Intrexon's Revenue Grows 17%. Here's Why Investors Should Be Worried.

Image source: George Redgrave/Flickr.

Engineered-biology conglomerate Intrexon (PGEN -3.68%) reported second-quarter earnings this week. While investors are more interested in the future than current financial results (Intrexon reported a net loss of $49.1 million for the quarter, mostly consisting of non-cash charges), it's important to keep an eye on results to see how far the company needs to go to start generating profits.

The top line looked pretty good, according to the headline of the press release -- but the details tell a different story.

By the numbers

You can check the press release for the full financial details, but here are the metrics investors should be focused on compared to the year-ago period:

Source: Intrexon press release.

The top line grew 17% from the year-ago period, but that growth was almost entirely supported by increases in collaboration and licensing revenue. Service revenue saw a modest increase of 5.1%. Product revenue -- nearly all from the sale of cattle genetic products -- fell 23.7% in the quarter and is down 26.2% in the first half of 2016 compared to H1 2015.

The company also continues to spend an incredible amount of money every quarter. If the current pace continues, then operating expenses for 2016 will exceed $300 million -- far more than the company is bringing in from operations or offsetting with collaborations. Investors will only buy on promises of a bright future for so long before they start expecting results.

Unfortunately, the main driver of Intrexon's growth is also the most worrisome. The following table breaks down collaboration and licensing revenue by partner type: those with market caps greater than $1 billion and those that are worth less than that. Intrexon also reports a subsegment called "other," which we'll assume consists mostly of small-cap and micro-cap partners.

Source: SEC filings.

In the collaboration and licensing category, combining reported revenue from partners with market caps less than $1 billion and "Other Revenue" accounts for $22.9 million, or 83% of the total category for the quarter. The dependence on small- and micro-cap partners is highlighted at the top of the recent press release: Intrexon lists partner "plans to initiate a clinical trial" and enrollment of "two patients" as business highlights. These sound somewhat desperate.

While revenue from blue-chip partners rose 182% year over year, Intrexon only reports two such partners: Ares Trading (Merck KGaA) and S & I Ophthalmic (Sun Pharma) -- compared to 12 small-cap partners that get their own line in SEC filings. Blue-chip partners (and, admittedly, $1 billion is a low benchmark for blue-chip status) simply aren't significant drivers of the business -- and that's worrisome, especially when investors consider that large-cap partners accounted for just 8.5% of total revenue in the first half. The good news is that this represents an improvement from 2015, when only 5% of all revenue was generated from partners with market caps greater than $1 billion.

A small improvement is better than none, but Intrexon's dependence on small- and micro-cap partners for revenue growth is troubling.

Looking ahead

Although product revenue continues to slump, that could change in the next 24 months, when self-limiting mosquitoes from subsidiary Oxitec and insect larvae fish feed from subsidiary EnviroFlight begin generating revenue. The first few years of either product likely won't blow the lids off growth-wise, but they'll nevertheless diversify revenue.

The former is what most investors are excited about, and good news continues to trickle in. The U.S. Food and Drug Administration recently finalized a previously preliminary finding that releasing self-limiting mosquitoes will have no significant impact on human or environmental health, which clears the way for Oxitec to begin field trials in the Florida Keys once it gains local public approval. Then it can conduct the trial, compare results to claims of the trial design, submit them to the FDA, and then await the administration's decision to approve (or disapprove) self-limiting mosquitoes as an animal drug. Most states will adopt the FDA ruling, although some could demand that Oxitec run additional trials. Either way, the earliest possible date Oxitec will generate significant revenue from operations in the United States will be sometime in 2017.

That could change if regulators and health officials decide to declare emergency use of the technology platform. While that remains unlikely in Florida at the moment (there have been just 21 confirmed cases contracted locally), it could be a possibility in Puerto Rico, where there have been thousands of confirmed cases. Investors will need to wait and see.

What does it mean for investors?

Intrexon grew revenue an impressive 17% in the second quarter compared with the same period of 2015, but digging deeper reveals some potential flaws in the company's growth strategy. Intrexon's dependence on partners with market caps lower than $1 billion doesn't give the impression that the company's in-house technology platforms are leading the way forward in the field, as management claims. While several acquisitions have brought legitimate technology with vast potential in-house, it will be several years before investors begin to see any significant contribution to the top or bottom lines. I would continue to view Intrexon as a risky investment with unnecessary complexity.