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

Good morning, everyone. Welcome to the -- I think it's 36th Piper Healthcare Conference. I am the diagnostics analyst, Dave Westenberg. With me is CEO of Natera, Steve Chapman; and CFO, Mike Brophy. We're going to start off with the -- show-me-the-money moment, $34 million in free cash flow last quarter. So your Q3 was about $25 million higher than your Q2, I believe, in terms of revenue. So you really got the operating lift here.

So what benefits did you see in Q3 that you didn't get in Q2? And is your contribution margin approaching your gross margins? Or is there still underspending in SG&A and R&D?

Do you want to take that?

Yes. No, thanks for the question. So look, just more broadly, I mean, I think our plan has been to just to build an excellent franchise for patients and build something that can have a lot of operating leverage. And so once you've got a critical mass of sales reps in the field, operations, lab operations, clinical trial data, you've got all these things going, which take years and years and years to build. Once you have that, you do get a bit of a flywheel effect where you have patients kind of coming in the door. So you're seeing volume continue to ramp while the operating expenses have grown much more slowly. I mean that's just fundamentally what's happening here. And so we've just crossed that threshold where you saw in Q1 and Q2. We were able to get the cash flow breakeven. And then Q3, obviously, we generated a meaningful amount of cash. We said on the call that we expect that cash flow dynamic to fluctuate quarter-to-quarter. But nonetheless, really strong performance from us. Revenues continue to grow and then also the gross margins just continue to improve, right? So that is a function of all of the work that we've done to get our cost of goods sold per unit down, gone down precipitously over the last 4 quarters. And you saw us put up 61% gross margin. Even backing out true-ups, it was like a 58%, 59% gross margin. It wasn't that long ago that we put up 39%. And what that is, is just the maturation of the reimbursement, particularly for Signatera, but also really hard work and improvement in reimbursement for our women's health products. So the cash flows really are kind of a consequence of all those things kind of coming together. We're really excited about where we're at.

Yes. So -- and you kind of answered my second question here, but gross margins did expand 1,000 basis points year-over-year. What were the key benefits? And sorry to put you on spot, Mike, I think you are going -- your guidance for Q4 does not drop into negative, right? So are you guys -- I mean, should we think about -- I mean, there's always scenarios where it could be different. But we think about Natera is just this cash-flow-positive company from here on out because I know you gave yourself room in Q2 and Q3 to go -- maybe there's one time.

Yes. No. Look, I think the cash flow, I like that metric for investors as a measure for us because there's no way to fake it. I mean it's just a change in cash. And so I think that gives people a certain level of confidence. That does include dynamics like working capital and CapEx, which we're not going to be carefully managing quarter-to-quarter. We're going to let the business do what it needs to do. I think we're in a pretty good position as the guide implies for Q4. And then just more generally, I mean, I think we were very clear on the call that looking into '25, our focus is really on delivering the best possible service we can, particularly in Signatera but across our franchise. So our focus is going to be on reinvesting cash flows into the business in '25.

Got you. Okay. I think you said on the call, 40% of oncologists are using Signatera. We just do oncologist kind of survey work and that kind of thing. So we don't have the perfect metric either, but we're getting a number significantly higher than that. I mean -- where do you think we're getting it wrong? Is that number actually probably growing, but you have to kind of say 40% of oncologist because it's kind of hard to track or anything like that?

Yes. So we're actually seeing really strong uptake and continued uptake. We look at just the number of physicians that have ordered the test in the previous quarter and then divide that by the number of oncologists that are out there, and we come up with a metric. And we don't -- it's sort of roughly 40%, but obviously, it's going up every quarter. Last quarter, we saw a record number of physicians using the test. And then as we move into October, again, it's another record number of physicians using the test. So we're excited about that. But as you get more -- and remember, that's just one use, right? That metric is, hey, they used it once during the quarter. What we really want to do is have physicians use it on every eligible patient that walks through the door. And so the further and further penetrated we get where we have a lot of doctors that are using it a little bit, that's actually better for us because it's much easier for us to take somebody from using 1 or 2 times a quarter to using it routinely than it is to get somebody to use it for the first time. So the further and further penetrated we get, I think the kind of flywheel effect starts to happen where people use the product, they're comfortable with it. Now they want to use it on more patients in, say, colorectal. They become happy with colorectal, now they expand to breast or to other cancers.

Got you. Well, I think Signatera has been on the market now, what is it 4, 5 years. So you probably have some visibility into some of these 5 -- 4-year, 5-year patient cohorts. Can you talk about the year 4 or year 5 ordering behavior? Now I know in the first year -- first couple of years, particularly neoadjuvant, adjuvant, it's pretty -- you probably do want to order 4 or 5 tests, but what are you seeing in that 3-year, 4-year time frame -- time period?

Yes. So this is something, obviously, we look at and we track. But what we do see is when patients come on with Signatera, if they continue on to a recurrence monitoring trajectory, they generally stay on unless there's some type of event. And of course, about 25%, 30% of patients recur and then they obviously have an opportunity to sort of reassess what they want to do. And then, unfortunately, some patients die. But we do see patients consistently outside of those sort of 2 main factors are staying on, which is what you would expect. And what we said at the outset is basically CRC, 4 tests per year, first year, 4 tests per year the second year and then sort of moving to kind of this biannual monitoring schedule. And I think generally, that's what we're seeing. It really depends on the practice and how the physician is using it. The other dynamic that we see, which I -- is it upside for us is that patients are entering directly into recurrence monitoring phase. So let's say, somebody that was tested -- was diagnosed and had surgery 3, 4, 5 years ago, they may just enter at this point in time. So the reason why that's upside opportunity for us is it gives us a chance to capture that prevalent pool, which I think is a much larger opportunity.

Got you. Going back to Mike, models look fairly on the conservative side when you're talking about you're having 50% year-over-year growth in '24. How should analysts think about the true-ups? And in your mind, has consensus done a good job of actually capturing all the true-up benefits that you got in 2024?

Well, the way that we normally think about growth, just given that we typically have fairly constant commercial operations kind of size in the field is that we look, rather than on growth rates, we just -- we try to evaluate the business on absolute growth units. And I think there, I think the bar is pretty high and it's going to be a challenge, and we're excited about being able to meet it going forward. In terms of -- in terms of true-ups, all things equal, I think those will kind of feather down back down to the -- what they historically were kind of in that $5 million a quarter type range. The true-ups that arrived this year came really as a function of the rapid increase in the ASPs, both in women's health, but particularly in Signatera just because that product was just kind of growing up as a product and reimbursement is really getting established, and the workflows for getting paid for coverage services, particularly from Medicare Advantage payers was getting established. And so any time you have a dynamic like that where the actuals far exceed the recent history, like you've seen here, you'll have some true-ups and I think you saw those moderate slightly in Q3.

And I'd -- probably going back to Steve on this one. What are your next submissions from CMS for Signatera? What are the organ types?

Yes. So right now, we have coverage for various colorectal submissions, breast, ovarian, muscle invasive bladder and then immunotherapy monitoring in breast, you have multiple different indications. So there's many others that we're submitting for. If you look at where we published peer review data that will give you sort of a good idea, you have to have a published clinical validation in order to submit to MolDX. The other thing that's important to remember is when you look at a lot of the tumor types, like say, for lung, for example, a significant portion of the lung patients are covered under the immunotherapy monitoring coverage. So when you look at what's not included there, it's sort of a minority of the overall patients because the vast majority of lung patients are getting immunotherapy monitoring. So we're pretty broadly covered right now. I would say somewhere around like maybe 25% to 30% of the tumor types that we receive are under a tumor type that's not part of a kind of a MolDX coverage. So obviously, there's still upside opportunity that we're chasing after. And then we still have the commercial opportunity as well.

Got you. And just how should we think about lapping the Invitae benefits? What did you quantify the benefits to being? And then and assimilating to that, I think Ambry was just acquired by Tempus. Now that's a good company and probably going to do it, run it pretty well. But any time there is a disruption or a change in hands, there is sometimes some shopping events. Is there any opportunity to pick up share in prenatal or BRCA there?

Yes. I think Invitae went really well for us. That was done very early in 2024. So I don't think that there's sort of a lapping opportunity just because of how early that came on in the year. I think it obviously contributed pretty significantly to our carrier screening business and also to our NIPT business. When you look at the Ambry acquisition, we obviously have a hereditary cancer business. We generally are focused more in the OB space in the community oncology space versus the hereditary cancer specialist center because we have sales teams that call on the OB space and the community oncology space. I think Ambry was largely focused more in the hospital system, in the hereditary cancer center. So I don't think that there's a significant amount of overlap where we would be in a position to pick up business. But we do think hereditary cancer is an opportunity for Natera to continue to grow given the size of our sales team and just the sort of depth that we're now getting to within our customer accounts, both in OB and in oncology.

Got it. Now let's just talk about the sequential Signatera volume. I think it's -- we're getting around 10,000 unit sequential improvement. Is that still the right way to think about that? I mean I think you guided -- you guys guided or talked about 8,000, but you continue to get 10,000.

Yes. I mean we've sort of said 8,000 to 10,000. Just if you look historically, we were kind of in that 8,000 range, and then we bumped up into the kind of slightly above 10,000 range. But things fluctuate quarter-to-quarter. There's -- sometimes there's holidays or there's more Saturdays or more Sundays during the quarter. And just at the scale that we're operating at now. I mean we're receiving more than 1,000 tests a day, right? So when you start looking at, well, there's 1 less day or 2 more days in the quarter, it can really kind of change this growth metric. So what we've kind of said is, look, just -- just look at the longer-term trend and don't really focus in on the measurement of the exact quarterly growth just because there's these other factors. Now with that said, I mean, we've seen some incredible weeks of volume coming in, which when I look at the reports, I mean, I'm always surprised just the continued strong growth that we're seeing.

Got you. Can you talk about maybe some of the ways of thinking about first-time exome and repeat testing? And what I'm kind of getting at with that is, internally, do you guys think about modeling it as an exome and then I think we have an expectation of 2 or 3 tests from this one? Or any kind of assumption there? And if you guys want to talk about sometimes you talk about an adjuvant versus surveillance in terms of percentage test, that's cool, too. And on that note, what are the costs of the exomes these days? And I guess that one would be for Mike for sure.

Yes. Well, look, when we get a new patient in, we sequence the exome and we start to develop personalized primers, and then the patient goes through the adjuvant window if they come in the adjuvant setting, and then they move into recurrence monitoring. So of course, as time goes on, you're sort of amortizing the cost of that exome over all the different points. And so the longer the patient continues to get monitored, the more you're able to sort of spread the cost of that exome. One of the dynamics that we've seen is that -- we just have -- we have a lot of new patients that are coming in. And because there's so much demand and there's so many new patients that are coming in, and like I said in the beginning, there's new doctors that are coming on, we're still seeing this kind of large amount of exomes coming in. And we think that's a good thing because ultimately, having more patients that are part of the system and part of the network is going to help us grow long term, and we want to help patients. And then from an exome cost, I'll make some comments and then I hand it over to Mike. So look, there's a couple of different things that have allowed us to, I think, reduce some of our COGS. I think one is now a significant portion of the testing, the exome testing that we're running is being run in our updated facilities where we run it in our CLIA laboratory versus, in some cases, we're using partner laboratories. That's obviously reduced the cost. And then the other is versioning the sequencers that we're using and just focusing on reducing the actual cost of -- on a per-run basis. And then last, I think it's just the scale. I mean when you're -- there's a big difference when you're running 100 exomes a month versus 10,000 right? And we're now kind of getting to the point where we're spreading some of the indirect costs more broadly, and that's really helping us to reduce the cost as we scale.

Got you. Maybe you could talk about Signatera pan-cancer, built from a CMS and a private payer coverage. You -- have CMS given you any kind of direction on what it takes to kind of get a pan coverage decision? And when you're talking to private insurers, do they want to talk about a pan coverage idea? I think some of the Blues may be extended beyond just CRC, if I'm not mistaken, but you can correct me there.

Yes. I think there is, of course, always this idea that as you get a certain number of tumor types that are covered, eventually it becomes just pan-cancer. Now I think probably going to have to do that the hard way, which is where you just go get each individual tumor type covered versus Medicare or any other payer just kind of saying, "Hey, we're going to cover everything." But that's an advantage for Natera because we have now, incredibly, over 100 peer-reviewed publications for Signatera. And we think we're significantly ahead any other competitor when it comes to peer-reviewed publications, validation studies, studies that can be used for reimbursement. So with the requirement to be tumor by tumor, indication by indication, grinding it out the hard way, that's a very expensive proposition for people -- for companies. And it's also a very long process. Remember, we've been at this collecting samples, getting biobanks, starting studies since 2015, almost 9 years. We've been grinding out to get these 100 peer-reviewed publications, to get the studies that are coming out. So that process is very long. The studies we're reading out now, for example, the GALAXY study, we have many patients with 36 months follow-up of overall survival data. So you just can't get that by coming in on day 1 and kind of starting up an MRD business. So the harder it becomes for Medicare, other payers, I think the better that is for Natera, given the lead that we have.

Got you. Maybe we can talk about IP. I mean, you had some success in IP against Invitae, a little success against NeoGenomics I think a lot of companies now are in this IP share with Personalis. How do you think it's just about IP and all the different competitive products that are coming out?

Yes. I mean we can't really comment on competitive IP other than to say our IP portfolio is very strong. We have something in the range of 300-plus patents, a significant number of oncology patents, foundational oncology, MRD IP. We've been -- just been at this for a long time, and we've been successful in our -- a couple of cases that we've we pursued, I think, in joining our 2 companies. So we feel very good about our position. And obviously, kind of have to see what the future holds here, but we think we're in a good position.

Got you. Now next, if you think about big payer wins, the private payer side, how are you kind of -- how should investors think about your ability to drive some payer wins? And if you can give maybe some context around some of the biomarker bills, if that could help some of the private payer wins in the coming year.

Yes. I think just commercial coverage, more broadly is just going to be a function of, first, the data, which you're seeing us roll out almost at every academic conference, then guidelines, which we think it's always very difficult to forecast when that happens, but we think that's going to be inevitable for the business as we put together larger and larger data sets and more and more physicians incorporate Signatera into their standard of care. So I don't think that investors should have in mind some particular binary event where you're going to, all of a sudden have commercial payers announcing coverage. It's going to be a continuum and it's going to be a gradual process over time. And that's completely fine with us where the business model is kind of designed to be robust to that. We talked about on the earnings call, there is an opportunity to start to drive incremental commercial coverage via the state biomarker legislation that's now been in place and we're starting to see some good traction from that. And I think that, again, is going to be a process where we're cautiously optimistic by second half of next year, first half of '26, you can start to see some real progress in terms of actual sustainable commercial reimbursement that flows from that legislation. But we'll have to see.

Got you. Yes. And how should we think about NCCN guideline changes. ?I mean, what's kind of -- is there any goals for kind of next year, footnotes? How should we think about post-VEGA, post-ALTAIR what that looks like in terms of how an update could look like? And again, is it footnotes? Is it small wins, I mean -- and kind of some of the timelines on when that could happen?

Yes. I mean I think we were excited to see the footnote that was included last year, and we'd like to see improvement on that or maybe something more substantial. One of the studies we're really excited about that is going to be reading out at ASCO GI, it's actually accepted as a late-breaking oral presentation is this CALGB/SWOG 80702 study or what we're calling now the 702 study and that's a randomized prospective trial, over 1,000 patients, that looked at adding celecoxib to a standard adjuvant treatment to look at whether this extended adjuvant treatment would actually improve overall survival for patients, disease-free survival and overall survival for patients. And that's a pretty significant trial in the space. We actually think that might be the most significant trial that's been done to date. That's going to be reading out in January at the -- I think it's January 17 or something in that range at the ASCO GI conference. So I think that has a potential to change care. We'll have to see sort of how that is viewed after it comes out. And then, of course, we just had the GALAXY readout as well first-time 36-month overall survival data. So lots of exciting things, but we'll have to see what NCCN does.

All right. We're out of time. Thank you very much.

Thank you.

Thank you, guys.