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

All right. Hi, everyone. Welcome to the Canaccord Genuity Global Growth Conference. I'm Kyle Mikson. I cover Life Sciences and Diagnostics for Canaccord. Pleased to present this fireside chat with Natera here with us. Natera is a leader in cell-free DNA based testing across women's health, oncology and organ health. With us from the company, we have Mike Brophy, CFO. Thanks, Mike, for joining us.

Yes. Thanks for having me.

Good to have you. So I think -- so last Thursday, you reported the second quarter results beat consensus by like $20 million on the top line, strong gross margin, broad-based growth. Just talk about like what kind of turned out in terms of volume and ASP dynamics, too?

Yes. I mean, yes, thanks, and thanks for having me. It's great to be here. I mean we had a great quarter. I think it's been pretty well received. I mean as [ Colm ] mentioned, we had a -- we posted 32% year-on-year growth in revenues. That was 8% sequential growth over Q1, which is usually kind of our strongest quarter. Posted a really strong gross margin of a little over 45%, had put up 84,000 oncology tests processed in the quarter. That was on an absolute basis. That was kind of an acceleration in terms of absolute unit growth over Q1. So every quarter, oncology continues to be kind of a record quarter. We raised the revenue guide -- we kind of reset the range on the revenue guide. So previously, the top end was $1.15 billion. That's now on the bottom end of the range. Now it's a $1.15 billion is the bottom and the top end is $1 billion -- $1.35 billion, and we reiterated that we're on track to meet our cash burn reduction target this year. We're going to reduce our cash burn by over $150 million this year. So another kind of very encouraging kind of sequential quarterly reduction in cash burn, and that's really just coming from us holding operating expenses pretty steady and continue to deliver revenue growth. So just kind of get -- continue to get leverage on this -- on the team that we've built. So really excited about the progress and the quarter kind of all the way around.

Okay. Yes, that was great. The revenue guide was raised for the beat like -- like I just mentioned $20 million, so like this may have been asked on the call or addressed earlier, but basically like how much conservatism and what is the philosophy of guidance now with the company? Because it's 3 years I feel like my time covering the company. Every quarter being raised. But how much conservatism is baked in basically at this point?

Yes. I mean I know and I see a number of familiar faces in the audience. And I've been setting the guide here at the company now for 8 years. And we have tried to -- we try to model and forecast the business in a prudently conservative way that allows for the various uncertainties that you'd see in a business. Having said that, I think that the underlying drivers of the business just look really strong. I mean you peel back the onion in almost any of the trends, it will quite repeatable. So I'm quite encouraged about the traction that we're seeing in the business right now. And so philosophically, we try and guide in a way that hopefully strikes you guys as something that's prudent and conservative and the underlying drivers are quite strong.

Yes. We were talking heavy oncology revenue. It's kind of like not -- it's a moving target. It's like kind of early segment. I feel like women's health is probably more visible to you. I mean is that a source of upside if you think about the 3 segments?

Yes, absolutely. I mean just rewind first, I guess, on ASPs, I mean, we were hoping to have ASPs in the 800s at some point this year. We got there in Q1. And we saw another pretty meaningful step-up in ASPs in the mid-800s in Q2. And that's a perfect example of one of the things when I peel back the drivers of like what's moving ASPs higher, they seem to be pretty repeatable trends. I mean this is a recurrence monitoring mix continuing to move in our favor. Fraction of our business that's coming from Medicare volumes continue to move in our favor, really driving volumes in these tumor types where we've got a Medicare reimburse beachhead. And then also within these reimbursed tumor types, just continuing to execute, getting paid on Medicaid -- on units that really ought to be Medicare reimbursed tests either from traditional fee-for-service Medicare or from the Medicare Advantage plans. So all that is looking continually quite strong. That -- you pair that with the volume growth. And I think this is another area where if you rewind us to the launch, I would never have told you that we would have more than 1/3 of oncologists ordering the test that we'll be doing 84,000 units a quarter. We've got very strong new patient starts. We've got very strong maintenance of patients continuing to stay with the test into the recurrence monitoring setting. I think that really just speaks to the utility of the test and the unmet need that Signatera is addressing both for the physicians and for the patients.

And there's no like competitive sort of headwinds thus far. Like what are you seeing in the market when you think about the tumor-naive test out there?

Well, look, I think as it relates to competition, we're obviously -- we're the category creator and we feel like we've got a multiyear head start of that as a result. I mean just a little bit of background, we didn't hire a consultant that like pointed out this is a big market and we should try to pursue this. That's not how we arrived at this product. We looked at what our core technology did extremely well, where we felt like we had an advantage measured in 10-plus years of work, and we said, okay, what are the unmet needs in oncology that would be a good fit, that could be solved by our core technology. And that's how we came into minimal residual disease assessment and recurrence monitoring. So when we launched the R&D programs in 2014 and 2015, we already had a big head start in our mind. And I think the data that we've been able to produce over that period of time now represents a very significant lead over the competition. Having said that, I mean, we've shown that this is a huge unmet need. It's a huge opportunity to help patients, and there's going to be more than one company over time serving this patient population. There's some excellent companies pursuing their own technologies and approaches. To date, there has not been a ton of published data from the field, while we published a huge amount of data. So I think the competition is still something that's in the future, it's something that we're very mindful about. We welcome it. We've shown, I think, investors in other very competitive markets that we can. We're happy to deal with competition and we can be successful even as the market becomes more competitive over time.

Okay. And then just as a result of being like first mover basically, you have really solid reimbursement on both, within the adjuvant window for basically like a subscription more or less? And then like the recurrent monitoring setting, look like it's kind of like paper test almost or at least a bundle of a few tests. So -- and that's from local indications. I think you got like 2 indications for CRC right now for colon cancer, then MIBC and then breast cancer, which was most recently and you have like 40 peer-reviewed locations with 25 tumor types, I guess, mostly solid tumor types. How do you think about like what's next in terms of reimbursement from Medicare for one of those tumor types? And then how tough is like the liquid tumors? And -- because, I mean, there's only like one company that's actually doing that stuff.

Yes. I mean, so we've put up some -- just to answer your last question first, I mean, we have some -- we put up some really strong data in liquid tumors. And I think over time, I think hematologic cancer is certainly something technically we've shown that we can perform quite well in and offer some significant advantages over. For example, if you need to do a bone marrow core every time, you want to do a recurrence monitoring test, that's less than ideal. I think the entire space is going to be evolving towards kind of just repeat plasma test for hematologic cancers. I think you do need a specific call point in terms from a commercial operations perspective, specific sales team to target the hematologist. Our focus on Signatera is really to serve the community oncologists that's seeing a range of cancer types in their practice every single day. And that's why Signatera is such a great fit for that physician is that it's out of the box. It's a pan-tumor assay, right? So like whether it's a breast cancer patient or a colorectal cancer patient or other GI, it's the same workflow, it's the same core test that we run in our lab. And I think that has a lot of arguments in favor of it. So in terms of what's next. You mentioned we're just going to continue to have a drumbeat of presentations. Every major academic conference continue to have a drumbeat of peer-reviewed publications that are impactful that are going to drive reimbursement. We've got a number of -- I call them more incremental tumor types that we would plan to submit to MolDX over the next year, and we look forward to working with them further on that. And then, of course, we've got the bigger prospective data sets coming in colorectal cancer as well and would hope to, over time, advance the commercial reimbursement in that tumor type.

Do you think MolDX would never want to do this on like a pan-tumor basis?

I think that at some point, I think like there's some kind of history for that if you look at kind of the history of kind of the therapy selection market over time kind of evolve to a pan-tumor paradigm. For us, up to this point, the conversations have been focused on tumor-specific factors. And I think that -- I think there's a lot of good rationale for that. There's different treatment paradigms, different use cases. And so I think for now, we just stick to our knitting, we continue to build the base of reimbursed tumor types. And over time, I think it probably does evolve to a pan-cancer type of a paradigm.

Okay. And then sticking with Signatera, just on the like NCCN guidelines and it definitely keeps getting brought up. I feel like this time last year, we had this chat and probably talked about it similarly back then. I mean, at this point, you have more data, you have CIRCULATE-Japan published, I believe you have 18-month data. Follow-up here coming out from that. You have more studies. There should be like a panel or a meeting like this summer from NCCN colon cancer. So I mean, is it possible that like within the next 12 months, we get at least like a footnote in those guidelines?

Okay. I think that's possible. I mean, I think -- so just to recap, this year will be the first year in which we've gotten -- that we have the 18-month prospective data on 1,000 patients from the observational arm of CIRCULATE in publication in time for submission for consideration from NCCN. I think what we would -- will be driving toward will be inclusion as like -- as a footnote as a prognostic factor for cancer recurrence and we'll see how that goes. Regardless of how that goes this year, we've got continued, like I said, kind of drumbeat of additional data sets coming. So for example, we'll have 24-month follow-up on this cohort of patients that we should be able to read out here in the second half. I'd expect to get a readout of the randomized Altera study readout in '24 as well. And we're very excited about both of those data sets. In addition to that, of course, we'll have -- we expect to have another readout of the bespoke CRC registry study and a number of other trials as well.

Got you. Okay. Sounds promising now on women's health. Maybe just starting to kind of like just some of the dynamics in the quarter around the volume shifting around an ASP dynamics, I remember, like I think around the third quarter, we talked about how the California prenatal screening program was going to be. There was some movement there, there's an injunction there. That will be a headwind to ASP. There's also the expanded carrier screening dynamics that is not being covered by payers. So now we have -- I mean, the carrier screening aspect, that broader panel, it's not really being -- I guess it's getting better and better. But really on the PNS on the California program, that's like -- that's all pretty much resolved. You're not trying to shift your volume back to Panorama from that lower price test, right? That's kind of -- that's progressing. So what's the -- how material is that volume in the second quarter, at least? And what's the update...

Yes. Well, I think that -- yes, so the update there is, I think a majority of our customers in California have opted to go with the Panorama test and they've had that opportunity to kind of make that transition this year. So we're happy to see that. We're also happy to serve the California program for physicians and patients that want to participate in the program. We're a happy member of that consortium as well. I think that is -- on balance, I think that's positive for ASPs versus kind of what the status quo was second half of last year when that launched. So I think I agree with you. I think that's obviously positive. Maybe just stepping back for a second, though, and just thinking about what are the -- what are some of the volume drivers that we've invested in, in 2023 at the expense of near-term gross margin, okay? So there's really kind of 3 main initiatives here that we talked about in some detail on our Q4 call in March. One, we talked about California PNS program. We made a decision to stay in California when the PNS program came into effect. The majority of the labs actually left California in response to the program launching. Natera and one other larger players remained in the state. We felt like the mission of the company is consistent with wanting to continue to serve our customers in California and there'd be some kind of resolution that would be acceptable to us. And I think that's largely happened, okay? So that was one volume-based initiative that we knew would penalize gross margins in 2023, this desire to stay in California. And that's looking like we made the right decision there. The second one was in carrier screening, okay? So as many of you know, there's a larger carrier screening competitor actually went out of business second half of last year. We had an opportunity where I think we're a natural home for a lot of those customers. We had a onetime opportunity to go ahead and absorb those -- a lot of those customers knowing that the book of carrier screening business that we'd be inheriting would, at least in the short term, be kind of gross margin dilutive to the corporate gross margin, okay? We took on that volume because we felt like over time that the reimbursement for those panels is going to improve. And that can be driven by guideline improvement and also just a broader awareness of the issue among providers. okay? So that's to be determined. I mean, I think that's still -- we've taken on the volume. That part has been quite successful. So we knew that, that would be a penalty to gross margins, and we look forward to seeing that work in our favor here in the future going into '24 and beyond, okay? The third...

Also in acquiring those customers naturally versus potentially allowing those customers to come to us over time [indiscernible]. If you just thought about that gross margin...

Yes. So I think the question was, was there a cost to acquiring those customers on mass versus just allowing customers to come to us over time. And I think there's actually not really a big difference here. And that is -- those customers -- these were physicians and clinics that had been served by the larger competitor that went out of business. And then they've got customers coming in every day, right? So they've got to make a decision about what lab they're going to go with to serve their needs. So we had a -- it was kind of a binary decision to pursue that business or not at the time. And then you've got time to -- you can change that decision later if you feel like the reimbursement is not going to be there, but you can't go the other way. You can't pick up that business later if you realize that the reverse is going to work out, okay? So there wasn't really like -- that was the choice before us. The gross margin impact here, I think, is kind of indicative kind of in the corporate gross margins. And I think that affected us, particularly in Q1. We had a bit of a lower growth, and we posted like a 39% gross margin in Q1 as we took on a bunch of that business, and we hadn't yet seen the benefit from the transition in California, okay? The third broader initiative that we knew would be dilutive to gross margins in the short term, but we thought is the right thing for the business over the longer term is to continue to drive volumes with Signatera, okay? Signatera is continuing to ramp in terms of its revenue contribution. And at the beginning of the year, particularly, we were kind of mid-700s ASP for Signatera on high-500s cost of goods sold. So dilutive to corporate gross margins, now fast forward to even Q2, you see the unit economics really improving for Signatera pretty meaningfully. I think in the relative near term, there's a point at which you can actually transition where that could be neutral to -- accretive to corporate gross margins in your Signatera business, okay, but would be dilutive for the full year guide this year. Now in return for us making those kind of volume-based initiatives in order to make investors kind of neutral on the EBIT line, we went through 2 pretty significant cost reduction initiatives where we did a couple of labs, okay? And so on the EBIT line, we were kind of net neutral gross margin. It would be this penalty in return for making these kind of longer-term kind of further cited strategic best. I think those volume initiatives so far, I think, are looking quite good. I mean we've talked about the progression we made at Signatera. We've talked about the progression we've made in California. Carrier screening, we have -- the volume has really come in, and we're kind of on track is the way I would characterize that last one. So those are kind of the 3 volume-based initiatives that we're driving that will be causing kind of the gross margin changes this year, okay?

I feel like the other drivers of gross margin kind of margins in general in this business would be like microdeletions. And then obviously, the expanded carrier screening like you kind of just talked about. There is this upcoming like next month, there's an ACOG prenatal meeting. These 2 topics are on the agenda. There was -- I think it was a mean like a couple of months ago as well. Like what's the most likely outcome here? And when -- whether -- what's the timing? When can we hear something possible?

Yes. Well, so not for me to say what the outcomes would be. I mean, obviously, this is completely up to ACOG to make their -- to evaluate the data and make the decision. We feel very, very good about the strength of the data that we presented in the SMART trial. So a 6-year, 20,000-patient prospective clinical trial showed a very high incidence rate in the population for 2022 to excellent sensitivity and specificity for the Panorama assay in detecting 22q. So we think that -- our perspective would be that the clinical rationale is clearly there. And our job now is just to await the outcome of any update -- any guideline updates. And it will be the same comment for carrier screening. Significant opportunity just to serve this kind of unmet need and really help a lot of patients in both categories. So happy to do that.

Right. Then maybe like a few minutes left. Let's talk about the cash kind of like targets and burn everything going forward. So the expectation is that you'll be cash flow positive or breakeven at some point in 2024. That's a quarterly number. I guess how do you think about the assumptions to get there, not necessarily talking about another raise or whatever, but just like top line growth and then like gross margins? I mean you increased the guidance this year and strong growth, but the margins are still 41% to 44% on this line, seemingly had a huge quarter. So I mean, yes, what has to kind of happen for you to get at '24?

Yes. I mean I think a couple of things need to happen. One, I think operating expenses need to be stable, and we need to continue driving revenues. And I think like this year is actually a pretty good case study that, that's a plausible assumption, right? I mean we're holding OpEx basically stable in absolute dollars, '23 versus '22 and yet the guide here in August still implies 25% plus year-on-year growth on the top line, okay? And we did 32% year-on-year growth on the top line in Q2, okay? So that's the starting point is that -- and that's consistent with our strategy is that we've built a world-class commercial and laboratory infrastructure to offer a world-class test in Signatera. And now we've got to drive volume to justify that and you see the volume pouring in. So I think that's ultimately good. The last variable is just kind of gross margin traction. And so I think you've kind of seen in Q2 that we can deliver some gross margin traction, okay? I think from here, obviously, we had a couple of one-timers that helped us a little bit in Q2, but I think we've set that up to say, look like we feel very comfortable that we can be kind of in the middle of this range for the year, and I would expect to have more gross margin progress next year. So those are really the 3 assumptions: stable OpEx, continued gross margin progress and continued revenue growth on an operating expense base that's designed to support that bigger revenue business.

And at scale, I think you talked about the overall company gross margins could get to 70%?

Yes, I think so. I mean, I think like -- to think about kind of longer-term gross margins for this business, if you look at the kind of the largest products for Natera, whether it's Panorama, Horizon carrier screening, Signatera, each one of them individually, I think you can -- not very heroic assumptions kind of get you on the low end in the 65% range, on the higher end 75% plus gross margins on that product level, and that implies a corporate level in that range over time.

Okay. And then an important question here. I mean like what happens when you get to breakeven? Like that you could do just push through adjusted EBITDA profitability and then you just like increase margins over time? Or do you want to kind of show investors you can get there and then just keep growing and investing and doesn't necessarily stay like -- or I guess, expand margins? Or do you want to just kind of just show that it can be like a really powerful operating model? Or the other thing is, of course, you have the swinging data to coming out, so you might like have to invest a lot there.

Well, first things first. I mean, I think for us, for right now, all our focus is on the above strategy. And as we get closer, I mean, we'll be able to have that kind of open conversation and dialogue with investors. And I think we'll be able to make those decisions at the time that makes sense for the owners of the business.

Got you. Okay. All right. Well, I guess any closing remarks that what should be -- again, I feel like we talked about like the guidelines and think of that they're like important catalyst. But I mean, if that's mentioned too often, like what in your view is going to be like really going to drive this business in the next year or so?

Well, I think the strategy that we laid out going all the way back to before the IPO was establish market-leading products with excellent technology supported by top-notch clinical trial data in a world-class commercial infrastructure, okay? So we've done that with Panorama, Prospera and now with Signatera. When you have the best-in-class data, which we feel like we have excellent data in each of those areas, you feel like you can drive significant market share and support a really good business that offers other opportunities like offering carrier screening and offering these other products as well. So I think you see that strategy continuing to mature in the Q2 results.

Okay. All right. Perfect. Well, let's leave it there. Thanks, Mike, for coming out. Appreciate it.

Yes, appreciate it. Thanks.