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The emerging technology of tissue engineering, in which functional human tissue is grown in the lab for applications in drug safety and, one day, human transplantation, has created a lot of excitement among investors. Several companies and research institutions are laying the groundwork for promising healthcare technology, but one of the only publicly traded companies involved in it today is Organovo (NASDAQ:ONVO). The $413 million market cap company is generally recognized as a leader in the field and as well-positioned to capitalize on the opportunities at hand.

While that may be true, and sales are finally starting to ramp up each quarter, one question persists for investors: When will Organovo Holdings finally start making money? 

The business

The company may wield a complex technical platform, but investor storytime hinges on a simple message. The pitch proceeds as follows: The pharmaceutical and personal care industries face significant unmet challenges when it comes to quantifying the safety and efficacy of products in the earliest stages of product development. Ideally, pharmaceutical companies would like to discover an investigational drug candidate's tendency to cause liver toxicity before spending billions of dollars on clinical trials. Likewise, personal care brands would prefer to discover if a new cosmetic ingredient's tends to cause skin irritation before placing it in products on store shelves nationwide. 

Current testing methods don't always reveal toxicity issues, but Organovo believes that its 3D tissue products, which more closely mimic in vivo human tissues than a simple diagnostic or assay, can fill the gap between technology and human trials. A tool that could avoid billions of dollars in wasted investments for its corporate clients could be worth hundreds of millions of dollars in revenue for the tissue engineering pioneer. Indeed, the company expects its ExVive Human Liver Tissue and ExVive Human Kidney Tissue products and services could one day generate over $100 million in annual revenue each. 

That's a far cry from current top line figures, which topped $1 million in quarterly revenue for the first time ever in the period ended September 30. There's a long way to go before Organovo hits that $100 million mark. How quickly can revenue grow -- and result in profits?

Growing forward

The company's fiscal 2017 second quarter ended Sept. 30. Here are important financial metrics for the first half of its year compared to the year-ago period:

Metric

H1 Fiscal 2017

H1 Fiscal 2016

% Change (YOY)

Total revenue

$2.27 million

$0.6 million

273%

Total operating expenses

$20.5 million

$20.3 million

0.8%

Operating loss

$18.2 million

$19.7 million

9.2%

EPS

($0.20)

($0.23)

8.7%

Source: Ogranovo press release.

To become profitable, Organovo must generate more revenue than it throws at expenses. One encouraging sign from the table above is that the company has managed to keep a lid on operating expenses (R&D and administrative costs) even as it entered the commercial phase of its technology platform. Investors should expect expenses to increase in the future, however, to support a more robust sales and services rollout. In fact, management expects net cash utilization in fiscal 2017 to range between $31 million and $34 million. 

The year-over-year revenue growth also looks impressive, but partially because it started from such a small base in fiscal 2016. Investors shouldn't expect similar growth in the near future. Why not? Management expects total revenue in fiscal 2017 between $4.5 million and $6.2 million. At the low end of the range, quarterly revenue in the second half of fiscal 2017 would average just $1.1 million. At the high end, it would average a noticeably higher $1.96 million per quarter, but not that different from the $1.38 million notched in the most recent quarter. In other words, don't expect a linear path to future growth. 

To see what's required for profitable operations, we'll need to determine when revenue will outpace operating expenses. First, it helps to break down revenue by source to get a glimpse of gross margin on products and services revenue, which will be the true driver of profitability. Consider the following metrics from the first two quarters of fiscal 2017:

Metric

H1 2017

% of Total Revenue

Products and services revenue

$1.697 million

74.9%

Collaboration and grant revenue

$0.569 million

25.1%

Cost of revenue

$0.561 million

N/A

Gross margin, products and services

66.9%

N/A

Gross margin, total revenue

75.2%

N/A

Source: Press releases. 

Organovo continues to generate high gross margins on products and services revenue, but it may be too early in the growth trajectory to settle on a reliable figure. Consider that gross margin on products and services revenue fell from 75.1% in the first quarter to 61.5% in the second quarter. Further, it's reasonable to expect growth in products and services revenue (which has a cost) to outpace growth in collaboration revenue (which is cost-free), which should also be accounted for when making projections. 

Now that those devilish details have been stated, we can make an optimistic ballpark estimate for what it will take for Organovo to finally begin making money. Let's assume:

  • R&D and selling, general, and administrative expenses rise only slightly to $25 million per year.
  • Gross margin on total revenue settles at 60%. 

In this simplified scenario, Organovo would need to generate $41.7 million in total revenue per year to generate its first dollar in operating profits. That represents 6.7 times the high end of management's revenue range for fiscal 2017, or the equivalent of averaging annual revenue growth of 50% through March 2022. In other words, it will take a considerable expansion of the company's customer base before it begins making money.

What does this mean for investors?

The technology leader is well-positioned to capitalize on the rise of tissue engineering, but investors may want to take a step back and consider just how long it will take before Organovo can stand on its own two feet financially. It will likely end its current fiscal year in March 2017 with half of the cash it began the year with, or roughly $30 million. That means it's likely that share dilution or a debt offering are in the company's near-term future. While that doesn't necessarily mean you should sit on the sidelines, it does hint that a lot of patience will be required before this technology pioneer delivers on its potential.

Maxx Chatsko has no position in any stocks mentioned. Follow him on Twitter to keep up with developments in engineered biology and materials science.

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