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NSTG > SEC Filings for NSTG > Form 10-K on 27-Mar-2014All Recent SEC Filings

Show all filings for NANOSTRING TECHNOLOGIES INC

Form 10-K for NANOSTRING TECHNOLOGIES INC


27-Mar-2014

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

You should read the following discussion and analysis together with the financial statements and the related notes to those statements included elsewhere in this report. This discussion contains forward-looking statements that involve risks and uncertainties. As a result of many factors, such as those set forth in the section of this report captioned "Risk Factors" and elsewhere in this report, our actual results may differ materially from those anticipated in these forward-looking statements. Throughout this discussion, unless the context specifies or implies otherwise, the terms "NanoString", "we", "us" and "our" refer to NanoString Technologies, Inc. and its subsidiaries.

Overview

We develop, manufacture and sell robust, intuitive products that unlock scientifically valuable and clinically actionable genomic information from minute amounts of tissue. Our nCounter Analysis System directly profiles hundreds of molecules simultaneously using a novel barcoding technology that is powerful enough for use in research, yet simple enough for use in clinical laboratories worldwide. We market systems and related consumables to researchers in academic, government, and biopharmaceutical laboratories for use in understanding fundamental biology and the molecular basis of disease and to clinical laboratories and medical centers for diagnostic use. We have an installed base of more than 180 systems, which our customers have used to publish more than 360 peer-reviewed papers. As researchers discover how genomic information can be used to improve clinical decision-making, these discoveries can be translated and validated as diagnostic tests based on our nCounter Elements General Purpose Reagents, or GPRs. In certain situations, we intend to translate their discoveries into in vitro diagnostic assays.

We derive a substantial majority of our revenue from the sale of our products, which consist of our nCounter instruments and related proprietary consumables, which we call CodeSets, nCounter Elements GPRs and Master Kits. We sell two types of CodeSets: custom orders and standard sets, which we call panels. We also derive revenue from processing fees related to proof-of-principle studies we conduct for potential customers and extended service contracts for our nCounter Analysis Systems.

Until recently, we have sold our products for research use only. After buying an nCounter Analysis System, research customers purchase consumables from us for use in their experiments. Our instruments are designed to work only with our consumable products. Accordingly, as the installed base of our instruments grows, we expect recurring revenue from consumable sales to become an increasingly important driver of our operating results.

In 2013, we began offering instruments and consumables for use in diagnostic testing. In September 2013, we received 510(k) clearance from the FDA to market in the United States a version of Prosigna providing an assessment of a patient's risk of recurrence for breast cancer. In December 2013, we commercially launched Prosigna in the United States. National diagnostic laboratories ARUP Laboratories, Laboratory Corporation of America Holdings and Quest Diagnostics have chosen to add Prosigna to their suites of breast cancer diagnostic tests, and the laboratories at the University of Alabama at Birmingham Comprehensive Cancer Center and University of North Carolina Lineberger Comprehensive Cancer Center will be among the initial facilities to offer the Prosigna assay in the United States, with the earliest testing beginning during the first quarter of 2014. These laboratories collectively serve the pathology testing needs of a substantial portion of breast cancer patients throughout the United States. In September 2012, we obtained a CE mark for Prosigna, our first diagnostic product, and, in early 2013 we commercially launched Prosigna in Europe and Israel.

In November 2013, we began offering a version of the nCounter Dx Analysis System to high-complexity, CLIA-certified laboratories for research and diagnostics purposes. This FLEX configuration of the nCounter Dx Analysis System provides clinical laboratories a single platform with the flexibility to support both clinical testing, by running Prosigna, and research, by processing translational research experiments using our custom CodeSets and panels. The nCounter Elements GPRs provide further flexibility by allowing laboratories to

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develop their own Laboratory Developed Tests for gene expression, copy number variation and gene fusion signatures, which can be performed by a laboratory and may include genetic tests and other tests for rare conditions.

To support the commercial launch of Prosigna, we are establishing a dedicated oncology sales force. As a result, we expect sales and marketing expenses and operating losses to increase as we market the product. In addition, we expect sales to grow gradually as more systems are installed, Prosigna gains inclusion in important breast cancer treatment guidelines and to the extent reimbursement by third-party payors becomes more broadly available.

We use third-party contract manufacturers to produce the two instruments comprising the nCounter Analysis System. We manufacture consumables at our Seattle, Washington facility. This operating model is designed to be capital efficient and to scale efficiently as our product volumes grow. We focus a substantial portion of our resources on developing new products and solutions. We invested $15.0 million, $11.6 million and $9.0 million in 2013, 2012 and 2011, respectively, in research and development and intend to continue to make significant investments in research and development.

In the future, we intend to collaborate with biopharmaceutical companies to develop "companion diagnostic assays" that may be used to select patients for specific drug therapies. Under such collaborations, we would expect to develop, seek regulatory approval for, and commercialize the diagnostic assay. We would also expect to receive development funding and potential milestone payments from our collaborators. Upon approval of the diagnostic assay, we would expect to generate revenues from the sale of the resulting in vitro diagnostic kits.

Our total revenue increased to $31.4 million in 2013 from $23.0 million in 2012 and $17.8 million in 2011, which was driven by the sale of additional nCounter Analysis Systems and consumables for use on our growing installed base of instruments. Historically, we have generated a substantial majority of our revenue from sales to customers in North America; however, we expect sales in other regions to increase over time. We have never been profitable and had net losses of $29.3 million, $17.7 million, and $10.9 million in 2013, 2012 and 2011, respectively. As of December 31, 2013, our accumulated deficit was $126.8 million.

Key Financial Metrics

We are organized as, and operate in, one reportable segment, which is the development, manufacture and commercialization of instruments, consumables and services for efficiently profiling the activity of hundreds of genes simultaneously from a single tissue sample.

Our chief operating decision maker is the chief executive officer, who manages our operations and evaluates our financial performance on a total company basis. Our principal operations and decision-making functions are located at our corporate headquarters in the United States.

Until the fourth quarter of 2013, we operated in two reportable segments, our life sciences business and our diagnostics business. In November 2013, our nCounter Dx Analysis System with FLEX Configuration was launched, enabling customers to perform both research and clinical testing on the same instrument. We have one sales force that now sells these systems to both research and diagnostic testing labs, and we launched our first product that can be used for both research and diagnostic testing, nCounter Elements GPRs. As a result of these fundamental changes to our business, we began operating the Company as a single reportable segment during the fourth quarter of 2013.

Revenue

We generate revenue from the sale of our products and related services. For a description of our revenue recognition policies, see the section of this report captioned "-Critical Accounting Policies and Significant Estimates-Revenue Recognition."

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Product Revenue

Our products consist of our nCounter Analysis System and related consumables. Our nCounter Analysis System typically consists of one nCounter Digital Analyzer and one nCounter Prep Station. The U.S. list price of one research use only nCounter Analysis System is $235,000. Outside the United States, depending on the country, the list price is generally higher. The U.S. list price of one nCounter Dx Analysis System is $285,000. Systems are sold to distributors at a discount to list price. Our customer base is primarily composed of academic institutions, government laboratories, biopharmaceutical companies and clinical laboratories that perform analyses or testing using our nCounter Analysis System and purchase related consumables, potentially including Prosigna kits.

For our research customers, related consumables include (1) panels, which are standard pre-manufactured CodeSets, (2) custom CodeSets, which we manufacture to the specific requirements of an individual researcher, (3) nCounter Elements GPRs, and (4) Master Kits, which are ancillary reagents, cartridges, tips and reagent plates required to setup and process samples in our instruments. Product revenue also includes payments for instrument installation. In 2013, 2012 and 2011, our average consumables revenue per system exceeded $100,000 per year.

For our clinical laboratory customers, related consumables include Prosigna in vitro diagnostic kits and nCounter Elements GPRs. We sell our nCounter Dx Analysis Systems to clinical laboratory customers or offer to lease them under "reagent rental" arrangements where an instrument is placed at a customer location at minimal direct cost and the customer commits to purchase a minimum volume of consumable products over a period of time. To date, all clinical laboratory customers have elected to purchase instruments; however, we expect that in the future, certain customers will elect to lease them.

The list price of a Prosigna test in the United States and Europe is $2,080 and 1,550 per patient, respectively. Although the price of Prosigna and our additional future diagnostic products will depend on many factors, including whether and how much third-party payors will reimburse laboratories for conducting such tests, we expect that the gross margin for our diagnostic kits will be higher than for our research consumables. We sell Prosigna kits to our lab customers, who will be responsible for providing the testing service and contracting and billing payors. Prosigna kits are sold to clinical laboratories on a fixed dollars-per-kit basis, which does not expose us to direct third-party payor reimbursement risk. However, we provide customary volume discounts, and in some cases, introductory pricing during the period in which third-party payor reimbursement is being established. As a result, we expect the average selling price per Prosigna test to be between $1,500 and $2,000.

Service Revenue

Service revenue consists of fees associated with extended service contracts and conducting proof-of-principle studies. We include a one-year warranty with the sale of our instruments and offer extended service contracts, which are purchased by a majority of our customers. We selectively provide proof-of-principle studies to prospective customers in order to help them better understand the benefits of the nCounter Analysis System.

Revenue by Geography

We sell our products through our own sales forces in the United States, Canada, Singapore, Israel and certain European countries. We sell through distributors in other parts of the world. As we have expanded our European direct sales force and entered into agreements with distributors of our products in Europe, the Middle East, Asia Pacific and South America, the amount of revenue generated outside of North America has generally increased, although there have been significant quarter-to-quarter fluctuations. In the future, we intend to expand our sales force and establish additional distributor relationships outside the United States to better access international markets.

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The following table reflects product revenue by geography and as a percentage of total product revenue, based on the billing address of our customers. North America consists of the United States, Canada and Mexico; and Asia Pacific includes Japan, China, South Korea, Singapore, Malaysia and Australia.

                                                  Year Ended December 31,
                                    2013                    2012                    2011
                                                   (Dollars in thousands)
      North America          $ 21,855        70 %    $ 15,906        69 %    $ 14,044        79 %
      Europe & Middle East      5,775        18         4,167        18         2,918        16
      Asia Pacific              3,773        12         2,900        13           838         5

      Total                  $ 31,403       100 %    $ 22,973       100 %    $ 17,800       100 %

Most of our revenue is denominated in U.S. dollars. Our expenses are generally denominated in the currencies in which our operations are located, which is primarily in the United States. Changes in foreign currency exchange rates have not materially affected us to date; however, they may become material to us in the future as our operations outside of the United States expand.

Cost of Revenue

Cost of revenue consists primarily of costs incurred in the production process, including costs of purchasing instruments from third-party contract manufacturers, consumable component materials and assembly labor and overhead, installation, warranty, service and packaging and delivery costs. In addition, cost of revenue includes royalty costs for licensed technologies included in our products, provisions for slow-moving and obsolete inventory and stock-based compensation expense. We provide a one-year warranty on each nCounter Analysis System sold and establish a reserve for warranty repairs based on historical warranty repair costs incurred.

We expect the average unit costs of our instruments to decline in future periods as a result of our ongoing efforts to develop a lower-cost nCounter Analysis System to expand our market opportunity among smaller research laboratories. We expect the unit costs of consumable products to decline as a result of our ongoing efforts to improve our manufacturing processes and expected increases in production volume and yields. Although the unit costs of our custom CodeSets vary, they are generally higher as a percentage of the related revenue than our panels, in vitro diagnostic kits and nCounter Elements GPRs.

Operating Expenses

Research and Development

Research and development expenses consist primarily of salaries and benefits, occupancy, laboratory supplies, contract services, consulting fees and related costs, costs associated with licensing molecular diagnostics rights and clinical study expenses (including the cost of tissue samples) to support the regulatory approval or clearance of diagnostic products. We have made substantial investments in research and development since our inception. Our research and development efforts have focused primarily on the tasks required to enhance our technologies and to support development and commercialization of new and existing products and applications. We believe that our continued investment in research and development is essential to our long-term competitive position and expect these expenses to increase in future periods.

Given the relatively small size of our research and development staff and the limited number of active projects at any given time, we have found that, to date, it has been effective for us to manage our research and development activities on a departmental basis. Accordingly, we do not require employees to report their time by project nor do we allocate our research and development costs to individual projects. The following table shows the composition of total research and development expense by functional area for the periods indicated. Prior to 2012, research and development expense related to our core nCounter platform technology and diagnostic product development were combined.

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                                                               Year Ended December 31,
                                                         2013            2012           2011
                                                                   (In thousands)
Core nCounter platform technology and diagnostic
product development                                    $     -         $     -         $ 4,359
Core nCounter platform technology                         4,330           1,537             -
Manufacturing process development                         1,588           1,183            969
Research products and applications                        2,914           2,183          1,875
Diagnostic product development                            4,605           4,783             -
Facility allocation                                       1,542           1,949          1,787

Total                                                  $ 14,979        $ 11,635        $ 8,990

Our clinical studies employ a retrospective / prospective design, which means that we use samples that were previously collected from patients and for which the treatment regimen and ultimate patient outcome is known. Such studies are capital efficient as they do not require recruiting new patients and they can be completed much more quickly than typical prospective clinical trials. We intend to use a similar approach whenever possible for the additional clinical studies we intend to conduct in support of our future regulatory submissions to expand the indications for Prosigna and for future diagnostic products.

We expect to license additional molecular diagnostic rights as part of our strategy to develop additional diagnostic products. For example, in February 2013 we secured an option from a customer to acquire an exclusive worldwide license for a gene signature that could be used, potentially, to develop a molecular diagnostic product or a Laboratory Developed Test to identify patients with cirrhosis who are at highest risk of developing the most common type of liver cancer, HCC, and to determine whether a patient who has been diagnosed with HCC is likely to have a recurrence. The related option fee was expensed in the first quarter of 2013. Such arrangements may include upfront, milestone or annual cash payments and revenue-based royalties. We believe that our continued investment in research and development is essential to our long-term competitive position and expect these expenses to increase in future periods.

Selling, General and Administrative

Selling, general and administrative expenses consist primarily of costs for our sales and marketing, finance, human resources, information technology, business development, legal and general management functions, as well as professional services, such as legal, consulting and accounting services. We expect selling, general and administrative expenses to increase in future periods as the number of sales, technical support and marketing and administrative personnel grows and we continue to introduce new products, broaden our customer base and grow our business. In particular, the continued commercialization of Prosigna requires us to establish a dedicated oncology focused sales force which will increase selling and marketing expenses significantly. Our legal, accounting and compliance costs have also increased as a result of our becoming a public company, and we expect them to continue to increase as our business grows.

Factors Affecting Our Performance

Instrument Installed Base

Our future financial performance will be driven in large part by the rate of sales of our nCounter Analysis Systems, which typically consist of one nCounter Digital Analyzer and one nCounter Prep Station. In some cases, our research customers increase the throughput of their nCounter Analysis System by purchasing up to three nCounter Prep Stations per nCounter Digital Analyzer. We plan to grow our system sales in the coming years through multiple strategies, including expanding our sales efforts outside of the United States and continuing to enhance the underlying technology and applications for both research and clinical diagnostics use. As part of this strategy, we increased our existing sales and marketing headcount by over 30% in 2013 in an

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effort to increase the rate of sales of our nCounter Analysis Systems. Similarly, since January 2013, we have contracted with ten additional distributors bringing our total to 16. As our installed base of instruments grows, we solicit feedback from our customers and focus our research and development efforts on enabling the nCounter Analysis System for additional applications, which in turn helps to drive additional sales of our instruments and consumables. We are developing a new generation of the nCounter Analysis System that we believe will increase our addressable market and simplify the procurement processes of our potential research customers. The new generation system will be a single instrument with a reduced footprint that combines the prep station and the digital analyzer. We expect to reduce the cost of the new generation system through the adoption of new, less expensive technologies. We are targeting release of the new generation system in late 2014.

Our sales process involves numerous interactions with multiple individuals within an organization, and often includes in-depth analysis by potential customers of our products, performance of proof-of-principle studies, preparation of extensive documentation and a lengthy review process. As a result of these factors, the large capital investment required in purchasing our instruments and the budget cycles of our customers, the time from initial contact with a customer to our receipt of a purchase order can vary significantly and be up to 12 months or longer. Given the length and uncertainty of our sales cycle, we have in the past experienced, and likely will in the future experience, fluctuations in our instrument sales on a period-to-period basis. We are developing an nCounter Analysis System that we intend to offer at a lower price, which we believe will simplify the procurement processes of our potential research customers as well as increase our addressable market.

We have sold more than 180 nCounter Analysis Systems, which we count based on the number of nCounter Digital Analyzers sold given that a system may couple an analyzer with multiple nCounter Prep Stations. Management focuses on instrument unit sales as a primary indicator of current business success and a leading indicator of likely future sales of consumables.

Recurring Consumables Revenue

Our instruments are designed to be used only with our consumables. This closed system model generates recurring revenue from each instrument we sell. Management focuses on recurring consumable revenue per system as an indicator of the continuing value generated by each system. We calculate recurring consumable revenue per system quarterly by dividing consumable revenue recognized in a particular quarter (other than consumable revenue related to proof-of-principle studies) by the total number of nCounter Analysis Systems installed as of the last day in the immediately preceding quarter. Historically, nearly all of our systems and related consumables have been sold to research customers. In 2013, 2012 and 2011, our average consumables revenue per system exceeded $100,000 per year.

As the installed base of the nCounter Analysis Systems expands, consumables revenue is expected to increase and over time should be an increasingly important contributor to our total revenue. Additionally, we expect Prosigna in vitro diagnostic kit revenue to contribute an increasing amount of recurring revenue. Over time, we believe that consumables revenue should be subject to less period-to-period fluctuation than our instrument sales revenue.

Revenue Mix and Gross Margin

Our product revenue is derived from sales of the nCounter Analysis System and related consumables, including Prosigna in vitro diagnostic kits. Generally, our consumables have higher gross margins than our instruments. There will be fluctuations in mix between instruments and consumables from period to period. Although results may vary period to period, over time, as our installed base of systems grows, consumables should constitute a larger percentage of total revenue, which would increase our gross margins. In addition, we expect both the average selling price and the manufacturing cost of our instruments to decrease following the introduction of future generations of our nCounter Analysis System. Future instrument selling prices and gross margins may fluctuate as we introduce new products and reduce our product costs and from variability in the timing of new product introductions.

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We derive service revenue from extended service contracts, which are purchased by a majority of our customers. Additionally, we selectively provide proof-of-principle studies in connection with prospective sales to customers to demonstrate the performance of our nCounter Analysis System.

The following table reflects the breakdown of revenue in absolute dollars and as percentage of total revenue.

                                                    Year Ended December 31,
                                      2013                    2012                    2011
                                                     (Dollars in thousands)
    Product revenue:
    Instruments                $ 12,995        41 %    $  8,786        38 %    $  7,112        40 %
    Consumables                  16,642        53        13,036        57         9,997        56
    In vitro diagnostic kits        181         1            -         -             -         -
    Service revenue               1,585         5         1,151         5           691         4

    Total                      $ 31,403       100 %    $ 22,973       100 %    $ 17,800       100 %

Impact of Our Diagnostic Products Strategy

We have only recently commercially launched the nCounter Dx Analysis System and Prosigna. Over time, we intend to build a menu of additional diagnostic tests that can be run on our nCounter Analysis System. As researchers discover how genomic information can be used to improve clinical decision-making, these discoveries can be translated and validated as diagnostic tests based on our nCounter Elements GPRs. In certain situations, we intend to translate their . . .

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