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

Dan Brennan, Life Science & Diagnostic Tools analyst here at TD Cowen. Third day at the 44 Annual Global Health Care Conference. We appreciate joining here on stage, senior management of Natera. We have Mike Brophy, Chief Financial Officer; and John Fesko, President and Chief Business Officer. So Mike and John, welcome. Thanks for being here.

Yes. Thanks for having us. And a lot of you guys know this, our CEO, Steve Chapman and his wife, welcomed the new baby the day before the earnings call. So he's still on e-mails and doing meetings and stuff, but we haven't been home for just like a couple of weeks here. So -- but John and I are happy to be here with you.

Awesome. There's a lot to get through 2023. So, guys, fourth quarter results were solid, the '24 outlook is well received. Maybe just reflect upon the performance '23 and kind of what excites you guys for '24.

Yes. So 2023 was a great year for us. We capped off with our recent kind of Q4 results, grew revenues 43% year-on-year in the quarter, improving the gross margin a little above 51%, and that compared to low 40s in the Q4 of the year prior and 39% in Q1 of '23. Operating expenses were basically flat through the course of the year. So -- and cash use was way down, particularly in the second half of the year, but obviously overall for the year as well. So a couple of, I think, key observations from that is, I think that's just 2023 showed that the strategy that we've laid out previously is really working, right? So we wanted to build a first-class operation, commercial and lab infrastructure to offer all of our products in a first-class way. And having built that infrastructure, we felt like we could drive more and more volume kind of through that infrastructure, and we really showed that as evidenced by the kind of the rapid growth in volumes and revenues on stable operating expenses. So it's one thing to kind of model it out and say that it makes sense and excel is another thing to do it. And so we're gratified and pleased to show that we're kind of turning the corner, continue to deliver the volume growth, but also getting kind of the gross margin traction that we were able to get through the year. So on the financial side, I thought that was really impactful and that was the key highlight. In terms of impacted patients, we've just continued to deliver a drumbeat of data that we think can be transformational for patient care kind of across the spectrum, be that in care for kidney patients and transplant patients. Generally, we've delivered a number of very impactful data sets in the oncology setting. And of course, we've read out some large prospective data in the women's health space as well. So really kind of hitting on all cylinders there as well.

So gross margins in the fourth quarter, I think, were a notable surprise. The guide is also well above expectations, Just discuss specifically what drove this trend.

Yes. I mean, I think, really, you start with volume growth. I mean each of the businesses continues to perform well. We continue to grow share and grow the market. Signatera on the volume side was in particular, a bright spot. If you look at kind of the growth in our clinical volumes, that has just continued to ramp. I mean that's just been a pretty steady kind of 9,000 to 10,000 growth units a quarter. We saw that again in Q4, similar commentary across transplant women's health as well. And then we continue to get ASP traction, right? The reimbursement landscape continues to mature in response to the data that we've been able to publish and the clinical utility that we've been able to show. And so I think sequentially through the course of the year, you saw meaningful gains in ASPs, particularly in oncology, but also in women's health as well. And so that, given the kind of the flat expenses, that's what's kind of driving your gross margin traction, and it's also driving your cash burn reduction.

And we'll get into it a little later but considering such a critical area and exciting one, like are -- is this adjuvant [indiscernible] mix where you've got the upfront sequencing costs for some PCR costs and kind of the margins. Is that the beginning? Like is that fourth quarter print? Was that some real shift there? I mean it's not a massive [indiscernible] shift but I'm just wondering if we're beginning to see that kind of leverage play out? Or kind of how much more of that has come...

I think a lot of that is still in the future, Dan. I mean, I'm actually heartened to see that the new patient starts are still so healthy that you're kind of forestalling this kind of long tail of recurrence monitoring, becoming the overwhelmingly dominant theme in the volume. So I'm quite happy to have that play out over a longer time period, even though it would help you like in the immediate term, if it came quicker. So we just continue to see really strong new patient starts, and we see very high compliance with folks wanting to stay on Signatera through their cancer journey. And so both of those trends are positive, but the new patient starts are kind of holding that longer-term trend in check, which I'm fine with.

And then maybe one more kind of on a top-down view and then we'll dig into some of the data...

You hear me okay?

I'm hearing you great.

So now Natera's '23 free cash flow positive, during '24 you appear in a path to turning EBIT positive. Just kind of discuss margin and cash flow profile Natera kind of -- what can this look like over the next 2, 3, 4 years?

Yes. I mean we have taken a moment here and there different earnings calls to kind of lay out kind of a longer-term framework for the company. I continue to think that longer-term gross margins for the business can approach 70% and EBIT margins can be 20% and that's just -- again, that's just a function of each of the areas continuing to mature in terms of their reimbursement profile. And it's also a reflection of kind of the relentless approach we've taken to cost of goods sold per unit reductions. That's always been a big focus in our R&D effort is how can we deliver a high-quality test at lower and lower cost because that's obviously critical in diagnostics and critical for taking costs out of the system.

Maybe let's flip over to readouts Altera. Altera is reading out in the first half or kind of middle '24. So for those people who don't kind of aren't familiar, you just spend some time speaking about what this might mean for the clinical utility of MRD testing, not just Altera, but for the industry as a whole?

Yes. I mean I think we've got a whole drumbeat of readouts coming across tumor types. The CIRCULATE study has already read out, I think, some really important data in the observational galaxy arm. So I think Altera is just kind of the natural kind of continuation of that trend. What Altera specifically is doing is that it's an escalation arm within the CIRCULATE study. So we've got -- this is a truly prospective randomized arm where Signatera is going to be used to kind of guide treatment for Signatera-positive patients. So the idea is patients found out to have colorectal cancer. They have their surgery as per the standard of care. They get a Signatera test. If screen positive on the Signatera test, meaning that we can -- Signatera indicates that they're likely to relapse. They then randomized 1:1 into this Altera arm where control is standard of care chemotherapy in active arm is standard of care chemotherapy plus TAS-102, which is an agent that is approved in the metastatic setting and has shown a good amount of signal for patients -- for later-stage patients. And the idea is, can we accelerate that treatment to adjuvant treatments and improve their outcomes? There's one other dynamic here where patients who screen negative post-surgery are going to continue to get surveilled with Signatera. And when they screen positive, they will then flip into the active arm and they'll get same care chemo plus TAS-102. So the point of the study is to show a relative risk reduction for these patients if they're Signatera-positive, can you get them a risk reduction by moving forward, what has been a metastatic treatment to this adjuvant setting, standard care chemo plus TAS-102? So that's -- that can be, I think, practice-changing and guideline enabling, and we're very excited to see the results. There's going to be a drumbeat of data sets coming behind that in colorectal cancer and other tumor types as well.

But just on DFS, right? I mean per clinicaltrial.gov, I think it's DFS survival at 3 years. There's numerous secondary endpoints, including rate of conversion to negative ctDNA, at 2 years in overall survival. So just give us a sense how it's powered for DFS and just kind of what kind of benefit would allow you in DFS to reach the primary endpoint and I assume you guys feel if you hit that DFS endpoint, that's going to trigger guideline adoption.

Yes. I mean I think the right -- like one potential precedent that one could look at here. So all these things are in terms of what is guideline changing, what's practicing. These are obviously judgment calls. But I think one precedent study that I think is worth reviewing is the MOSAIC study, which was published in the New England Journal in 2004. That was really one of the last times we had a practice-changing study in the treatment of adjuvant colorectal cancer. And the setup for that study, the design of that study should seem fairly familiar to the design I just laid out for Altera. The design of study was control arm getting standard care chemotherapy, which at that time was FL and then the active arm was FL plus a third-generation platinum. And the idea there, very similar, right, is for patients that are going to get chemotherapy, if you give them the platinum plus the standard of care chemotherapy, can you get relative risk reduction for that cohort of patients? And they were able to show that in the Mosaic study. So they -- I think the hazard ratio was something like 0.77. So that implies kind of a 23% relative risk reduction, which was sufficient to be guideline enabling and practice changing. If you think about what that means, that's for every 5 or so patients that you treat with that new regimen, you're going to get a cure that you might not have otherwise gotten, okay? So that's kind of how we think about this as we think about what can be the impact? What can be the relative risk reduction for these patients. And obviously, that is ultimately derived from DFS, Dan. And so you'll get that update like that. You'll get a hazard ratio, you'll get absolute risk reduction and so on and so forth.

Got it. Okay. And kind of as a hazard ratio like 0.8% or below. Is that -- I mean, probably you guys discussed the DFS and -- so that would be clinically significant...

Again completely a judgment call, but I mean -- and I would think about it as a continuum rather than a binary. You know what I mean, I think you have that precedent of the hazard ratio of 0.77 being something that was practice changing, okay? So I would view that as an outstanding result and moving up and down that hazard ratio curve, there's not like a brink point where you totally change your paint on that, you just move your enthusiasm, you dial it up and down based on that result, I think.

The exports we posted yesterday, one of which was not really using Signatera [indiscernible] colorectal cancer. She felt like a 10% to 20% DFS benefit would be...

Well, there you go. And I think that fits in pretty well with the math I just walked through, right?

Yes. Okay. So we can come back to that therapy if we need to. So just on broader MRD. So Medicare approvals, you recently got 2 new Medicare approvals and neoadjuvant breast and adjuvant surveillance for ovarian cancer, which I think kind of 2 of maybe the 4 or 5 you thought you'd get this year, kind of how quickly can these ramps? And what kind of impact can they have?

Well, yes, I mean, I think the volumes are coming in, in terms of kind of impact to ASP, I mean, I think it will be kind of a modest impact to ASP in '24. So the next step there is to get pricing, right? I anticipate pricing will be very similar to what we've had for other solid tumor types. And then it will be a contributor through the course of the year. The guide for the year implies basically stable ASPs off of the Q4 performance, which admittedly -- I mean, we had a ramp in ASPs through the course of the year. So to get a full year benefit off of that ramp, I think, is what helped kind of drove kind of the guide above expectations, as you mentioned. And so we'll just -- we'll see how that progresses through the year.

And kind of what percent of your portfolio today is in -- the volumes that you're doing at Signatera today, what percent are neoadjuvant breast and ovarian?

Yes, it's high single digit percent of the volume are in those 2 categories combined, yes.

And in terms of the next indications, what should we be looking at for 2024? And which of those do you think could be the biggest opportunity?

I don't anticipate the mix within tumor types to change really meaningfully from what we've seen historically. And as we've talked about on calls, it's a little more than half of the volume mix is colorectal cancer. And then breast cancer is a strong #2 and you've got immunotherapy response monitoring. And then you've got kind of a longer tail of a lot of different solid tumors neoadjuvant and breast is important, ovarian cancer is important, gastroesophageal cancer is important, lung cancer is important, although the later stage lung cancer patients, you do tend to see them in the IO monitoring setting, but early-stage lung speaking of tumor types that we'd like to be able to continue to pursue, and we've generated good data in. So those are -- that's kind of the volume mix as we see it. And our base case is that the volume mix remains relatively stable as it has been for the last couple of years.

And you would still think or plan like you could still get 2 or 3 more approvals this year. Is that right?

I think that's possible, although it's certainly not contemplated in the guide that you would get a certain number of additional approvals. And I also just given that the vast majority of the volume is coming from tumor types where we at least have a Medicare reimbursed beachhead. I also think that that's not something that's a huge needle mover in terms of your numbers per se. It's more about from our perspective, continuing to just deliver that data for an ever broader swath of patients across these tumor types.

So the competitive landscape, we hosted John back in December at a liquid biopsy event we did, a number of private companies coming. And on the public side, there's a few personnel out. Neil obviously have the injunction with, but others are talking about exact myriad and we have list of on some private companies. So just how does [indiscernible] share? I mean, today, you arguably have 80% -- 90% share of the market or someone in that zip code. So give us a sense of how you defend it 5 years out, like is it right to assume like you -- that share comes down, but it's still a very healthy growth rate.

Yes. I think Natera is in a strong position because of the truly vast amount published years-long multi-center evidence data that we've generated. So any competitor has to come in and show that they're different and better and also that they have equivalent amount of data. And so that takes years to get through. A second barrier to entry is reimbursement. After you generate that data, you have to go through what is typically a 1- to 2-year process to get reimbursement coverage, which is important to physicians. I think a third barrier to entry is the legitimate complexity involved in running a truly patient-specific personalized test at scale. This is often overlooked, but that's not trivial or easy to pull off and to do that quickly. An additional barrier after that is there's a switching cost. So once a patient has gone through the expense and time and potentially diminished what's left in the tissue to build a personalized test, they stay with that personalized test throughout the course of their treatment and cancer journey. So I think compared to every other product we sell or have even looked at the barriers to entry on Signatera are much, much higher.

How about the sensitivity itself? Is there superior sensitivity that wasn't only brought up there? Is that an important aspect? Or does it kind of fall down the spectrum below all these other factors you mentioned?

I think sensitivity is important. You have to go through all those hurdles that I just described. I think we've seen this pattern where upstarts will have synthetic samples or a very carefully controlled analytics study that generates a seeming claim of superior sensitivity. But when you look at any sort of larger study, that tends to go away and be reduced. I think Natera has developed a lot of expertise around cell-free DNA and that performance. And we have continually made improvements to the Signatera test as well to improve sensitivity.

I think there's another dynamic where we've continually raised the bar in terms of the type of data that you need to produce to drive adoption. So rewind 5 years ago, what you had available were these kinds of case-controlled studies, things like that. But now, I mean, we're talking about prospective randomized data sets that are reading out, sometimes in partnership with the pharma trials, sometimes in partnership with large academic consortia. And so when you're talking to a physician, it's well and good to be talking about like your analytic sensitivity, but what we're trying to do is deliver data that says, hey, when the patient gets Signatera and they have their Signatera positive and you give them chemo, they do better, right? So that's data that fits in much better with the actual decision-making framework that physicians are facing every day.

How about just on the IP front, just -- there's been a lot of news over the last 6 months, specifically in MRD in junction with NeoGenomics. Just kind of what can we expect? Is it possible just to discuss the IP estate and kind of what that can mean in terms of the future competitive landscape?

Yes. I mean just at a very high level, I mean, the -- it's heartening to like come to conferences and see words like MRD and recurrence monitoring used as industry terms. I remember us writing those words on a whiteboard middle of last decade. And so how did we arrive at Signatera? We didn't pay a consultant to go find a market that to go commercialize in. We thought hard about what our core technology could do and what are some large unmet needs in cancer that would be a good match for our existing core technology, and that's how we ended up kind of creating this category, okay? As we identified this unmet need for patients that we felt we could solve with our core technology and then we just worked on delivering the data. So that has certain implications for the IP landscape because it just means that a lot of the fundamental IP that powers our test has priority dates that will precede the advent of Signatera or MRD as a category. You've seen a couple of data points here in the second half of the year, demonstrating, I think, the strength of the IP portfolio. So in each of those litigations that you referenced, Dan, we were able to achieve an injunction not on the same patent though, right, different patents that issue in each of those cases, which I think is a data point to consider going forward. I think IP is obviously important, and we'll continue to defend it.

How about enhancements to MRD? You've talked about innovation, I think, on the Q4 call and in recent calls, you're working in the background on a lot of things. What is your strategy to roll out even a better version of Signatera, like would you look to go more beyond the 16 markets that it's currently focused on?

Well, I think like one case study is the Panorama NIPT. I mean, I think we're on like version 9 of Panorama. We've just continued to improve that test, and that's core to how we operate as a business, and we're going to continue to do that clearly in Signatera as well. There's going to be opportunities also for kind of what I would call kind of complementary menu expansions and things of that nature. Our typical framework has been to work on a new launch, get it launched and then like the following quarter, talk about it with you guys. So let's -- we're going to try and keep that going, right? We're going to try and have some additional improvements in product launches, not just in Signatera, but a kind of across business this year and the first half of next year, and we look forward to sharing those with you once we've launched them.

I think for 2024, you've talked about like absolute Signatera volumes year-on-year kind of isn't a bad starting point for '24 versus '23. If we look out and we're trying to think about MRD volume growth over the next kind of 3 years? I don't know like just how would you consider that?

Well, I mean, I think you can. I think over that time horizon, you've got to think about what kind of data have we been able to produce and what kind of clinical utility have we been able to show. So far, I think we've been able to show whole lot of usefulness. We've got some big randomized prospective data sets coming. So we've got the escalation arm in Altera. We've got a de-escalation arm in VEGA coming next year. We've got some potentially practice-changing data sets coming in bladder cancer here over the next 12 months or so, 12 to 18 months that we're very excited about. And I can just go on down the list, across tumor types. I do think in terms of just thinking about volume growth. The only -- the simplest way that we think about it is that the rep -- the commercial infrastructure is relatively constant, like we'll continue to make selective adds to that. And so the reps don't get to grow based on what their growth rate was. They just say, hey, I added X number of units last quarter. And can I manage my existing growing book and then add the same number of units next quarter? So that's why I kind of default to that as a use case for modeling the business. And it has proved so far to be pretty consistent, right? Like I mentioned, is kind of 9,000 to 10,000 clinical units growth every quarter, that's going to fluctuate, right? Like there's going to be a quarter where we do 15,000 units and everyone's going to be excited and we're going to say, hey, [indiscernible] fluctuation -- it's going to be a quarter where 6,000 units. I'm going to say the same thing, probably be easier to sell you on that when it's 15,000 units, but we will see. As you go out to the 3 years, I think it's more about, hey, what fraction of patients that have cancer when you get the test, and I think that's going to just continue to increase. Right now, the penetration as measured by total tests available is still quite low, even though 40% of oncologists ordered at least one test from us last quarter. So I think that's a very good kind of early indicator.

Just biomarker bills, you've been pretty outspoken like positive, the company about, wow, you got 15 states, I think, that have -- that's a number past, you have 15% of the population in terms of your volume are in those states. Just what's kind of the progress there right now? It's early, but how should we think about when the impact or benefits of biomarker legislation might show up in Natera's results?

Well, I think it's not -- they're not really -- it's not contemplated explicitly in the guide. I mean I think the biomarker laws are important for improving patient access. And a lot of them are fairly new in terms of when they became effective. And so we're going to be engaging with our partners' commercial payers in those states to work that out. These things usually take a bit of time. These things usually take 12 to 18 months to start to get normalized in terms of what are the workflows, what are the -- what's the documentation needed to get reimbursement. And so I'm kind of thinking about it on that timeline, of course, it could come quicker.

Obviously, women's health is actually your biggest business, and we haven't even touched that yet. And you've talked the last 12 months, the SMART study and expanded carrier screening [ 22q ], these are really big opportunities to the extent guidelines decided to incorporate them. So, I came up on the 4Q call. But just what's the latest thinking there? Any sense on where ACOG and the decision-making just kind of what can you share with your confidence in the guidelines getting updated? And any sense on when that can happen.

Sure, Dan. So we don't know what ACOG is going to do. We don't control that or their timeline and their bureaucratic organization. On 22q, we do think that is increasingly recognized as an important problem to solve. 22q unique amongst the conditions we screen for in pregnancy, allows families and patients to take intervening clinical steps that meaningfully and permanently improve the health of that child. And we've seen a lot of interest among a lot of the leadership in ACOG to make this change. We've also seen 2 other medical societies, the American College of Medical Genetics and the Genetic Counselor Society who have recommended that all women have access to 22q screening, so we think that is important. Natera has generated the practice-changing study here, a 20,000-patient study that took something like 5 to 7 years all in all to run and readout last year. So we are optimistic and hopeful, but unable to predict exactly when that will happen.

But the confidence remains super high, I guess that it will happen, but timing is just uncertain.

It's hard to predict timing on these things and obviously beyond our control. It wouldn't be something that you'd include in a guide. And the reality is that the way that we make decisions in the business, we kind of leave those things for others to control and we just control what we control. And I think the things that we can control allow us to have a really exciting kind of next 12 months here.

I think another meaningful factor there is -- in the California program, they have retail data tracking. And one of the things we've noticed is that people will self-pay, so Caucasian and Asian populations are self-paying to get access to 22q and other populations, Hispanic, African-American population much less so. And one of ACOG's pillar priorities is removing these disparities in access to health care and maternal health. And so I think that is also a significant factor. But as Mike has said, it's very hard to predict the timing of these.

Got it. So maybe just on 22q, Mike, you talked about this. We have 50 seconds left [indiscernible] have a closing question. But I think you said, what, 900,000 tests you do, and you're really not getting paid or correlate at all on those? Like to the extent it does get in guidelines, what's the feedback you hear from doctors ultimately, if we looked out 2, 3 years, what percent of these tests you actually think will -- could get reimbursed?

Yes. I mean the feedback from physicians has been phenomenal. I mean I think we had an enormously positive response to the SMART study that [indiscernible] out. And so you do see physicians responding by ordering 22q screening for the majority of their patients. And I think the reimbursement is really -- it's a function of a broad professional society adoption. And so see above, it's -- I think it's gated on professional societies, and so we'll see how that develops.

So maybe last question would be stock has done really well. There's a lot of -- there's optimism towards Natera, but yet you have all these growth drivers ahead. Like how do you guys view where you are on the opportunity curve today? And kind of what's the kind of concluding message for investors.

Yes. I think we're basically on track. I mean if you go back and take a look at some of our comments at this conference, I'm just reflecting back over the years. We basically laid out the framework in terms of where we are, and I kind of summarized that at the top of this chat. So we're just head down, continue to execute and continue to try and deliver great results for our patients.

Excellent. Well, thanks, Mike. Thanks, John, for being -- and thanks, everyone, in the audience.

Thanks.