Natera, Inc. (NTRA) Earnings Call Transcript & Summary

I'm Matt Sykes, the life science tools and diagnostics analyst at Goldman Sachs. We have the pleasure of hosting Natera this morning. Steve Chapman, Chief Executive Officer; and then Mike Brophy, Chief Financial Officer, will be on his way. But Steve, thanks for being here.

Yes. Thanks for having us. Appreciate it.

Maybe if we start, you can kind of set the stage for us and go over some of the sort of key highlights this year and what investors should be focused over the balance of the year.

Yes. So Natera is the market leader in cell-free DNA testing, and we have deployed our technology in 3 very large areas of health care: in women's health, oncology and organ health. And our goal has been to deeply penetrate these markets and make a significant impact on patients. And so we've been on this really great run with incredible revenue growth and volume growth. So this year, for example, in Q1, we've reported out 57% year-on-year product revenue growth and 41% year-on-year volume growth. So we're seeing great utilization, but there's a long way to go. When you think about the key milestones for the year, in each of the different business units, in women's health, in the very beginning of the year, we reported out the results of the SMART study, which was a 5-year multisite prospective study to look at about 20,000 patients. Now that strongly supported the use of 22q screening in the prenatal setting. And so we think that society guidelines could be coming in the future, which could make a significant impact on patient care and also a reimbursement. In fact, some draft guidelines are circulating now that I think are very supportive of 22q. When you look at the organ health business, our goal while growing patient volume and continuing to serve patients and physicians was really to publish definitive data in lung, heart and kidney. And we've done just that. In fact, over the past 12 months, we've had 13 peer-reviewed papers, including very significant lung validation data, very significant multisite prospective heart validation data. And at any moment, we're expecting the publication of the Trifecta study in kidney, which is the largest multisite prospective fully biopsy-matched study that's ever been done in the field of donor-derived, cell-free DNA. And in oncology, we have very significant milestones, I think, largely circulating around -- largely evolving around the publication of the CIRCULATE trial, which we think is a guideline-enabling trial that we think could be published this summer. I think that's going to be a big defining moment for us, along with just rapid increasing penetration in the space.

Great. Just maybe on that CIRCULATE, I mean, congrats on the really success of the CIRCULATE Japan study and your launch of CIRCULATE U.S. Could you maybe talk a little bit more in detail about the study? And what do you anticipate enrollment will be completed?

Yes. So in CIRCULATE Japan, which is a large multisite prospective trial that's now been enrolling for several years, we're looking at the idea of whether MRD-guided adjuvant chemotherapy can outperform the standard of care. And the data that we've presented thus far shows that MRD testing makes a very significant impact. So just at ASCO GI and at ASCO -- the Society of Surgical Oncology earlier this year, we presented data on the first 3,000 patients that have been enrolled with 1,000 patients that had 12 months of follow-up. And what we showed was that if you're MRD-positive, you will respond to adjuvant chemotherapy. And if you're at MRD-negative, you don't need adjuvant chemotherapy. And that's really, I think, very significant because the vast majority of stage -- high-risk stage 2 and stage 3 patients get adjuvant chemo and only 25% of them benefit. Now this publication has now been submitted to really the premier journal, and we think will be published this summer and then we'll go to the NCCN guideline committee potentially for inclusion in guidelines.

And what benchmarks are you using to evaluate success for that?

Yes. So looking at disease-free survival and overall survival to basically determine whether patients that are MRD-positive that get adjuvant chemotherapy do better than patients that are MRD-positive that don't get adjuvant chemotherapy. And the data so far shows that if you're MRD positive, you're more likely to respond to adjuvant chemotherapy than not. Similarly, if you're MRD negative, we think you can avoid chemotherapy altogether. And the data so far show that the disease-free survival is the same for patients that are MRD negative, that get adjuvant chemotherapy or that are MRD-negative that don't get adjuvant chemotherapy. So you don't need to subject yourself to all the toxicity and cost unnecessarily if you're not going to have disease progression or recurrence.

Got it. And how are you thinking about the approval process for additional cancer indications for MRD, lung and breast? And how will that be different for CRC?

Yes. So we think CRC represents probably only about 5% of the overall opportunity. And although today, it's more than 50% of the volume that we're receiving, we think the big opportunity is going to be expanding into other cancer types. And we started accepting additional tumor types kind of mid-2021. And we see really exceptional uptake there, a lot of interest from physicians, a lot of organic interests. And -- but long term, we have to say, okay, how do we get reimbursed for these tests? And so the good news is that we've generated a ton of peer-reviewed data for Signatera. So we now have more than 15 peer-reviewed publications. And we think this year alone, we'll probably publish between 20 and 30 additional peer-reviewed papers. So we take that information. We submit it to MolDx. We try to get coverage. And so far, we've already submitted additional coverage for multiple different indications beyond colorectal. So we got immunotherapy coverage. We got stage 4 colorectal, which wasn't part of the initial submission. And then right now, there's a handful of other submissions that are pending feedback from MolDx that we think we'll have basically any day now.

Got it. Earlier this year, I mean, I think we appreciate all the additional information you kind of provided in response to the news flow that we saw in March in your Times article and other things that have come up. Have you seen any impact within the women's health market in terms of customer feedback or growth as a result of those things? And any other additional comments you want to make on that? I know there's been a lot of news flow and a lot of discussion.

Yes. So we've had just incredibly strong support from women's health physicians with regards to the value of prenatal testing. I think you've got to remember, OB/GYN doctors have been doing prenatal testing since the 1980s, and they're used to test that have a positive predicted value of about 5%. So the vast majority of women today in the United States still get biochemical screening to look for chromosomal abnormalities. The positive predictive value there is 5%. With our test, with -- for standard aneuploidies, the positive predictive value is greater than 90%. And for microdeletions like 22q, the positive predictive value is 50%. When you get into some of the more rare microdeletions, you can get in that 3% to 5% range, which is what doctors are used to. But I think the idea that physicians don't like the way the test performs and those types of things are just simply untrue. So we've had very strong support. We're operating at record volume levels. We're very transparent with the data. So we published 26 peer-reviewed papers in a field of cell-free DNA -- fetal cell-free DNA, including the largest in the field. We put the positive predicted value on every single report along with the negative predicted value. And I think ultimately, we're in probably the best position of any of the NIPT providers to do an FDA submission if we chose to go that route.

Got it. And maybe you could just talk a little bit about the recent news on the multisite clinical validation, Prospera Heart test, you mentioned a little bit at the outset. But how does that impact Prospera's value proposition in your mind?

Yes. So this is in the field of organ health when you're looking at the use of donor-derived, cell-free DNA testing. So initially, we launched in kidney, which we thought was a good opportunity, and that's where we had our initial validation data. But since then, late last year, we expanded and validated both lung and heart. Now the big thing at heart was that we needed to publish our validation data, and we did that just actually in past 60 days roughly. In JHLT, which is the Journal of Heart and Lung Transplant, that's the highest impact factor journal in that space. We published a multisite prospective study that looked at 800 samples that were from patients that had heart transplants. And there were 700 prospective samples in that study, and the performance was just exceptional. So we think based on the performance of our tests that we're going to do very well penetrating this market. We've already submitted that for MolDx reimbursement along with our lung data, which has been submitted as well.

Got it. And moving back to the women's health. Just how has increased penetration in sort of NIPT in the average risk pregnancies has been trending? And how are you seeing that market expand?

Yes. So we think within 3 years, NIPT will be about 90% penetrated overall. And if you look today, we think it's probably about 45% penetrated. So high risk is probably about 80% penetrated today, and that's women over 35. The vast majority of pregnancies are women under the age of 35, and that's probably itself about 40% to 45% penetrated. So there's a long way to go here to get to 90%. The volume is effectively going to have to double from where we are today, and we think that's going to happen relatively quickly. A lot of that volume is in big hospital systems and big state programs, areas that I think we're competitively set up to win because of our deep entrenchment, a significant amount of peer-reviewed data and the clinical differentiation of our product.

Got it. And maybe just talking about the reimbursement tracking across Q1 for Signatera and specifically in the immunotherapy response monitoring subsegment. Are you planning on expanding Signatera into other tumor types as well?

Yes. So right now, we have coverage for colorectal cancer. We expanded that to include stage IV colorectal cancer. We have coverage for immunotherapy monitoring, which is pan-cancer. So that goes across lung, renal, melanoma, et cetera, bladder, all the different areas that immunotherapy is being used today. And then we've submitted 2 additional MolDx submissions for additional tumor types, and we're waiting to hear back on that. But ultimately, we have a plan to basically submit for every cancer type, and we're generating the data that you need. You have to have a peer-reviewed paper to submit. And so when you look -- we published in bladder. We published in lung. We published in breast. We published in esophageal. We have great data that's come out in multiple myeloma. We have ovarian that's published. And then at ASCO, we had new data in pancreatic cancer, and we've just shown, I think, recent renal cell and Merkel cell data. So we have a lot of papers that are either in submission or already been published that allow us to submit for coverage.

Got it. And in terms of integration of Signatera within EMR systems, I'm just getting reports that -- other EMR systems you partner with. And can you maybe talk about that progression and how important that could be eventually?

Yes. So we've always partnered with EMR companies to do integrations to make our tests ordered and results available through these EMR systems. So we have thousands of different connections around the country. But we did do a couple of very large-scale deals, one with Epic and another with Cerner, where they've sort of pre-installed us on their latest software versions. And so we actually did that probably 2 years ago. So now any time anyone uploads the latest version of Epic, we're already pre-installed on their system where they can basically push a button and order any of our tests. Now we didn't announce that when we did the deal because we just wanted to go execute and get it done, but that went live probably mid-2021 roughly.

Got it. And Mike, thanks for coming. Maybe we'll switch a little bit to the financials. And you've talked about women's health as being kind of getting close to the breakeven and potentially generating cash for you in the future and being sort of reducing some of the pressure on the burns for that. Could you give an update on that progress there and what you're seeing in terms of the path to profitability per segment? And then for the overall company, how do you see that play out?

Yes. Well, thanks for the question. I think it's an important topic. And just as a reminder for people that are somewhat newer to the story, I mean when Steve was first promoted to the CEO role, we came in, that was in January 1 a few years ago and came into the JPMorgan conference that year, Steve had a slide up that had the kind of top 3 goals for the business over the next of intervening years. And the #1 goal was to get the women's health business to cash flow breakeven, despite the fact that cash flow wasn't as -- nearly as much as our business now. That's kind of always been an important component to how we've run the business. And we achieved that goal last year. So we got Q2 of last year and a crossover as those products started contributing cash to the overall business. And this year, it's a significant cash generator, just those products alone where all the investments coming is kind of building the infrastructure necessary to launch a world-class cancer test, cancer franchise in the enormous market. And so with that business now, we're kind of seeing the next version of what we've already executed in the women's health space, where we've got a strong commercial channel and now the volumes are ramping. So just as in women's health, we're able to kind of keep the operating expenses relatively stable and significantly ramp the volumes. We're seeing that playing out more rapidly in the oncology space today.

Okay. Yes, I was going to ask you that, about learnings from women's health and how portable that is from a path to profitability standpoint for oncology. And do you think it kind of sounds like you can get there quicker than when you did -- what you did for women's health?

Yes. I think that experience for us really informed our confidence to be able to kind of provide a more granular pathway for overall business cash flow breakeven that we provided on the last earnings call where that -- even at very modest levels of gross margin improvement from where we are now, we felt like the business could get to cash flow breakeven at about that $1.3 billion kind of level. And of course, gross margins can improve more rapidly than that, then you'd get there at a lower kind of absolute revenue base. But based on where we are now, I think you can see that we're well down the path to get into that level. And just conceptually, I mean, we have the market-leading products already validated and in the field, and they're already ramping into some large markets. We've got all of the people in place today necessary to drive this kind of discontinuous growth that we've been producing quarter-over-quarter. And so now, it's just a matter of just kind of getting leverage kind of much more modest growth on OpEx compared to the revenue growth. And that's why we felt confident saying that we feel like cash burn will be significantly decreased next year.

Got it. And in terms of COGS, I mean, maybe if we pick on Signatera, just making progress on reducing the COGS of the whole-exome sequencing or the blood test, like what's the progress? And what's sort of the road map for that cost reduction over time?

Yes. So Signatera is a great example. I mean we've also kind of laid out this road map previously and executed on it with the Panorama asset. So long-time followers of the company will recall a time when the Panorama cost of goods sold was something like $350. And then we've kind of methodically reduced the cost of goods sold for running Panorama now to where it's about $160 to run the Pano test and clear line of sight to getting that to $125 and below. And so it's really kind of the same playbook again with Signatera. You get to benefit from a lot of the same -- the fact that we're using a lot of the same technology for the test. In particular, though, one area where I think we can get a lot more efficient over time is in the upfront exome. As we kind of just scale the business, we're going to be able to get a lot of scale efficacies from that component, significant cost savings to be had there. That's just very low-hanging fruit. On the plasma test, we get to leverage a lot of the things that we've already learned from Panorama and are already in place for low COGS in the plasma test.

And the potential for lower sequencing costs over time given some of the news so that we've seen, that's just upside? I think you're talking about a current sequencing cost of earnings.

Yes, absolutely. I mean there's not -- in that walk, I just kind of talked you through, I'm not baking in some enormous reduction in sequencing costs per se other than kind of the regular way savings that one would expect with volume. But of course, that's always upside for us, and that's something that's been largely untapped is the proliferation of sequencing technology, something that would be a huge benefit for this business.

And there's other COGS opportunities as well even beyond like the exome. I mean, even just in Panorama, for example, we're doing, I don't know, 1 million tests or something in that range. And a lot of that is being run on messy instruments. So as we move up to kind of higher throughput instruments, these aren't like big technologically risky projects, right? It's just sort of versioning up an instrument can reduce the COGS significantly.

Got it. And then Mike, maybe talk about OpEx trends moving forward. In Q1, it's probably like a little bit higher than we expected in terms of the spend, but you've committed to this path to profitability. And I know there's certain sort of the R&D spend for the clinical trials that you've already got running. We could see some over time that may be come down. But just talk about the flexibility you have within SG&A and R&D and how you can move that up and down in terms of the macro environment, what you're seeing, anything like that?

Yes, absolutely. And I think here again, the experience that Steve and I had as part of the management team from 2015 to 2019 really informs our thought process here, work for that entire time frame and shares were pretty much range bound between like $9 and $12. The capital markets were not always available in a real way. And yet we were able to execute a very high-quality growth strategy by being at very efficient with our operating expense investments. I think the same thing is in place here. Fundamentally, though, what you need in order to get to cash flow breakeven and have a high-growth business is you've got to have great products in underpenetrated markets. And that's exactly what we have across each of these parts of our business. We don't need to go hiring significant new tranches of commercial teams in order to make those things grow. We've got the data. We've got the people in place now. So as we mentioned on the Q1 call, we feel like we can have very stable operating expenses and still see the strong growth rates we've seen in the top line.

Got it. I mean one of the questions we get a lot is sort of the spend versus grow equation. I think that there was an expectation a few years ago that I think business models were sometimes built on sort of a financial environment as its is expected to continue forever. So I could keep growing because I can raise money, I keep spending. So as that spend maybe starts to come down as things get a little more rational, one, like do you think that growth momentum could continue for you given what you've already spent in the cost you have? And two, like how do you think about sort of the competitive landscape in sort of the new environment where that equation is becoming a lot more...

Well, I'll talk about that and I'll let Steve talk about the competition. I mean, I think the women's health case study is absolutely critical here. So I think that business model where you need to spend in order to grow, that's basically what that really equates to is, hey, I've got -- if I want to grow, I got to keep hiring more and more sales reps. I got to be spending more and more in sales and marketing in order to kind of drive that growth. For a constant level of effort, I can't grow the business. That's not at all what we've done with women's health business. We've been able to really get that business to where it generates cash. We've been able to get leverage on that team. And that's the key. I mean that -- now that's kind of independent of any kind of financing environment when you show that you can get leverage. And that's been the #1 goal in this business is to show that we can do that. So now it's just repeating that playbook. We've got it for cancer -- for Signatera, for example, you've got to build the infrastructure. You've got to get the sales reps into the territories. You've got to have the capacity to take in the volume. But once you're at that level, which we are now, now we're in a position where we can get leverage on that investment, and that's kind of independent of any kind of financial environment. So Steve, do you want to talk a little bit about if there's any implications for competition?

Yes. I think there are, I guess, across all different areas that we're operating. When -- you have to look at the expense of building out that big sales team that we've already taken and we already have, and it's already part of our plan. I think right now, in women's health, in oncology, the scale that we're operating at is very large and significant. And to go from scratch and to build that is $50-plus million. So I think someone that comes in and has a product that then has to go out and build a team, it's going to need to be able to make very significant investments. I also think that in MRD, particularly, we've created a very significant lead, both in data, in utilization, in scale. And I think we're in a great place.

Great. Maybe just moving to organ health for a little bit. I think it was a lot of focus on women's health and oncology. But organ health side, I feel like it's an underpenetrated market. There's clearly another competitor in that space, and there's a certain value proposition that you could potentially provide in that. How are you finding early penetration of that market? And is that value proposition potentially resonating with the transplant centers or the key constituents within that segment?

Yes. Definitely, I think in the kidney space, we think, overall, the market is only about 10% penetrated. And although there's a sort of heavy competitive battle that's occurring, the big opportunity is just growing the market penetration overall. And we think we're in a good position to do that. And a big moment that we've been waiting for is the publication of the Trifecta study. I think most people kind of think back to like maybe the DART study as being one of the original sort of standards for validation in the field. And I think our Trifecta study has 3x more -- roughly 3x more rejections that are biopsy confirmed. So we're talking about a very significant study that's going to be hitting the market that I think can make an impact on physicians and patients. But overall, we're doing well. I mean, we're seeing record levels in the organ health business. We've seen like very strong support from the physician and the transplant community. And I think we're feeling very good. We're also expanding. So not just kidney anymore, but now we're doing heart and lung. And then we talked about Renasight as another area of opportunity in chronic kidney disease. Now we announced the RenaCARE study is actually going to be finishing enrollment this quarter. So that's a large prospective multisite study in the field of chronic kidney disease germline testing that was done with Columbia University and several other leading academic centers. So I think that's another opportunity where we think we're going to add value to patients in the chronic kidney disease setting.

When you think about your commercial strategy and you think about women's health, oncology, organ health, the differences within those markets, I mean, for organ health, there's the transplant centers, there's nephrology. And it seems to be a little bit more of a complex ecosystem. I could be wrong in that. But as you take your template from the success you've had in women's health and apply it to oncology and then apply it to organ health, what changes do you have to make? And how many -- how much adjustments do you have to make? And does that cause for a slower ramp-up? Like how are you thinking about that?

I mean it's incredible that there are very strong synergies that I think have to do with just launching an advanced diagnostic test into any field of health care. And so the only real difference is that the salespeople and the medical affairs people that are out in the field and the way the test works is slightly different and then the data that we published, but everything else is basically the same. I mean it's the same strategy to have a technology-driven approach backed by very strong clinical data, an amazing user experience and a strong commercial team. And we've taken that sort of blueprint and just applied it across these different areas. And I think sometimes we're the first to come in like with Signatera. And sometimes, we come from behind like we did with Panorama. But the blueprint works and we're basically executing against it across all the businesses. And that's why we've already raised our revenue guidance this year once, and as we indicated on the Q1 call that we're seeing very strong momentum as we enter the second half of the year.

Got it. Maybe I'll open up the -- any questions to the audience. Just raise your hand, a microphone could come around. Happy to take questions. But just in terms of commercial momentum. I think -- actually shifting for a second. I think there's a lot of focus in terms of -- on the OpEx side, sales and marketing and then R&D. But there's also an infrastructure portion of the business, whether it's billing, support, things like that. And a lot of times, when companies grow as fast as you have, there's a catch-up that needs to take place for that infrastructure. Do you feel like in terms of that size of that sort of -- the stuff that no one talks about, the plumbing of the business, because that's where a lot of trip-ups can occur actually. And so like how do you feel like you're set for that? And does there need to be more spend that we might not be thinking about because we're so focused on sales and marketing R&D?

Yes. Maybe I'll just comment and then you can comment. I think a lot of times when these things like customer service or billing or other kind of SG&A functions grow really fast like we have. It's done in a way that is maybe not as kind of scaled and cost efficient. And so I would actually say it's kind of the opposite, which is where we now -- now we can kind of take a step back and look and say, okay, do we really -- is there a way to do this with a more technology-driven approach or maybe a more streamlined way where I think we can actually like be more efficient and reduce some of the costs in those areas. Because the last 2 or 3 years, we've really grown those areas dramatically. And I think sometimes very fast. And I think there's an opportunity there.

Got it. And then maybe moving back to Signatera. I mean you guys have kind of reported volumes in the past, things seem to be going very well in terms of how you're expecting to kind of keep the market up on that progress. How are you thinking about that? Because it's obviously a huge focus for the market. But how are you thinking about kind of in terms of reporting that type of volume? And any kind of color you can give us on that?

Well, first, I would say that oncology MRD testing is exceptionally underpenetrated right now, and there's a huge amount of upside. And second, I would say when we look at our numbers, we're continuing to see just exceptional volume performance. I think we reported out what we did in 2021, which was a very large number, but the volume has just continued to really grow quickly. And I think we're in a great position, and we're scaling, and we're ready to take on more.

Got it. You mentioned a little bit before, and I kind of asked a question about porting to the knowledge of how you've ramped up. But we've always been fascinated with coming from behind in women's health and then leading at MRD. And how do you get people's kind of minding you for those 2 different various situations? Because when you lead oftentimes, you have folks drafting off a lot of the work you've done. But in women's health, it was a different story. So how do you guys think about that? And how do you kind of focus the commercial team on those 2 different types of opportunities?

Yes. I think for us, it comes down to 4 key things. The first is you have to have the best technology, and we think we do, and we've always taken a very technology-driven approach. That's sort of fundamental to everything that we do. The second is that you have to have very strong clinical data. And in NIPT, we have 26 peer-reviewed papers. In MRD testing, we now have more than 15 peer-reviewed papers. And in organ health now, we've actually caught up. When you look across heart, lung and kidney, we have some of the most significant papers in the field. So that's been a lot of our focus. And that does make a big difference. You can't cut corners on that. Then you have to combine that with a strong commercial team, which we built -- we have in place. We have one of the longest-tenured sales teams across all of our businesses. We combine that with an amazing user experience. So it's those 4 things really working together that I think make us successful. And I guess it doesn't really matter whether you come from behind or you start off in a lead, you have to do the same things. And if you try to not generate data and put a test out in the market, you just won't be successful. Similarly, if you don't have a strong commercial team, if you have a great technology, it's just hard to be successful. So you have to combine all those things together.

Got it. In terms of sales force retention, labor costs, I feel like we're entering a period now where there might actually be some softening in that just given the opportunities to go to the brand-new -- a person might not be as attractive as they once were maybe back in February. But in terms of how you're seeing retention of salespeople and labor costs, like how are you dealing with that situation currently?

I mean I think we're actually doing really well. I think we've had extremely high employee retention rates and very high employee engagement scores. So this is something that we monitor frequently. We interact with the employees to understand what their needs are, and we put a lot of attention there. So we've had very strong retention rates. And I think a lot of people are excited about the impact that we're having on patients. We see all the time from our sales team, stories about the Signatera patients that they've helped or someone got stopped in the airport because they were wearing a Natera shirt and someone was crying about the impact of Signatera had on their life. I mean we see that stuff all the time and people get really motivated about that. And I think they see the opportunity and the excitement ahead. You got to remember, this is just a very, very early stages. So everybody knows Signatera is like 3%, 4%, 5% penetrated. I mean people are going to be here for a long time. There's a lot of opportunity for the sales team members. Women's health is probably 45% penetrated. There's a huge upside that's going to happen over the next 3 years. And organ health is only about 10% penetrated. So if I'm a sales rep right now, I'm looking at my territory, thinking about how much upside I have because of all the opportunity is just simply increased penetration.

Got it. Maybe in the 30 seconds or so we have left, what do you think is underestimated or misunderstand about Natera currently right now? What do you want to get across to investors?

I mean I just think we -- the huge opportunity that we have ahead of ourselves. I mean we have a strong track record of executing and we're continuing to do that. So I think we're in a very, very good position right now across organ health, women's health and oncology.

Great Steve, Mike thank you very much. I appreciate it.

Appreciate it.