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

Great. Well, the green light means we're on. Our next session is Natera. We're lucky to have with us today, Steve Chapman, CEO; Mike Brophy, CFO. I'm Dan Leonard, I cover diagnostics for Credit Suisse. Welcome, Steve. Welcome, Mike.

Thanks for having us.

Yes. Thank you.

So given the timing, you had Q3 earnings last night, I thought we can kick things off by recapping some of the key highlights from your earnings report.

Yes. So we had a great quarter. We saw strong revenue growth, strong volume growth. We raised guidance again for the third time this year, so now up about $40 million at the midpoint from where we started the year. We also went into some detail on Signatera volumes, which have really been outpacing our expectations. We now think this year we're going to do greater than 100 -- 185,000 oncology tests, which include Signatera and Altera this year. So overall, I think things are going really well, continuing to see very strong clinical data generation both in oncology and in organ health and continuing to see nice growth across all the business units.

And 1 of the points you made on the call last night, I don't want to say you're a victim of your own success, but with the Signatera volume growth, comes some pressure on gross margin. So can you walk us through those dynamics?

Yes. Maybe I'll make some high-level comments, and then Mike, you can comment as well. So right now in Signatera, we're covered by Medicare for colorectal testing, muscle invasive bladder testing and immunotherapy monitoring. We don't have commercial coverage, and we don't have Medicare coverage and indications outside of those that I just mentioned. So somebody orders a breast cancer test or lung cancer, gastroesophageal, pancreatic, we're not able to get reimbursement today from Medicare. Somebody orders commercial colorectal testing, we're not really able to get reimbursement today. So as the volume grows, which we think is a good thing, particularly as we start to see acceleration in some of these non-covered areas like breast cancer, for example, that does put pressure on the margins. And we are seeing, I think, very strong uptick and interest from physicians even in these areas that are sort of beyond the currently covered applications. Now we think it's important to continue to serve the patients and physicians given the strength of the tool that we're offering, and there's a lot of demand. And so we've decided to continue to allow those types of tests coming in, even though it does put pressure on things.

I'd just add that I think it's a transient dynamic. We've seen the ASPs in Signatera improve dramatically since the launch. So we started with an ASP in the 500s. We've now got an ASP in the 700s, a little circa a year later. So that's a very rapid improvement. And that's really just come from our volume mix shifting into more reimbursed indications, both Medicare mix within colorectal cancer and then overall mix shifting toward some of the recurrence monitoring indication as more patients have gotten started with Signatera and now they're in the repeat monitoring phase. We've got -- there's a natural progression, I think, to be had on the ASPs that can continue in Signatera clinical, and then we've got a number of big opportunities to actually expand the set of indications that are covered. So we've got -- there's a potential for NCCN in guideline inclusion in colorectal cancer, which would be a real sea change for the business. I think that will happen, timing obviously is uncertain on that. And then secondly, we've got additional indications that we're pursuing with MolDx, breast cancer being one potential opportunity. So...

And Mike, is the mix shift towards more initial tests to recurrence monitoring within Signatera? Shouldn't that have a gross margin benefit associated with it?

Absolutely. Yes. So relative to where we were, this is Signatera clinical. I think we've got a clear line of sight for that to become progressively less dilutive to corporate gross margins. Still in that zone right now, but I think there's a clear line of sight to this being flipping over to becoming accretive to corporate gross margins.

So the preponderance of testing today, though would be that initial test that includes the whole exome sequencing.

Yes, we're seeing a real shift in that mix where we're getting more and more recurrence monitoring testing. I think that's actually going to continue. Yes.

Yes, that is happening, I think. But at the same time, just the interest in the test is driving a lot of that first time point orders. So while the patients that kind of came in, in maybe early 2022 or 2021 or 202020 -- 2020 are now in the recurrence monitoring. There's just so much new volume coming in where we're getting the new exome. Like we said on the call, in last quarter, we saw about 25% of oncologists in the United States ordered the test. And they're ordering a lot of new patients that we bear the cost of kind of running that exome upfront.

And what do you think the holdback is with Medicare for giving you a broader pan-cancer label? You have 4 reimburse indications today. You have clinical validation data for a couple more. I think you've messaged there could be a couple more Medicare reimburse indications in the near future that bring you to a half a dozen. I feel like with traditional tumor profiling the tipping point occurred after a handful and then the broader NPV reimbursed pan-cancer tumor profiling. So what do you think is the distinction here?

Yes. I mean, look, I think that is possible longer term. I think the good news for us that I think is a differentiator is that we actually have very significant amounts of data in multiple different tumor types. So when we go to MolDx and we go in with our package, we have strong data across all these different indications. So we just said we have new data coming out on gastroesophageal cancer, which is more than 900 time points. That's the sixth largest cancer in the United States. We have new data coming out on pancreatic cancer. We have new data coming out on melanoma. We have -- we just published our ovarian study. So all of these are areas where we haven't previously published data, but we now have new studies coming out that are -- with the exception of ovarian, greater than 500 plasma time points, and that gives us the ability to go and try to get reimbursement from MolDX. So I do think at some point in the future, you might be able to get this sort of pan cancer designation. But in the interim, we've set ourselves up to be able to go tumor type by tumor type by tumor type and get coverage. Now I think that does create, I think, a positive competitive dynamic for us because a lot of these studies, we started 5, 6, 7 years ago, like the ovarian study that we just published, that started in 2015, right? So if you're trying to come in now and put together a sort of pan-cancer data strategy, it's very challenging to, I think, kind of catch up to where we are.

Understood. Do you think there's a regulatory aspect to that? If you had an FDA-approved product, would that meaningfully tilt the scales from Medicare's point of view?

I still think that -- while I do think having an FDA designation is a positive. And in fact, for Signatera, we've announced we're doing CDx level trials, and we do have an IBD development program there, both for international markets and for support of those pharma CDx products in the future. I do still think that you have to deliver the clinical evidence in order to get pan cancer designation.

And then, Mike, you mentioned the NCCN guideline inclusion or maybe that was you, steve, sorry. But what's a reasonable way to frame the timing of that now? Is that considered a 20 -- middle of '23 event, first half, second half? How would you encourage investors to scope that?

Yes, I'll take that. I mean, to me, I don't think it's -- the way that we run the business and model the business is, we actually don't have something a date in mind where we're beyond this point. We've got to have that guideline inclusion to be successful. It's hard to handicap, and I wouldn't want to presuppose that process because that -- and that committee has got important work to do where they've got to be able to weigh all the evidence. What our job is going to be is just to continue to deliver more and more prospective clinical data and we're really excited to do that. So for example, we mentioned on our call last night that the 18-month prospective follow-up data in our BESPOKE trial is now -- sorry, in the CIRCULATE trial has now been accepted for Nature Medicine. So very much looking forward to getting that published. And I think that's an important kind of next step on the path. But that's the only thing we're doing. We've got a raft of publications, both prospective and kind of clinical experience data that continues to support the clinical utility that we think we've already established with the data that's been published.

Yes. And I'll just add on to that. The -- while we weren't able to get the CIRCULATE study into the NCCN review in August, now that it has been accepted in Nature Medicine, which has an impact factor of 87. I mean that's might be the highest in the field of medicine or maybe the second highest in the field of medicine. I mean that's exceptionally high. It's important that when they meet again, that's going to be included. And then we just saw the Japanese Society come out with a positive guideline for MRD testing where they talk all about Signatera, and I think that's a huge step forward. I mean there's probably some read-through there, sort of conservative Japanese committees met reviewed the data and have made a decision to put out a guideline that is super positive for Signatera. Then the other thing, Mike mentioned some of the clinical experience data, at ESMO, we presented a clinical experience results for 16,000 colorectal Signatera tests that had been performed with some of the top academics. And it was a nice consortium of academics to put that study together, and it's going to be submitted for peer review, but it was presented by Dr. Cohen. In fact, she's on the NCCN Guideline committee. And the findings from that study were very positive. They showed that Signatera negative patients didn't benefit from adjuvant chemotherapy. So similar to the readout from CIRCULATE. So I think it's a positive that we're seeing these top academics I think working together, generating the data and speaking positively at conferences.

Great. So moving on, when thinking about the next 12 to 18 months, I was wondering if there's any framing thoughts you had for investors as they think about key priorities, initiatives and any thoughts on 2023 specifically. You offered the messaging on your conference call that expenses should be up low single digits next year, but unsure if there's anything else you could flag from either an organizational standpoint or even from a modeling standpoint?

Yes. Well, look, I mean, I think the good thing about Natera is we've built the infrastructure right now to be able to scale up in a very big way without dramatically increasing our operating expenses. Mike mentioned low single digits. I mean, it could even be less than that. We built big sales teams now across all of the different areas that we're working, and we don't need to add any more people. We're already at peak levels of R&D spending and peak levels of clinical trial spending. And we don't really need to increase that. We just take the spending and sort of shift it over to the new project or slightly reduce it. So I think we've built this infrastructure. We're in these very big markets that are highly underpenetrated. We have on-market products that are reimbursed largely and have a pathway to improve reimbursement. So we just have to go out and execute and grow volume, continue to get some reimbursement wins while we're keeping the operating expenses relatively flat, and that's our strategy. Now layered on top of that, there's a couple of big opportunities for the company that I think could be like dramatic shifts that could make a significant impact. Now several of those revolve around society guideline changes. In fact, in the future, I think there -- it's a possibility that there could be 4 guideline changes that could impact Natera in a positive way. And as we kind of generate the evidence and the data needed to turn guidelines, although it's not something that we directly control, we've done the work, we generated the data, we published the papers. As the committees go through and make decisions, we will benefit from that in the end.

Do you think there's anything further you need to do to support the inclusion of microdeletions in guidelines, for example?

I think at this stage, the best large-scale prospective study that you can do has been done, and it's been read out, and the results were exceptional. Like when we designed the SMART trial, we met with the most senior leaders in the field of maternal-fetal medicine. We met with many society members and got their input, and the trial was designed, in fact, by the 2 PIs, who themselves are highly involved with the various societies. And they said going in, "we think you need to do about this number of patients. We think this is the number of positives you would need to see. We think this is the incidents you would need to see, and this is the sensitivity and specificity you would need to see." And for every metric that they said that we would need to hit, we actually exceeded the expectation. So I think we've done well. The test works really well. The study shows that there's a lot of clinical utility for this type of testing. And at this stage, it's -- look, we think it's a benefit for patients and physicians. We think the data is in. It's really just up to the guideline committees.

So you've done what you can on that front?

Yes. Yes. I mean, look, we spent 7 years working on a 20,000-patient prospective trial that had genetic follow-up with a microarray on the live birth patients. And so you can't really do any better than that. There's no better gold standard than what we did, and the results looked incredibly.

And then I want to follow up on the comment you made, Steve, around the company being at peak spending levels currently and you'd get high incremental margins with revenue growth, reimbursement wins, et cetera. A couple of the R&D programs you talked about on your call last night, sounded expensive. So can you remind us how you could target some of these market opportunities that are in your gun sites and cost efficiently?

Yes. So when you look at our R&D spending over the last several years, I think we've really tripled the spending to kind of where we are now. And that's largely on programs that help us scale, on programs that reduce COGS, on programs that advance the technology and then on clinical trials. And because we've ramped things up to a certain level, we just don't need to grow that any further. I mean if we stay consistent at this current level, there's a ton of dry powder in that current level that we're spending at to put on all of the projects that we need to do. Now ultimately, if we decide that we don't need to do some of these technology advancement projects, we could reduce the R&D budget. But I think a lot of these make sense, but that is an option if we chose to pull that trigger. Now I'll give you an example of like what some of the projects are and why we think they make sense. So one, for example, is Panorama. Today, we're running Panorama on the NextSeq. So we can save money just simply by moving that to the NovaSeq. That's not a complicated project that just takes work and development effort and validation, and we will ultimately reduce the COGS of Panorama. Another one is building out and scaling or further tissue capabilities at Natera to be able to process the tissue in a higher throughput capacity. That reduces COGS, that's a large part of the effort. So those types of things aren't -- they're not like R&D projects where we're kind of hunting around for an opportunity. They're largely COGS reduction and scalability projects. There are things that we could do if we wanted to kind of say, look, let's maybe reduce some of the more innovative things. Like, for example, like our clinical genomic database. So this isn't something that we've talked a lot about, but we have a team of people that works on extracting all of the DNA from the clinical reports and clinical data and patient information for Signatera. Now by the end of this year, we think we're going to have more than 250,000 exomes in Signatera time points in our clinical genomic database. If you look at other companies that have monetized their oncology database, they're generating $150 million, $200 million plus in revenue from their clinical genomic database. And we think there's an opportunity for us in the future to do really well from this at a very extremely high margin. Now we haven't generated really any revenue from that today. We've been spending COGS on it. We've been building the infrastructure. And we could say, look, let's shut that off and just put that on hold, and that would save money. But we think there's a big opportunity there. I think the other is early cancer detection. I think, largely, the development work that we've done on early cancer detection has been, I think part of a joint program with tumor-naive MRD testing, and our data looks good. I mean on early cancer, the proof of concept that we have internally, I think, are very positive. I think as we start to get more of the case control study data, we think we're going to be in a position to share that with investors before we make any big commitments in to doing spend. But like I said, even if we did proceed with a prospective study, that's already something that we've built into our model, and we think it would be in the range of like $15 million to $20 million and take maybe a year time frame with some of the new kind of decentralized way trials are being done. But we don't have to do that. If the data doesn't look good or we don't see a clear path, we could say, look, we're not going to push forward on that. So there's lots of levers that we can pull if we chose to, to not make some of the bigger bets. But I think we're trying to be prudent, wait for the right data to come in spend in the right places and grow in a scalable way.

So you're messaging that your cash burn is somewhat tunable by how you're assessing the market opportunities as you pursue them?

Definitely tunable. Yes.

Okay. Let's talk about the early cancer screening program. I wasn't entirely clear the different work streams you have underway there. You mentioned colorectal, you mentioned multi-cancer, you just said there's a tumor-naive MRD program, you have a tumor-informed in that. So if you could help me better understand the tumor-naive work that's informing the -- one of the pathways you're pursuing? Just anything to help clarify the different routes forward in that.

Yes. Yes. So when you look at -- one of the advantages that we have is we now have tens of thousands of early-stage whole exome sequences from early stage colorectal cancer patients. So when we take that data and we mine it, we can find DNA signatures, including ones that aren't available in the public literature, for both targeted DNA mutations and methylation that we can use to build an early cancer detection test. So we've done a lot of the proof-of-concept work there for both the DNA markers and methylation markers and run some internal proof-of-concept studies, and they look good. And I think there's an opportunity for us to leverage that data that is unique to Natera into, if we wanted to, a tumor naive-test, I would say at one point, in the company's history, we thought that, that might be valuable given some of the competition coming in. However, at this stage, we think that that's a lot less valuable given that physicians are choosing tumor informed in droves, and we're seeing a lot of uptick in tumor informed. And so we've sort of put less priority on a tumor-naive option because we just don't think that, that's what physicians want. But a lot of that work that we had done is now being sort of parlayed into the early cancer detection program. So we're continuing the development work there, both on the DNA signatures and methylation signatures. We think we're going to have case-control data to share publicly in '23. And then from there, we're going to kind of decide whether we pull the trigger on and doing a more significant study. But if we do that, it will be based on us looking at the data and saying this is a winner. And I think people will feel good about that decision.

And that's for colorectal specifically or both?

Yes, for colorectal specifically. And the vast majority of our energy at this stage is on colorectal, but there's some, I would say, mining and exploratory work on multi-cancer, I think, but the majority of the efforts on colorectal. Where, as I said, a lot of that R&D work also kind of parlays into a tumor-naive MRD test, which we could launch in the near future if we felt like that was something that doctors wanted.

Understood. You also mentioned a liquid biopsy test for tumor profiling. You don't talk about -- you have a tissue profiling test that you launched. I think it was 2 years ago, Altera, you don't talk about it a lot. So surprised to hear that you would -- I don't know if double down is the right word but expand your offering in tumor profiling to a blood test. Can you walk me through what you were messaging on that front? And what efforts you have underway?

Yes. So for tumor profiling, actually, our Altera product is doing really well. We're seeing strong growth there. There's a lot of interest. I think it makes sense when you order Signatera, if you can order comprehensive genomic profiling at the same time, it makes it easy to do all of that from 1 tissue sample, and we are seeing increases in that product configuration. When you look at liquid biopsy and comprehensive genomic profiling, we've actually been working on that behind the scenes for a while, and we've now generated some very good internal validation data that looks very competitive and strong. And I think the question is really just do we move that into development or not. So if you look previously, we had done a couple of acquisitions in the kind of late 2020, kind of mid-'21 time frame, somewhere in there. And those were around largely around technology advancements. I think that put us in a place where we could continue to work on oncology advancement projects. And the data looks very good there, and it's something that we absolutely could launch in an extremely competitive way. We have a big sales team at this point. I think we might have the biggest sales team in oncology diagnostics. And so it makes sense for us to have a full menu of tests for those folks to sell.

And with the incremental news flow there or the incremental gave the kind of clinical validation study of paper that you can publish and then commercialize the product in the back up. Is that the next step?

Yes. Yes. I mean look, that's not going to happen in the next 6 months. Just to be clear, I think we're kind of talking more about like some of the things that we're -- we have cooking. But yes. And look, right now, that's not -- our plan for 2023 is to do exactly what we've been doing in oncology, which is grow Signatera and get additional coverage for Signatera. It's working. The doctors love it. We're generating a lot of data. We don't need a kind of bell and whistle there to go kind of change the strategy. It's what we're doing is working, and we're going to stick with it.

Understood. And before we run out the shack log here, how do you continue to drive growth in your reproductive health business?

Yes. So in reproductive health, if you look at NIPT, we think it's about 45% to 50% penetrated overall now. And we think that's going to scale up over the next several years. Believe it or not, there's still a lot of large centers that aren't doing NIPT. We're seeing big hospital systems do sort of RFPs and decide to now roll out NIPT broadly to their communities. So there's still some upside there. In addition, I think there is some opportunity to improve the ASPs across the reproductive health business. And now in addition to NIPT and carrier screening, we also have hereditary cancer flowing through our reproductive health business as well. So there's some good opportunities there to continue to do what we've done and grow that business while we also look at continuing to get guidelines in place and doing the right things from an operations standpoint to reduce COGS and improve the ASP.

The hereditary cancer test being in power?

Yes.

You made an announcement about that on your conference call. You were consolidating, I thought, Empower into the oncology business.

Yes. So we had 3 different call points for Empower. One is women's health, where that's sold already through the current women's health team, and that's actually gone really well. And then separately, we had a team of dedicated sales reps. It was calling on hereditary cancer centers and breast surgeons. And then we have the oncology team that was also selling into community oncologists. So what we've done now is consolidated that separate team that was calling on hereditary cancer centers into the oncology team. So now the oncology team sells Signatera, Altera and Empower to community oncologists and breast surgeons. And we thought it was important to -- as we see more doctors using Signatera breast, which is actually an area that we've seen a lot of uptick. We like the idea of including empower hereditary cancer testing and including the breast cancer call point into that oncology strategy.

Okay. Well, we're running short of time. All that makes sense. Steve, Mike, thank you for your time.

Great. Thank you very much.

Thanks for having us. Cheers. Yes.