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

Thank you, everybody, for joining us. I'm here with Natera CFO, Mike Brophy; Head of Oncology, Solomon Moshkevich, right? Did I get that right?

President of Clinical Diagnostics.

President of Clinical Diagnostics, sorry about that. Great. So I think the biggest surprise of Q3 was probably the cash burn. How did you remove so many expenses? And why do you feel like nothing will impact growth on a go-forward basis from those -- the big cuts in expenses?

Yes. Really, it didn't -- the cash burn reduction really did not come from some dramatic reduction in operating expenses. It was really, in our mind, just the kind of often articulated strategy of ours kind of coming to fruition and starting to show some results, which was: build world-class lab and commercial infrastructure and data behind best-in-class tests, hold the infrastructure, the commercial sales footprint constant and then get leverage on that commercial footprint and continue to drive really rapid revenue growth while holding operating expenses really stable. So operating business were really stable. Sequentially, again, in the quarter, revenues grew very rapidly. We're up kind of 33% year-on-year in Q3. Gross margins were quite strong. So we were at 45% gross margins in Q3, which -- and we went through some detail on that on the earnings call, talking about how we really felt like in Q3, that was a fairly repeatable gross margin performance. There was not a lot of like onetime benefits or things like that, like all those seem like organic performance, which, on an organic basis, showed continued good traction sequentially versus Q1 and Q2. So that's the formula, right? You've got best-in-class products, you've got rapid growth on revenues, you've got improving gross margins and stable operating expenses. That's how you drive reductions in cash burn. And I think coming out of that -- coming out of the quarter, as we mentioned, we feel more confident than ever that the goal that we set for ourselves a couple of years ago was to get the overall business to cash flow breakeven, a little more confident than ever that we can hit that goal next year, get to a quarter where we're kind of -- we're at cash flow breakeven.

So why are you so confident in the cash flow breakeven targets on -- as we move the next couple of -- few quarters. What's coming off the P&L? Because I mean I think you still are burning double-digit millions even though the last time. So there has to be things coming off the P&L, we should -- you maybe want to talk about.

It's less about things coming off the P&L, David, it's more about revenue coming on to the P&L and just continued gross margin improvements. So we feel like we've got a great kind of volume and revenue runway ahead of us in all 3 of the -- of our primary businesses. We've got meaningful cost of goods sold reduction projects that are underway that are scheduled to launch both this year and next year. And again, with that backdrop, if you're holding operating expenses to be kind of more modest growth, kind of mid-single-digit growth, that's what can drive you to -- that's going to get you from $38 million down to 0 in a quarter.

Got you. Mike, can you maybe give us a flavor on -- maybe a ballpark or conceptually thinking about Signatera test versus -- an upfront Signatera test, the exome versus a recurrence test, i.e., the PCR follow-up. And kind of where are you at in terms of maturity? Because as the business matures, I mean, I assume you're going to see a lot more PCR test as a percentage of the overall test. I mean where are you at maturity? And I don't mean a perfect number here, just kind of way to think about it.

We're still very early stages of that. I mean I think kind of at a mature steady state, I think you could expect that high percentage, 80%, 85% plus of the volume would come from patients in a recurrence monitoring setting. If you think about kind of the waterfall of patients, new patient starts and then they stay with us for a number of years, and we're seeing -- we got really launched in late 2019, early 2020, and it's now kind of end of '23, and we've got very high compliance of patients who started with an exome in 2020 are getting recurrence monitoring testing ones today. So having said that, just where we are in the launch, there's still a meaningful component of the patients are in that, either they're getting the exome this year or they're still kind of in their 6-month adjuvant treatment window because the volumes are growing so rapidly. So early days, and so that's a driver that I think can really help us going forward.

Got you. How are you sizing the TAM in MRD? I mean, I don't think you've put out like a major slide. And where do you think the market will be in 10 years? And I'm talking about actual market size versus just the TAM.

Yes. Do you want to [ follow up ] on that?

Yes. We put out numbers a few years ago, when we were just getting into the market. We think MRD is probably something like 15 million to 20 million tests a year opportunity. And just a simple way -- you can break that down in a few different ways. But if you think about 2 million new cancer diagnoses per year in the U.S. alone, most of those, by far, are early-stage disease. And if you consider that, let's say, in our lead indication colorectal cancer patients, we expect to get 10 to 14 tests over their first 5 years. If you figure they're testing consistently with Signatera in years 1, 2, 3, 4, 5. So you can pretty quickly get up to those kind of numbers. Where are we going to be 10 years from now? I mean, we all have our own crystal balls. I think with the significant Phase III randomized data sets that are going to be reading out over the next 3 to 5 years, I mean, in some cases, in colorectal cancer, we're going to see in less than 12 months. Mid next year, we're going to see the first readout in a Phase III randomized data set with the ALTAIR trial. But 10 years from now, I mean, I think that's going to be maybe 40% to 50% penetrated. I mean you see some diagnostics that are standard of care in guidelines today that are still not being adopted in more than 50% to 60% of the patients. So there is some kind of ceiling on it. But I think we're going to see a pretty big transformation.

I'm sorry, another topic on -- it's interesting you say that because I mean, would you say that your test has maybe adopted ahead of guidelines like in a higher penetration rate than you would see normally?

Well, I think that's been the experience, right? But that's just been the data is 3 years in the launch now. In the last quarter, we had a little more than 1/3 of oncologists in the United States ordering the test. And so I think that kind of speaks to the huge unmet need and the pretty clear clinical utility that physicians are seeing for Signatera right now.

Got it. You sounded really positive on ACOG switching to the women's health or NIPT business. What's kind of giving you confidence in ACOG on -- this particular time?

Well, I mean, first is just the data that we've put forward for 22q. We -- starting in 2014, we ran what became a 6-year, 20,000-patient prospective real-world clinical trial that, for the first time, going to prospectively define the incidence of 22q in the population, and definitively showed our excellent performance of our assay, right? And that study was designed specifically to answer the important kind of clinical questions that practitioners had at the time around screening for 22q, and we feel like the study was an important contribution to the field. That's now been published, there's been sufficient time for that data to be kind of socialized and understood and discussed. And our understanding is that the relevant professional societies have had their meetings, they've done kind of guideline committee meetings and are not in a position to update guidelines. I would just caution you, though, that -- that's not something that we have a crystal ball around. It's not something that we would guide to or plan to, would presume that as something that would be upside to our business that we got it. Maybe one early case study there was the update of the ACMG guidelines late last year, December of last year. It was a very strong guideline in favor of 22q screening. That was published from ACMG, and we await updates from ACOG at this point. There's another guideline that would, I think, have a significant impact on us and for patient care, and that's related to broad panel carrier screening. That's been a topic that I think is quite important to physicians in the field. And again, the feedback that we've heard is there's a lot of support for an updated guideline in that area as well.

Just getting on to that one. What would that look like? Because expanded carrier screening is already kind of in guidelines. So I mean what mechanically has to change to make the insurance companies like realize, hey, this is actually in guidelines.

Well, I think that -- I mean, largely, I think we're actually seeing that happen. So I mean if you -- for those of you that follow us closely, I mean, we -- I think we've been pleasantly surprised by the coverage we've seen this year. After some reversals last year that caused several players that were focused on broad panel carrier screening to go out or -- actually go out of business and patients to actually lose access to the technology. And so I think there are -- there's language to kind of clarify the importance of the technology for practitioners that makes it more clear that there should be broad coverage for tests.

And just on this, I mean, if you get in the guidelines, I mean, obviously, there's going to be an ASP benefit because you get more of this coverage. But there actually -- could there actually be a volume benefit from guidelines? Or is that just kind of physicians already like it and know it?

Yes. I mean I think -- look, I think there's already been broad adoption of carrier screening, in the space. I mean, just for reference for every 100 NIPTs that we run in our lab, we see about 55 carrier screening tests. They often come together at the same time in a patient's journey. That's up significantly from where it was even a couple of years ago. And I would quote that statistic, I would say, for every 100 NIPTs, there's only about 40 carrier screening tests. So certainly, mind share of carrier screening continues to expand. And I think expanded guidelines could have an impact to continue to expand that -- the use of that technology.

Got it. Can you highlight the chronic kidney disease, your new -- like your new announcement in chronic kidney disease. How should we think about the #2 opportunity? Can you help a size in terms of patients and potential reimbursement? And what's your data showing?

Yes. That's a really exciting new opportunity, big clinical unmet need that Natera uncovered really in commercializing its Prospera rejection test, and we met a lot of nephrologists -- transplant nephrologists and discovered a pretty significant unmet need in renal genetics. So there's estimated to be about 37 million adults or actually, I should say, adults and kids in the country who suffer from chronic kidney disease. And there are a lot of genetic causes for kidney disease. But very few patients get genetic testing today. And probably about 1 million new diagnoses of CKD per year. So if you think about the testing opportunity, it's going to be somewhere between that -- it's more than 1 million if you figure you're going to have the opportunity to test and improve outcomes for patients who've been diagnosed over a multiple year time frame. And the opportunity is really significant because for the most part, up until now, most physicians have not had access to a lab who's been able to provide quick quality service with genetic counseling and with high-quality performing tests. So it's -- folks are pretty excited in the nephrology community. I think it's going to be a big step for us in terms of inflection points. We just put out really great study data from the RenaCARE study, demonstrating the utility of the test, not only in patients who had no other -- no known diagnosis, but also in a lot of patients who -- the existing diagnosis was either wrong or was nonspecific or needed to be refined further in order to impact treatment decisions. So really expanded the utility and the scope of who might benefit from the test. But we also expect the guidelines committees to implement changes to the guidelines in the future to enshrine how important renal genetics is as part of the diagnostic workup for a new CKD patient.

Got you. How long have you been working on this chronic kidney disease area? I'm just thinking about like is this -- would this be a new avenue where you weren't thinking about it a couple of years ago or even like 6 months ago, so it would be outside of the long-range plan. And Mike, I know you like to give a lot of people, investors and analyst c*** because like a lot of people didn't spot minimal residual disease and you're like -- you're talking about this saying, "No one wanted to hear it, tell us more about NIPT." Is chronic kidney disease that?

Well, I think the concept and our awareness of the scope of the unmet need, I think, probably started out of our conversations with nephrologists as we talked to them about Prospera and as -- very similar to the way that we evolved in carrier screening and talking to patients and physicians in the women's health setting. This seems to fit very cleanly within the offering that we provide to patients that are getting Prospera when -- particularly when they're getting treated by the nephrologist. So I think that is a very clear kind of case study. And we've done this time and again. It fits in nicely with our strategy where we innovate a market-leading test that solves an important unmet need that's based on our core technology. And in this case, it's Prospera. And then that product launch gives us insight and access to a set of patients where we can solve all their needs for them, often at the same time or a similar set of patients for the same physicians. So this is just right out of kind of the standard playbook of trying to solve unmet needs and solve problems for the physicians. It's potentially -- it's -- Solomon kind of talked you through some of the numbers, it's quite a large patient population. I think we just got to see. I think we've got to -- we published this data, which we found, we thought was incredibly encouraging. And we've just -- we've got to quietly monitor it. I mean part of the way that you continue to deliver kind of high growth year in and year out is that you have to do these kind of things. You've got to produce the data, you've got to solve a problem and then you've got to be patient and have the uptake happen in the background. It's a little bit different from Signatera in that sense and that it doesn't require some truly, truly enormous upfront investment in a commercial and lab infrastructure in order to serve it.

Yes, clinical development as well.

All right. I mean -- and I'm not saying break -- fix something that's not broken with Signatera. I mean it's been probably the fastest product I've ever seen to this hundreds of millions of dollars in revenue in diagnostic. I mean I can't think of anything close. I mean Guardant360 was always really fast. I mean that's the closest thing I can think of. But what can we look forward to in terms of product enhancements here or product differentiation or different products to add to it? I mean could we be thinking about a tumor-naive version. Can you talk about maybe more upfront genome versus exome, more marker versions? I mean what do we look forward to?

I think on all those things, our approach has always been just to offer a menu of solutions for the physician and for the patient and not be locked into any one technology or like one use case. There will be scenarios, I think, where some of the products you mentioned, they fill -- even if it's a smaller niche, they still fill a niche nonetheless for our physicians and patients, and we want to be in a position to kind of be agnostic as to which product the physician and the patient want to go with. So I think all those things are on the road map and would be potential additional launches for us.

Got you. Can you talk about reproductive health. I think pricing has stabilized here. A lot -- because of the pricing issue, you've seen a lot of exits from the market and companies go out of business. Is that a good step in terms of -- no, we don't want these companies to go out of business, but, is that a potential where you could actually see ASP lifts from here, even in the absence of ACOG because you've seen these exiting companies and maybe there's price competition and maybe more pretty clear to the players like you're going to have less product if you don't have...

There's certainly been a very meaningful market shakeout in the women's health space over time. And as you mentioned, there's been a number of competitive exits. And I think we've been able to win a large share of that kind of the market that's opened up as a result of those exits. I think when I unpack kind of the trends on ASPs in women's health business in Q3, I mean I have to -- I mean I felt quite encouraged about what I saw. I think that we're in a position where women's health ASPs can be stable and actually potentially improving next year, leaving aside any positive impact from guideline inclusion. And so yes, I'm actually feeling quite encouraged about that business.

And then how should we think about the gross margins long term? Do you think you're now on a permanent upswing where this could be kind of linearly up and how fast can that upswing go?

Yes. The reason why we give annual guidance is that I fully expect there to be variability quarter-to-quarter. Just taking 2023 as a case study. If you ask me what the kind of the organic gross margins were in Q1 through Q3, I'd say, 41%, 42.5%, 45% but the printed gross margins were 39%, 45%, 45%, right? And that's just because there are some onetime factors that will affect gross margins quarter-to-quarter but if you're able to kind of look -- zoom out over the course of the year, you'll find us -- see in our guide kind of this -- that 43% to 45% metric, which is more stable. I do think that at the distance of 1 year, I do think that we have all the ingredients in place to have meaningful uplift next year. And maybe you and I will be sitting here next year, and it will be kind of 100 basis points sequentially every quarter or maybe it will be lumpy. But I think at the end of the year, we can be significantly higher than we were this year, and that's kind of commensurate with this goal of getting to cash flow breakeven.

Yes.

In terms of the mature gross margins in the business, I mean it's an interesting question. We actually -- when we set out this goal a couple of years ago to get to cash breakeven actually kind of laid out a kind of a longer-range model for this business. And we thought that the mature gross margins of this business could be 70% or better, and I absolutely still believe that. I mean I have probably more -- was confident in it at the time, obviously, because of [ 1 of ] the slide, but I think we've hit all the marks between -- over the last 2 years for us to feel we've gotten obviously closer to that number and also we're just closer in terms of the clinical trial. Data development and reimbursement milestones we need to hit to get there.

Well, let's actually talk about the other parts and the -- as you grow the expenses. So we're thinking about R&D and -- sorry, in sales and marketing, what percentage is dedicated to Signatera? How are you balancing the cash management with the need to really solidify the competitive advantage here with data, particularly when we're talking about outcomes kind of studies that are really important in terms of generating competitive advantage?

Yes. Look, the North Star remains do the work on generating data, particularly the interventional prospective outcomes data that changes clinical practice and helps you to meet the unmet needs that patients need it for. I mean that's the goal. If you think about the operating expenses and investment in clinical trial expenses, there's an outsized investment still in Signatera because we're relatively early in the development of that product and that use case, right? So that's going to continue to be a focus. We're not going to make some kind of short-term decision to not fund or not participate in a clinical trial that can change clinical practice. We're going to absolutely be committed to doing that. We can do that in the context of relatively stable operating expenses from here and growing revenues. So I think that we can actually -- we're at a scale now where we can have both as long as they're going to be -- expenses are relatively stable.

Got you. And I guess only time for one more, real fast one. This probably isn't even a fast question, but is there any competitive offering in MRD that you deem maybe stronger than others? Do you think maybe it's tumor independent given the not lack of tissue? Or do you think it may be other kinds of ancillary products, say, maybe it's bundled with an Oncotype or something like that? Is there any?

Yes. We've been relatively surprised by the kind of the lack of data generation and the lack of products on the market or really any volume traction from many competitors over the last 3 years. I mean just looking historically, that's just a fact of the matter. Looking forward, this is a huge unmet need, it's enormous opportunity to serve these patients. And so we -- and there's lots of great companies that are running as hard as they can. So there will be competition in the future. And frankly, we welcome that. I mean, that's why we're putting the time and effort in now on evidence development, excellent commercial operations and excellent laboratory operations.

Thank you very much for coming. Thank you, everybody.

Thanks.