Adaptive Biotechnologies Corporation (ADPT) Earnings Call Transcript & Summary

Hey, everyone. Good morning. I'm Tejas Savant. I cover Life Sciences here at Morgan Stanley. Before we begin, for important disclosures, please see the Morgan Stanley research disclosure website at morganstanley.com/researchdisclosures. If you have any questions, do reach out to your Morgan Stanley sales rep. So it's my pleasure this morning to host Adaptive. And speaking on behalf of the company, we have Chad Robins, CEO; and Tycho Peterson, my old boss, CFO. Thanks for joining us today guys.

Chad maybe just to set the stage, can you reflect on the last 4 years post IPO in terms of what's gone well relative to your expectations back in 2019? And where progress has perhaps been slower than you'd anticipated in terms of monetizing the value of what is still a proprietary and incredibly valuable immune medicine platform?

Yes, sure. So first, thanks for having us, Tejas. Yes, if you reflect back to the IPO, the MRD business was just moving along really nicely. We're executing, we're operating. Our volume growth is good. We're putting all the right pieces in the right places and feel very, very comfortable. I'm also quite enthusiastic about our cell therapy deal with Genentech although it has albeit gone a little bit slower than expected. The data so far on the private product is looking really good and that's moving along well. And excited that we announced last quarter that our first IND filing happened for the shared products. So that's moving along as well. The area if you kind of reflect back that was a little bit of a pivot, a lot of a pivot was in the areas of kind of mapping the immune system, which we're still doing. But in terms of commercializing the diagnostics, we're refocusing that data and effort into target discovery. And we're also using that information as a potential biomarker in kind of future trials, and there's a richness of that data. So, but just in terms of you asked me to reflect back on the last 4 years, I think what we've learned about the diagnostic industry just in terms of the rate of clinical adoption and the rate of kind of payers implementing payment on diagnostics has been, it's a challenging environment, and that's why we made the pivot.

Got it. Makes sense. Sort of a similar question for you, Tycho. I mean you've known Adaptive since its inception first from the outside and now as CFO. In your opinion, I mean, give us a sense for how the company has evolved and matured? Over the course of that time frame, especially over the last 12 months, and why you think sort of the next 5 years of Adaptive journey could look very different from what happened since 2019?

Sure. It's a couple of things. I think it's sharper, crisper decision-making. So Chad talked about what we decided around T-Detect. And then I think importantly, everything we're doing operationally. So you're starting to see some benefit in gross margins. We've got a lot going on in the lab now. We're doing a lab move, the consolidation. We're doing a valuation of NovaSeq X. You saw this past quarter, about 8% sequential increase in our underlying sequencing margins. So we're going to continue to drive COGS and margin improvement. And then the other thing we did when I came on board was show up the balance sheet. So we did the $250 million deal with OrbiMed. We drive down half of that. We said that's enough cash to get to profitability. So we're continuing to get more and more efficient every day and really just kind of grow up as a company.

Got it. Makes sense. Let's start on the MRD side, Chad. So blood-based testing accounted for, I think, over 1/3 of all MRD tests is up, I think, 16% from the first quarter, driven by community accounts. You put forth significant efforts to increase penetration in the community setting over the last year or so. Can you describe sort of the factors that were the most important in terms of driving that metric higher?

Yes. So first, we doubled the size of the sales force last year. And we, 29 of those reps are focused specifically on the community, and 4 of those reps are even more targeted to what we'll call kind of super accounts like for cancer specialists, Tennessee Oncology, really, really big network practices. And so that's been a big driver of community, which accounts for 60% of all cancer patients are at least initially treated in the community. So in terms of kind of blood-based testing, most community practices prefer blood-based testing as opposed to the marrow. So the increase of the community, what you're getting by default then is an increase in blood-based testing. But also, if you look at the expanded indications into DLBCL and CLL, these are indications which are blood-based test. And then finally, our biggest growth driver in terms of multi myeloma, we've done a lot of work in kind of blood-based multi myeloma testing showed that it is an alternative and an option there as well. So yes, right now, we're at 37% in terms of blood-based testing. We hope to, we will continue to increase those numbers as additional indications roll on. And as these reps get more productivity, which, again, we've been really pleased with the productivity gain kind of from on a -- if you look at sales per rep, it's gone significantly up in the last year.

Got it. And in terms of community accounts, I think they represent north of 20% of clonoSEQ volume now that's close to double of where that number was in, I guess, June '22. Could you just share what that trajectory could look like by 2025?

Yes. We're certainly looking in the mid-30s. Again, right now, academic medical centers represent a large portion of the accounts with the fastest growing is in the community. And all the efforts that I just got to mention will get us to at least 10 to 15 percentage points on, I would say, on the low end by '25.

Got it. And then in terms of the efforts on the way to close the policy gaps, improve collections, can you just elaborate on some of those? And somewhat related note, you talked about ASP headwinds and those are getting better here in the back half of the year. Just walk us through what are the factors that could be driving that improvement?

Yes. Let me take this from a macro and then we'll kind of dig into each one of those categories. So first of all, about 70% of our tests right now are currently being paid and they're being paid at around about [ 1450 ]. So really, really nice average selling price for the test that we get paid on. 30% of those tests, which are accounting called nonpaid or like round to 0 paid test. And what we're really trying to do is close that gap. And that comes in 3 different areas. One is out of policy tests. And if you look at out of policy, that means we either have policy and need to expand to noncovered indications. Like mantle cell lymphoma, which we're submitting to Medicare later this year. And then secondly, CTCL, which is we're submitting next year. And then there's policies that are in place in myeloma that aren't yet covering CLL or DLBCL. So we need to get a kind of expanded payer coverage for them. And then secondly, there's a bolus of kind of coverage policies that we need to go out and get. And so for example, Centene is one we're in active negotiations with, the other is Anthem. And then the third, there's a handful of Blues which represent a significant number of covered lives. The advantage of that, obviously, is you're kind of increasing your covered labs, but also specifically like with Centene and other significant policies cover Medicaid. And it's, that's a huge issue for us. We have a higher percentage of Medicaid patients particularly related to kind of pediatric ALL and some other indications, which are essentially have been a drag on ASP. So we have a significant effort in kind of closing those coverage really those noncontracted payers. And then third is operational efficiencies, which kind of is what you started with, which I'll end with. We've got significant efforts on rev cycle management on making it easier to get prior authorizations. There's a whole bunch of things based just on workflow to make it easier to go after collections and how we're going after and speeding up appeals processes, et cetera. And then I'll just mention, there's an industry, I'm sure most who are invested in diagnostics, it is an industry-wide problem that we're addressing on Medicare Advantage, meaning commercial payers are required to pay Medicare Advantage, and they're putting in onerous requirements to get paid. As an industry, I'm on the board of Coalition for 21st Century Medicine or C21,and a bunch of diagnostic companies CEOs that sit on the board with me were going after this from a industry perspective because any one of us doesn't have as much kind of power as we do collectively.

Got it. Makes sense. In terms of the Epic EMR integration, you had a press release this morning, moving forward from pilot to the first time going live. Can you talk about sort of volume contribution increases, what is the guardrail around that? We've heard about sort of 50% to 100% increases in volume at some sites after EMR is integrated, not specific to Adaptive, but for some other liquid biopsy companies.

Yes, we're hopeful. Those are big numbers. First of all, yes, we're thrilled. This has been a major effort and it's been a major investment for us. Our first Epic site gone live today. We've got 3 or 4 more in the very near-term pipeline to get up and running. These are some of the bigger sites by design. We just want to make sure that we're kind of working the kinks out. And then next year, we've got a planned rollout for, call it, another 20 sites that are queued up. In terms of volumes, I'm hesitant to speculate. Here's what I'll say. We have good volume growth baked into next year. That, multiple factors will contribute to that, including, we mentioned blood-based testing expansion into DLBCL. Epic integration is part of that. And so we're not necessarily trying to tease out what Epic -- how Epic is going to specifically contribute. But Epic is really -- there's two -- if you -- there's two main areas where Epic is going to help. One is existing accounts increasing the ordering. And then two, is access to new accounts that may have been kind of reluctant to order from a portal or just workflow was too complicated. But now we have this kind of ease of use where you go out with connector that's one or a kind of plug-in and boom we're on Epic, and we can send out automatic reminders, build in the order set that says in a work -- and just for those of you just a little bit more definition, why is this so cool is when -- you can build in an order set for when you're treating a patient that has multi myeloma, every time they come in on your EHR system, it will pop up and say, we need to do the following 7 things. And one of the things that we're trying to build into every order set is you need to get your clonoSEQ tested. You need to get your MRD tested. And so yes, we're extremely hopeful and it's one of many initiatives we have to grow the volumes.

Got it. Chad, how many sites are we talking about in the overall network, and it sounds like first 1 goes live today, but where do you think you'll be year-end '24? Like, would you be sort of at 75 to 100 sites? Is that sort of fair?

No, I just mentioned it's -- I would, again, I'm hopeful, but we're talking probably more in the 25 to 30 sites. The only reason I hesitated honestly, we could go faster than that, but you need IT resources on the other end. And it's a matter of getting the attention. So if you look at companies who have successfully integrated into Epic systems, it's been a multiyear rollout. Like take Exact for instance. I mean, it didn't happen overnight. They've seen a huge benefit from it as will we, but they will roll on. And I hope we can go faster than that, but I don't want to set expectations too high here because we're not in control of some of it.

Got it. And in terms of additional EMR providers, how are you thinking about that?

We're evaluating them. So Epic is, although the leading market share, it's largest in the academic medical centers. If you start to look at the community. INOMED, Flatiron are a couple of systems that we're kind of looking at integrating with and looking at what that investment is. I think just, and again, we're under evaluation. I want to see, give it a month or so to see how Epic is working and making sure everything is flowing through the system and before kind of moving on to the next one, but it's under valuation.

Got it. You mentioned DLBCL. So any color on how you think the slope of the uptake curve looks like over there in 2024?

Yes, it's one of the growth factors in 2024. We haven't put specific kind of volume growth numbers on it yet, but we're also continuing to, refine the assay for cTDNA making that better. That's particularly more important on the pharma side. But we have data coming out at ASH and really one of the biggest growth drivers of clinical uptake is patient management use cases and how you're using the test to change clinical behaviors. So we have more data coming out at ASH, and ultimately, it is, again, one significant component of our '24 growth driver.

Got it. Multiple myeloma, you flagged it as a large driver of clonoSEQ use in clinical trials within MRD. Is this largely due to just the number of trials are underway in that setting? And how do you expect sort of that to shift once CLL, DLBCL, the new clonoSEQ indications start ramping?

Yes. I mean, yes, the reason it's currently the largest contributor to -- contributors to our MRD pharma revenue profile is that there's a ton of trials going on in multi myeloma, which is also a little bit of a headwind because there's a lot of competition for patients right now. So you can't recruit the patients, the number of patients that we thought would be on the trial. But we do see a shift over time to CLL, DLBCL. And frankly, mantle cell lymphoma, even though it's not a huge indication, there's a lot of therapies that are being developed in MCL that we see as really an important growth driver in MRD pharma for us. I did mention on one call again, we're improving kind of the sensitivity of the DLBCL assay with a ctDNA assay, which is different than our cellular assay. So it's an area that we've been making investments into kind of R&D to expand our opportunities set.

Got it. You talked about a little bit of a slowdown in the pharma business with the portfolio reprioritization and then some of these trials getting extended and so on. How broad-based is that impact? And given that you've reiterated the guide, how are you thinking about sort of mitigating that impact?

Yes. So we've still got a few weeks to go in the quarter, so we're not going to comment on quarterly guidance yet. I will say there is broad-based industry challenges right now related to pharma, both from the Inflation Reduction Act and from -- which the reprioritization of budgets in pharma. And again, one of the specific headwinds that I mentioned for us is not just reprioritization, but kind of competition for multi myeloma patients. That being said, we've got a strong pipeline and a competitive market position in MRD Pharma. If you're starting a trial you're looking at clonoSEQ as the test of choice in your trial.

Got it. In terms of the $400 million eligible sort of milestone payments and line of sight to approximately half of those, what about the other half? Or what time frame do you see those sort of being part of the opportunity?

Yes, I mean what we said is we've got line of sight. There are 70 active trials, right? So about $170 million or so of that $400 million, just under half . We put a 50% probability of success and kind of think about that over the next 5 to 7 years. We'll have mid-single-digit milestones this year, and then we said next year will be bigger. Beyond that, yes, we don't have great visibility on kind of that back end.

Fair enough. Chad...

I should also add we don't assume FDA endorses MRD as a primary endpoint. So if that happens, and it could happen at some point, that's upside.

Got it. Got it. Chad, two sort of big picture questions for you before we move to immune medicine. The potential for FDA LDT regulation. I mean that's -- Tycho and I wrote about it in 2012 and still hasn't happened. But every time, every 3 years, it becomes something that investors tend to focus on. So just curious as to your thoughts on that. And then what about the biomarker bill? And then more states sort of signing up to that?

Sure. So I'm not particularly concerned about LDT regulation by the FDA. As a matter of fact, I think the larger, more established labs will probably be beneficiaries of that, meaning like we've been through hundreds of pharma audits, CLIA, CAP, and by the way, clonoSEQ is already FDA regulated. We're one of the few diagnostics who've gone through the FDA process. On many of our tests, if you look at ALL, multi myeloma, CLL all through the FDA. So not a huge concern. I also think just practically the FDA is so overburdened right now. Their ability to regulate these tests is going to be a real challenge. And third, there's going to be a grandfather clause in. So in terms of whether that practically impacts our business or the ones that are -- most of the ones at this conference, I wouldn't be particularly concerned about it. The biomarker legislation is interesting in that, so just briefly, for those not familiar, what this legislation is, it's state -- I think there's 13 states right now that have biomarker legislation that says that if your test is covered by Medicare, that private payers in that have an obligation in that state to cover those patients through policy. That is not happening right now. And there's been a lawsuit in Illinois. And again, the insurance company lobbies are a lot bigger than there's only -- there's not too many profitable diagnostic companies. And so just the money putting into lobbying is a lot less. Again, being on the board of C21, we're trying to tackle this as a group to be able to go and say, "Hey, you need to uphold biomarker legislation" I'm just going to be practical. I don't think it's happening any time that soon that we're going to win one of these lawsuits. It's unfortunate, but my personal opinion.

Got it. Got it. Fair enough. Switching to immune medicine Chad. You got the first milestone on IND acceptance of the first shared candidate. Any sort of sense in terms of when the next milestone within the shared program would be on the table? And then in terms of what's left to recognize under that upfront amortization? I think it was roughly $90 million, and Tycho go you talked about that coming through 2025. But, any sense of the linearity there? Is it sort of evenly split between '24 and '25 or is it more front-end loaded?

Yes. I mean we said it would be kind of $35 million this year in that range and then step it down to kind of $20 million next year and then it tails off so.

Got it. Got it. And in terms of the second milestone Chad?

So we've submitted 2 additional TCR packages for evaluation for the shared product. And so timing to be determined as when we were going to get a milestone on that. We also have the first shared product for which the IND accepted going into trial sometime next year. We don't have a specific date on that yet. And then the private product has been advancing quite nicely. And we're seeing, we're able to pick out patient-specific TCRs that put a whole end-to-end production facility into our South San Francisco lab. And now we're bringing that through kind of the FDA requirements of GLCP and other lab-ready practices to be run in a trial.

Got it. So two follow-ups. One, just in terms of the private program that you mentioned on the personalized program. What specific steps remain to be done or what needs to be ironed out before you get to the required regulatory sort of stage?

Well, some of which I just mentioned, we're putting together our part and at the same time, Genentech is putting all the manufacturing in place, et cetera. But remember, this is the first time the agency has seen a patient-specific cellular product, right? So we're, there's a lot of conversation going into the FDA about what the requirements will be in order to submit an IND and to start a trial on it. Again, it's GLC peak on our side. It's other FDA-regulated lab processes and then there's manufacturing and other, because the goal is kind of 30 days end-to-end from sequencing of patients, tumor mutations, picking out the T-cell receptors that are specific to those mutations growing those up and then putting those back in. So there's a whole kind of variety of steps, both in terms of kind of how you pick those out, what the manufacturing looks like and how you essentially treat each patient. It's a bespoke therapy for each patient. So what can be standardized versus kind of what can't be.

Got it. And just in terms of the signaling value of that first milestone coming through from Genentech, has that sort of spurred any other discussions for you with other pharma partners?

We're in constant discussion with pharma partners related to not just what we can do in cancer, but what we can do in some of the other exciting areas where we're kind of had some nice developments and particularly in the autoimmune space. So, would I say that specific IND filing driven, not necessarily, but I would say that we've got some really robust conversations in play right now.

Got it. In terms of the pharma services component within immune medicine, is it subject to sort of some of the same macro headwinds in the MRD side? And how things been trending there through September? And how do you see that piece of the pie evolving next year?

Yes, it is. It is subject to the same macro headwinds, frankly, even more so because MRD trial a lot of them kind of, I'll call it, biomarker or research and development work, or if you're looking at TCR repertoire analysis are subject more to reprioritization of budgets than kind of MRD where you're on trial. So yes, you're seeing some headwinds there related to IRA. And then what was your second question Tejas?

Just around sort of trends into 2024 for contingent on macro, I'm presuming?

Yes. Again, I mean, the trends will continue on macro. Again, not commenting on quarterly guidance. We've got a few weeks left to finalize. But, just to be clear, in our immune medicine business, if you look at the revenue profile, pharma services is one component. And then we do have a fourth quarter weighted that are really deal dependent. And that deal dependency, I don't think has that subjectivity to those macro trends that I was talking about. So if you're doing a deal around, for example, a target or something of that nature or some disease states that really doesn't, that's not, it's IRA dependent like as using technology in a trial.

Got it. Makes sense. You've also talked about identifying at least one novel specific disease target by year-end. Where are those efforts? And once you've identified the target, what happens next in terms of developing it?

Yes. So again, this is an area that we're pretty excited about and research and development has progressed quite nicely. What we talked about is autoimmune disorders and more specifically, we called out multiple sclerosis, and this is the area that we're most advanced on but that really same hypothesis, technology and platform and validation steps that apply to multiple sclerosis will apply to, we believe, other autoimmune disorders. So we have in the process of kind of final validation of an MS related target. And the thesis here being is that in multiple sclerosis and in other autoimmune diseases, there are actually a common set of T cell receptors between patients. And once you know that common set of T cell receptors, you can then go the opposite way and find the antigen target. And so a lot of the work that we've been doing with Microsoft and the technology that we've been developing that was originally supposed to be purposed for T-Detect has been extremely useful in identifying novel targets and we're kind of honing in our first one.

Got it.

And then I think the question is the follow-up was, okay, what do you do with that? And so we're in an evaluation process. Does it make sense to partner the first one. But remember, we developed two different platforms in terms of developing assets against those targets. The first, we've talked about with is what we're using in cell therapy with Genentech, to be very clear, I do not want to develop a cell therapy platform in autoimmune disorders. I don't think it's a modality that this is going to be something that's scalable. But we have an antibody platform that we developed for COVID, really nice COVID antibodies before. Granted, they weren't commercialized, but the platform is very, very good in picking out way out on the TL antibodies that have great affinity, avidity, non-cross cross-reactive properties that we believe there's a potential to, I won't say that. So I'm going to rephrase that. There is a potential that we can use that antibody platform to go after some of these targets depending on whether they're Class II, et cetera.

Got it. On the guide, Chad, on your comment around macro not really being a factor for some of these large deals that slipped in terms of time lines. How are you thinking about, I guess the question is really how much of the deal timing is coming through in 4Q is in your control versus your partners control?

Look, any time you're doing business development deals, I mean, that is certainly a swing factor in the guidance. The control of a deal is based on a variety of different factors. I wouldn't say our control versus partner's control, I would say, it's collective control as to how soon we can get things done.

Got it. And, how much of a contribution, how much of a swing factor could that be in the guide in the back half of the year Tycho?

So Street -- in the fourth quarter, we said about 65% of back half revenues will be in the fourth quarter. Last year it was 55%. A little bit more. The Street consensus is around $20 million.

Okay. Is that sort of fair?

Those are -- yes. We said, look, these are all ongoing discussions in some cases over a year. This is all based on the data we've already generated. So like we're moving down the path, this isn't stuff we just kind of picked up a month ago. I mean pretty far along. But yes, that's the magnitude of $20 million.

And what's the, I guess, deal concentration there, right? Because it just sort of 2 deals and...

We haven't said, I mean we said deals, plural, but we haven't said. And it could be a combination upfront. I mean there are multiple flavors to deals, too. So.

Got it. Got it. Fair enough. And then more of a medium-term question. But as that Genentech amortization comes down, clearly, that's a significant headwind on margins. You talked about a bunch of initiatives on the COGS front that could be meaningful offsets. Where are you in terms of your, have you fully transitioned over to the NovaSeq X now or?

No, no. So we did a technical evaluation. We have to grade it for compatible with pattern flows, which we are. We sent the samples to a CRO and the data looks good. We have a fleet of 40 NextSeq. So that's a negotiation with Illumina around trade and value. They'll do matchmaking, they actually won't take it back, so they'll set you up with people. And so we're -- then we have to get in the queue, right? And then it's maybe 4 or 5 months to actually get a system, and then we'll have to kind of run in parallel with some subset of our NextSeq fleet. So we're really talking about incremental contributions in the back half of '24, but really '25 is where you're going to see the benefit of the NovaSeq transition.

And I was going to say one thing that didn't come up yet, but in terms of margin improvement, there's multiple factors that we're working on for kind of the gross margin improvement profile, but we just, this basically last week, finished the laboratory move. We're spread across 2 buildings. So literally, samples were kind of going back and forth. We finally got consolidated all into one building. So pretty excited about that. And so that should help in terms of the workflow margins, et cetera.

Got it. And Tycho once the transition is complete, how much of an uplift are we talking about? Is sequencing roughly like 15%, 20% of COGS? Or is it more or less?

Kind of 1/3.

Kind of 1/3, okay.

So I mean it could be meaningful. There's no reason at scale. I mean the Street does have us getting north of 70% of gross margins. There's no reason that we won't get there.

Got it. And is it fair to expect this year, obviously, you're cutting OpEx versus last year. But something similar next year from some of the cuts you've done this year, annualizing essentially?

Yes. I mean our goal is to kind of continue to drive operating leverage. So yes, I mean, we haven't officially guided for next year, but the goal would be to spend less next year than we're spending this year.

Got it. Got it. Cash burn, I mean, it's come down again on the last?

$35 million now quarter in the back half of the year.

Do you think there's room to go lower next year? And what, I guess, is a question for you as well, Chad. I mean how are you thinking about the balance there, right? Because at some point, you don't want to start cutting into bone. You don't want to compromise on top line growth. But obviously, you want to run a lean mean operation?

Yes, absolutely. I mean the balance is that we're allocating capital as efficiently as possible and looking for operating leverage. And, the reality is, I think we grew too fast and covered a lot of us did, but I'll point, I'll point the thumbs here and so we grew too fast. There is additional layers of management that we frankly needed to take out. And there's ways that we can do things a lot more efficiently. And so there's no stone unturned in terms of looking at how we can be more efficient. That is not in any way to sacrifice growth in terms of volume growth and certainly in the MRD business, but we do certainly need to look at how we're allocating capital between the different business opportunities and segments.

Got it. We're out of time so that's a great place to leave it at. Thanks so much, guys. Appreciate it.

Thank you. Appreciate it.