutting down, it’s just obvious there’s going to be an impact. And we just can’t… It’s honestly just, it’s impossible to [forecast].

We truly believe it’s going to be less of an impact… I would say this: We know it’s going to be less of an impact than in March.

We believe that the majority of our volume is with clients that actually have pretty reasonable COVID protocols now and we don’t think it’ll be that big of a deal.

Plus, we’ve got our… All of our online capabilities will help us through the throws of the COVID… COVID lows that are helping us now.

And we see the general market backdrop.

So, we’re feeling really bullish.

We just have no idea. And therefore, we would hate to get everybody all excited and pound the table and say growth is back, we’re back on, let’s do it. And then have, hey, COVID hit. “Oh, why did you miss?” “Because COVID hit.”

We just don’t want to get there. We don’t need to get there…

And I’ll tell you, it was interesting yesterday, it was pretty clear.

We have zero interest in trying to convince people that our stock should be higher than it is now in the next couple quarters, because we’re really going to fare well with this winter.

It’ll come back in growth and recovery and whatnot. If indeed those are covered…

In fact, we have no reason to start getting people’s expectations up there and deal with that uncertainty.

So, we’re just kind of telling people there’s going to be [an impact]. We don’t know what it is.

We’re saying that about it, we’re encouraging everybody else to be saying that about it, and there’s really no other story beside that. There’s nothing we see.

There’s no reason to try to softball or sandbag anything.

We’re just being circumspect. There’s going to be an impact. And nobody, no matter what they say, nobody knows what that impact is.

OG:
Yeah. Really goes for all businesses and health. Fair enough.

Sh G:
If you look at the last quarter and this quarter, it’s like 42% volume growth.

And if you look at last year, third to fourth quarter, it’s 14%.

It’s sort of been in that range historically.

So, I wouldn’t expect that this would be… there’s no huge bounce back. In everything, there’s some bad guys, because of COVID and such, and [inaudible] have a good fourth quarter because people spend more money in the fourth quarter, but all bets could be off.

So, I wouldn’t think that it would be any higher growth than you had historically between the third and fourth quarter.

OG:
That was very helpful, actually. Thank you, Shelley. That was excellent.

Okay. Yeah. I don’t want to drill down into any of the details right now.

We have no idea what this catastrophe is going to do, so we might as well stop guessing.

SG:
Yeah, that’s where we stand, that’s right.

Sh G:
No, but I think the other message that we’re trying to really get across is, we have never been on the quarter by quarter matters.

And we’ve tried to educate people on that.

I think in this day and age, that’s really, really important because it could be the fourth quarter. It could be the first quarter, who knows?

But when you look two and three years out, do you believe that we’re putting all the pieces together to have that incredible growth early in the first quarter before COVID hit middle of March?

That’s the thing that you really have to focus on. We’ve stitched all of these things together. Business model is working.

That’s what we’re really focused on, building and growing. And that’s a two to three year out.

That’s not, this quarter really matters [inaudible] the number or not, because COVID should eliminate that anyway, but I think really focusing on what we’re building…

It’s a genetics company, and that’s why Dr. Bob’s, a lot of those comments about how the Mayo clinic is going to start testing every single man for the prostate cancer, because of some of those findings.

That’s super important stuff that genetics is here today, and that people are starting to understand this.

So those are the good signs.

And that’s what I think we take pleasure in. And we don’t worry as much about exactly what happens in the quarter.

As Sean said, we’ll pull the levers we have to pull to be prudent in our business, but we just urge you to think about what it is that we’re doing to change the genetics. As you said, to really change the name of the game.

OG:
All right. I appreciate it, guys. Stay safe and we will talk, I suppose, in probably about two months at JP Morgan.

SG:
All right. Looking forward to it. Take care.

Sh G:
Thank you so much, Ophir.

Risk
The risks for Invitae as a stand-alone were large, now as a combined entity, more risk has piled on, and, in fairness, some risk has been diminished.

* Plans for FDA approval are great, but plans fail. Invitae has three products now from ArcherDX that are pending. This is a substantial risk.

* Integration with a new team and a decentralized laboratory combined with somatic offerings is difficult and assumed synergies only materialize if integration goes well. That means assumed improvements in gross margins are also at risk.

* COVID-19: It’s a real risk and it has not gone away, irrespective of the market’s rally.

* Cash flow: At some point the company will either hit the target of positive cash flow or every investor will bail on it. We’re betting that the company hits its goal but it’s still a risk.

Conclusion
Invitae was on a path to substantial growth and its acquisition of Archer DX continues that path.

We firmly believe that Invitae is not a test-by-test genomics company, an industry which CEO Sean George has openly said is dead.

Invitae is a network genomics company, with some of the most impressive technology in the industry and a clear competitive advantage which, at least for now, seems quite defensible to competition.

Now it has added somatic capabilities that are also industry leading technology.

It has diversified the risk of a centralized laboratory approach by acquiring a gorgeous apparatus for a decentralize approach.

Having said all of that, please be aware of the risk inherent in a company with such a large and growing cash burn relative to cash balances, debt burden, and overall revenue.

Thanks for reading, friends.

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