Veracyte, Inc. (VCYT) Earnings Call Transcript & Summary

Hey, guys, good afternoon. My name is Tejas Savant, and I'm the Life Science, Tools and Diagnostics Analyst here at Morgan Stanley. Before we begin, for important disclosures, please see the Morgan Stanley research disclosure website at morganstanley.com/researchdisclosures. And if you have any questions, please reach out to your sales rep. It's my pleasure this afternoon to host Veracyte. And speaking on behalf of the company, we have Marc Stapley, CEO; and Rebecca Chambers, CFO. So thanks, guys, for doing this. Marc, maybe to start, you've been in your seat for about a year now. What do you view as Veracyte's key accomplishments since you took charge? And what are you most excited about heading into 2024?

Yes. And thanks very much for having us both here again. And maybe before I start, I'd just like to make my own statement regarding today, we may be making forward-looking statements. So I would refer everybody to safe harbor that can be found at www.veracyte.com and in our filings. So I've actually -- I've been with the company now for over 2 years. And if I think about the accomplishments that we've made in that time, I'm very proud of a number of different things, but particularly the way that we brought our core business to the stage that it's at with our Afirma and Decipher tests. And the strength that we're seeing there in that core business for thyroid and prostate testing. And the level of penetration that we've been able to accomplish in those businesses. In addition, our continued investment in funding in the long-term growth drivers that we are very, very focused on, which is our IVD strategy for making our tests available to patients outside the U.S. as well as our groundbreaking nasal swab test for lung cancer. In addition to that, a clear strategy that we have and those drivers of the business. The level of profitability that we've been able to achieve and cash flow generation, really balancing our portfolio during that time to get to the stage we're at today and also the team that we've built. We've been able to bring in a lot of talented executives and team members to help drive this business. So I'm very excited about the things that we've been able to accomplish over the last couple of years. Well, frankly, for many, it has been a very difficult environment and at Veracyte we've been able to really, I think, shine and differentiate ourselves.

Got it. So let's start with Decipher, I mean, that's been a real growth engine for you since you bought the company. As we think about the penetration for prostate classifiers, it's about 30% today. I believe you said decipher holds, I think majority market share in there. How is the test differentiated from competition? You've sort of myriad in there and they've come at it more from a data angle generating more data and you have MDxHealth, I mean you leave to get a more portfolio approach in that sort of go-to-market push. So where do you think Decipher really shines? And what is it that physicians are focused on?

Yes. So just a reminder for everybody, that we acquired that Decipher business in March 2021, which is right around the time just before I joined the company. And there's a lot of reasons why we acquired Decipher, it's a very -- in our mind, a very differentiated test. And I believe that the performance of that business has reinforced and validated that. So you're absolutely right. We put the market penetration at around 30%. There's about 288,000 new incidents a year of prostate cancer in the U.S., and that's growing. We do believe we're the market-leading product in that penetration and the reason for that is a number of different things. One is the level of evidence that we have developed for the test with over 75 peer-reviewed publications and studies that support Decipher, and frankly, more than 90% of the indications in that market that I just referenced. In addition to that, that level of evidence that we've generated over many years has led to NCCN Level 1 guidelines, which makes Decipher prostate the only RNA expression test for prostate cancer that has that level of NCCN guideline coverage. And we also -- one thing that we've done is we run a whole transcriptome for Decipher prostate as well, which produces in our minds, a very differentiated test and also enables us to offer research use only product to physicians for their practices as well, which cover more broadly than the standard classifier. So I think when you put all those things together and you layer on top an extremely effective and dedicated sales team that is executing extremely well. That's why you see the level of growth that you've seen. So for example, just in Q2 alone, the volume -- Decipher volume at around 15,000 tests grew 50% year-over-year. So a very impressive performance by our team and based on the effectiveness of the product.

Got it. What does it take to get penetration from 30% to, let's say, over 50% or 60%? I mean both in terms of time lines as well as -- is there anything you need to do differently in terms of your go-to-market? Or is it just a function of time, continue building the evidence, continue sort of like reaching out to physicians?

I think in our mind is continued evidence development, and it's not just evidence that we develop ourselves. Others develop evidence using the Decipher test in a real-world setting as well because they're so predominantly used now, at least in the market to the extent it's penetrated. But to your point, there are so many patients today with prostate cancer who aren't getting molecular diagnostic. And we clearly need to change that. Where it ends up, it's hard to say because there's not too many analogs out there, but I think it would be reasonable to assume something like 70% to 80% penetration ultimately where you get to. So to your question of how quickly do you get there? I believe it's continuing to do what we're doing. It's a sales team that can be highly leveraged. We don't need to grow our sales force linearly at all. In fact, we've demonstrated that, that's not the case. And continue to encourage physicians who don't use any molecular diagnostic to start using Decipher and those that are not using Decipher in every instance to increase utilization. We have customers, physicians who use Decipher 100% of the time and customers who use it a few times. So there's every combination there that we can continue to push on in order to make sure patients are getting the access to the test, which is ultimately why we're here.

Got it. We've -- some investors ask us about some of these new imaging-based modalities like Natera. How do you see uptake for them evolving and impacting sort of tests such as Decipher once reimbursement falls in place. I mean there's still some way before we start seeing them commercially, but...

Yes. Remember, it takes a lot of years to generate the evidence that you need to drive adoption. And we've been doing that for a long time with Decipher Prostate and then coverage as well and reimbursement, as you say, not just with Medicare, but also commercial payers. And we're still ourselves in the journey of doing that in terms of driving all commercial payers to cover the test. But what we hear a lot from our KOLs is there's no substitute -- the ones that are leveraging molecular diagnostic and particularly Decipher, there's no substitute for the molecular diagnostic test. Looking at the genome level, RNA expression-based information, having the whole transcriptome as well, for example, you can't substitute that with imaging. Being able to go from the imaging that we have today to imaging with AI is a step forward in imaging, but it doesn't replace or substitute for molecular diagnostics.

And is there room for -- I'm not talking specifically of Natera but is there room for that sort of modality to coexist within Veracyte as sort of perhaps a complement to what you're doing on the molecular front?

I mean if you think about Veracyte today, the AI and data analysis is very embedded in the algorithms that we produce the products that we have, the assays that we develop and we have those skill sets in-house. And so continuing to evolve around that to the extent that we need to is clearly within our wheelhouse. But as I said before, I think the real way to drive further adoption and penetration of Decipher is doing exactly what we've been doing for the last multiple years in Decipher before that. So continuing with the well-proven formula that is clearly working for us is where we should be focusing our time and attention.

Got it. Is there anything different that we should be expecting on the strategy front for the urology business, given the leadership change or not really?

No, not at all. And the leadership change you're referring to is Tina Nova after 2.5 years of staying with Decipher from Veracyte post the acquisition has decided to stand down and focus on other things that she wants to focus on. She's still working with us. But Tina and I knew at some point, this would be the case. And it typically is after you acquire a company. In fact, I'm proud and very pleased that we were able to work so closely together for so long. But we built -- she built an incredible team behind her and we hired John Leite as well, who both of us have worked with previously, as has Rebecca too, to be the leader of our CLIA U.S. business and with the intention that we would be able to put that business under John at some point. And so that time has come. And I don't see any concerns from that transition at all. So Decipher and our urology business is very well established. No change in strategy at all there. One thing I'm excited about, I'm sure we'll get to it is that we are going to submit Decipher as an IVD test penetration outside the U.S. as well. Up to this point, everything we've talked about, every number has been U.S. only. But there's clearly pent-up demand for a molecular diagnostic test like Decipher outside the U.S. KOLs outside the U.S. are very aware of it. They're already involved in studies using Decipher. They're on publications that have used Decipher. And so we're excited to make that test available to them. So we'll submit it for regulatory approval in 2024. And then follow through with commercialization.

Got it. Where are you on the commercial channel build-out? I think you've thought about approaching 50 reps there. Do you think that's enough? Or as you start to drive penetration perhaps into -- the skeptics or the nonbelievers are just the late adopters for testing such as Decipher, do you need sort of more feet on the street?

Not to a great extent. You've seen that evidence. Like I said, we grew 50% in Q2, and that was a sales team that wasn't significantly larger than the sales team we had the same time last year. So it's a very leverageable specialty model. The territory is already well established. We don't need to go and distract and change that significantly when we need to add sales reps, we do and we will continue to do so. But at this point, with roughly 45 sales reps today covering Decipher, we have most of what we need.

Got it. And how are you thinking about the bladder cancer test in terms of the pipeline? Is that something that you'll put more resources behind starting next year?

Yes. Bladder is a natural extension in that specialty urology channel that we have, of course. It's a smaller market than prostate with around 80,000 incidents a year in the U.S. And for us, it's continuing to develop the evidence to support the clinical utility of that test in multiple indications in the same way we did with Decipher and then leveraging the channel to the urologists to make that available. So continuing to develop that test, develop the evidence. It's not -- I don't see that as a needle mover in the next year or so. But certainly, it's part of our long-term strategy.

Got it. Switching to Afirma, you took up sort of revenue expectations there. I think it was low to mid-teens. Just underscoring strong penetration into new accounts, further penetration to existing accounts. But it is a pretty sort of like established mature market as well. So how much of the increase is driven by price versus volume? You've got some ASP tailwinds there as well from the CPT code switch.

Yes. I mean I'll talk about the volumes and what's been driving that business, and Rebecca could talk about where we are on the ASP improvements this year. But the real -- to me, the real driver of the volume is, one, it's a test in a market that's about 50% penetrated. It's the market-leading test. So similar to our conversation about prostate, there is plenty of opportunity for that to grow. And again, could it get to 70% to 80%. I don't see why not. And so we're trying to drive that ourselves with the market-leading test there. We continue to invest in Afirma. So for example, we launched TERT as an additional test modality. We've invested in the physician ordering process and portal. We've had multiple reasons to engage with our customers, and our sales team has been effectively doing that, coming out of a post-COVID environment. They very quickly got back out on the road and visiting customers, and that's proving to have a positive impact. And that's why I think we're seeing both, as you mentioned, new customers and existing -- penetration into existing customers.

With regard to the volume versus price impact, about 3/4 of the growth has been volume related. So only a small amount of the tail would be tied to ASP gains. And those ASP gains aren't just from the CPT code piece. Over the course of 2022, we did have a headwind, as you well know, tied to a code change back in 2021. Those towards the end of the last year abated, we did have some goodness as we resolve those payer-by-payer instances over the course of '23, but even more so than that, just the efficiency and the gains on the managed care side and on the billing operations side have really lend itself to that higher collections rate. And so while the CPT headwind has abated and now become a tailwind. In the first half of the year, we had about $2 million of prior period collections for Afirma specifically. And so as we move forward, that's something that we'll try and optimize, but can't necessarily count on every quarter in of it.

Got it. Marc, about your 50% penetration comment, can you just elaborate on what those areas are that can help you sort of move the needle there? And do you really need to expand the sales force? Or is it just things like you've already done on the TERT side, et cetera?

Yes, I think it's very similar to what we've already talked about for Decipher again, a specialty sales team that is focused on Afirma and endocrinologists. They've been in their role for a number of years dedicated to that particular indication. They're very effective and very leverageable again. We don't necessarily need to grow that significantly. Clearly, it's a case of getting out and visiting those accounts that still at this stage, surprisingly, haven't adopted any kind of molecular diagnostic in this indication. And then broadening the indications too and going beyond where the test currently is able to be utilized and that comes back to evidence always in reimbursement. And so continuing with that is, I think, a really important part of the story, and always have been.

Do you think there's been any sort of post-COVID catch-up dynamic at play in terms of cancer diagnosis. There was recently a paper out in Lancet about late-stage diagnoses going up. Is that something that has sort of helped volumes at all or not really?

It's not to the extent that I think it's really driving a lot of what we're talking about here though we do see -- we saw similar data that said, the level of prostate incidence is going up by about 7%, and that there might be a little bit of a post-COVID effect there. But not really. I don't think that's what's driving our numbers today. I think it's the things we've just talked about.

Got it. Switching to nasal swab, completion of enrollment into NIGHTINGALE, the clinical utility study. That's been pushed out a little bit, I think, by roughly about 6 months or so. Were there any factors that led to that push out just beyond staffing shortages?

No. To take a step back and just talk about the nasal swab, I mentioned it earlier, it's a breakthrough test. For us, the market that we're going to be going after there is the screening and incidental lung module population. And using a very simple nasal swap to be able to classify patients as low, intermediate or high risk. NIGHTINGALE, as you referenced, is our clinical utility study for that. We've been enrolling -- initiating sites and enrolling patients now for a while. What we have seen, and I think it's happening more consistently in lung more than any other indication in particular, is resource challenges at our customers at the site. Challenges with some of the PI staffing and resources and their estimates on how many patients they can enroll per month have ended up being a little lower than they originally estimated. And so we've taken that into account and conservatively estimated it's going to take until the second quarter to get to the final patient. The same number of patients that we were always planning to enroll. So that hasn't changed at all. And so like I said, that will be the middle of next year.

Got it. And what does that imply for trial readout? I think you've sort of talked about perhaps an interim readout as well and then sort of not requiring as much follow-up before you submit for reimbursement. So what's the latest thinking there?

I think given the time lines for the nasal swab test commercialization, which we've talked about as a long-term growth driver, it's in the [error] -- couple of quarters is within the [thereabouts] of those time lines. We still -- it doesn't change our strategy or our plan to be able to take a shorter-term look at the data, which we can do and are doing, following our patients for 1 year or 2 years, being able to see the performance of the test with, like I say, that subset of data. and getting to a point where we believe we've demonstrated clinical utility to our satisfaction. Which then, of course, we need to go to the payers, both Medicare and commercial. And demonstrate the same thing with the peer review publication. So that whole process takes a number of years, and that's what we're focused on. Once we have a clear path to reimbursement, of course, we'll be able to launch the test fully commercially.

Got it. And how do you think about the competitive landscape for nasal swab? You've got a couple of other lung nodules with classifiers out there. You also got people taking a crack on your lead detection side of things. We have blood-based assays which -- some people are worried that might sort of change the size of that patient funnel, so to speak, in terms of who would be candidates for nasal swab. So does that sort of factor into your calculus about the size of the opportunity?

Actually, if anything, that could potentially increase the funnel, and let me explain why I think that is. I think the first thing you have to consider is in a multi-cancer early detection scenario, A, you've been able to demonstrate the multi-cancer early detection has a mortality benefit in a way that it is heavily adopted and reimbursed. If that's the case, and a patient is identified using that test as potentially having lung cancer. The very first thing that will happen with that patient is going to be low dose CT. You've got to get an image of that lung nodule or even see that there is a lung nodule there. Once you're in that paradigm, you're treating this like a screening patient. So if anything that can increase the screening funnel would be very beneficial to patients and to us from the nasal swab standpoint. Today, 15 million people in the U.S. alone should be getting screened for lung cancer. A fraction of that, those people are actually getting screened for lung cancer every year as we know. And that is the USPSTF guideline. So it's woefully underserved today. So the more people that can get screened, the more people identify with a lung nodule the more opportunity to utilize nasal swab. In addition to the 1.6 million incidentally found lung modules that the patients are dealing with today. So that's how we think about where nasal swab plays. In terms of other competition relative to that, we're not aware of anything else that uses a simple workflow like a nasal swab that can be done in a pulmonologist's suite, physician's office, sent to our lab tested and a result returned. Yes, there are the blood-based assays out there, but that's a completely different workflow.

Right, right. So on that point, Marc, given that it's just a nasal brushing and you can get it in the pulmonologist's office. Does that essentially insulate you from the point of view? Because the theory is that if it's an early cancer detection test and it's positive and then you do detect lung nodule and the CT scan, you still need to risk classify it.

Yes. I think the answer -- we believe you do. But the big question, I think, that really matters in that case is, have you gotten reimbursement for multi-cancer early detection test for healthy people and at what level, then reimbursement. For low dose CT for lung cancer specifically, in multi-cancer early detection, that paradigm would be competing with low-dose CT, which is a relatively straightforward accessible and low-cost paradigm. So that, I think, is where the challenge is going to be. Once you've got the low-dose CT result, we absolutely believe you need the nasal swab to classify that patient's risk.

Got it. Switching to nCounter. You submitted an Envisia through the IVDR process. I think it was late last year. Can you just remind us what are the key changes in the new projects versus the prior process and where are you within the review cycle?

Yes. So the previous process was much easier in terms of self-certification and so on. And now the regulations are not the same as, but you can think of it a little bit like what we go through with the FDA in terms of submitting the dossier, answering the questions and ultimately getting approval. You're 100% right. We submitted Envisia actually in December last year. And we've had that round of questions back and forth. Has been very effective actually dealing with those. Our team has done an outstanding job. And consequently, we're now in the final stages, hopefully, of getting that approved. I can't tell you how long that's going to take because it's too early into a process, we don't know. But here we are in September, so roughly 10 months after we submit it. So we'll wait and see how long that takes to get approval. The learnings from there with both us and also the notified body that we're working with will help all of us get, hopefully, to a quicker process for getting prostate approved. And as I said earlier, I do believe there's pent-up demand for that and then getting our nasal swab approved when we submit that later in 2025. To be clear, we are working on Envisia, prostate and nasal swab in parallel. It's not a series. We stop one and start another. We're working on them in parallel. There are different stages of completion based on when we did the bridging from our clear assay to the IVD assay. And just one thing, if I can just really demonstrate the power of our model. We do all the R&D work to develop the assay with the algorithms to launch these tests, CLIA test in the U.S. We do a lot of work to develop the evidence and generate the evidence and guidelines and KOL support, and that is leverageable for outside the U.S. We may have to do a little bit of extra work to bridge and do local studies but we can utilize a lot of the effort we've already put in.

Got it. And in terms of -- once you have Envisia IVD approved will we start to see you sort of gradually ramp up the commercial push behind nCounter? Or is it still too early and it doesn't have to be a gated approach. It's kind of like you wait for the 3 and then you kind of really push the product?

Yes, excellent question. And the point being that we actually already have developed the sales team and the infrastructure being commercial, market access, medical teams and the support functions for all the major countries in Europe to support our Prosigna, which is already on the market as an IVD. So the beauty of this model again is once we launch a new test, which we're then selling to the same labs in each of these countries, we largely have the team in place in order to do it. Of course, as the revenue opportunity grows, we can increase our team. The one area where we would need to add additional skill sets would be specific to indications on the medical side. But other than that, it's the same sales team and the same market access team who understands reimbursement country by country, not test by test. It did matters country by country.

How many reps do you have at the moment on the Prosigna side of things?

Around 20.

20 or so. And do you think that's enough for that initial push?

For initial push. And the great part of it is as we see the opportunity to expand, we can be very not reactive. We can be ahead of that, but we don't have to be years ahead of that, it can be 6 months to fan enough.

Got it. Got it. And then in terms of just in-sourcing the kit manufacturing, where are you in sort of that process? And can you walk us through the impact on COGS from in-sourcing that?

Yes, I'll talk about that and then Rebecca feel free to add on the COGS side. But the goal there is to transition the manufacturing of those kits so that they're in our site in Marseille, France. We're making great progress on that. The team is working incredibly hard in getting that done. Where you'll see the benefit is when we have scale.

Yes, absolutely. Not much more to add. It will take obviously the volume absorption to really see the benefit over time. But theoretically, we should see many, many percentage points gain over time as volume ramps. And again, I wouldn't necessarily think about that as being driven by Envisia, but much more of Decipher play over time.

Got it. Got it. Fair enough. Switching to biopharma, Marc. Are you seeing any macro-related headwinds in the pharma business? You've talked about -- I mean, others have talked about cancellations, elongated decision time lines, et cetera. And is there anything you can do to sort of mitigate that impact?

We are. And actually, we were probably one of the first to call that out late last year in terms of certainly the cancellations and then the extended time lines we are seeing. Although the pipeline is in trading and growing. It's going from a level of interest to engagement, contract and full-blown working on those pharma contracts. That whole business, biopharma and other represents, if you look at our guidance for the year, it represents more like 5% of our total business. So it's pretty small relative because the core testing business has grown so well. It's hard to tell when that's going to end. Clearly, at some point, it will, but we don't know yet, and it's too early to say whether you see a headwind or a tailwind next year.

Got it. And over what time frame do you see sort of customer concentration there not being sort of as much of a factor? And do you envision sort of expanding from -- I think you've talked about just biomarker development to CDx development over time. Is that sort of a couple of years process in your mind?

It's multiple years, and that's still the long-term strategy for that business. But oftentimes, these start as small studies, but then transform into a much larger opportunities, and we have had a customer concentration. And so our goal is to really diversify that customer base.

Got it. Switching to the financials, Rebecca, do you still expect the third quarter to step down sequentially in line with typical summer seasonality? You saw really strong clinical testing momentum in the first half. So is there a chance that you don't see that to materialize at all?

Yes. I wouldn't change our commentary from the earnings call at this point in time in the quarter, Tejas. So I would reiterate that and refer you back to that.

Got it. And then in terms of gross margin expectations, I think you took those up as well from the mid- to high 60s or to mid- to high 60s. Can you just walk us through the puts and takes on that line in terms of gross margin expectations? And how much of the benefit was from the out-of-period collections there in the first half?

Yes, the out-of-period collections were, call it, roughly in the second quarter, I think about 1/4 of the benefits. So while they were great, they aren't necessarily really what was driving the sustained expansion of gross margin that we saw in the first half. In addition to that cash benefit in the first half, we did also have meaningful absorption given the volume gains during the quarter. So what we have said is the second half is expected to have a slight step down for the reasons cited. And also, we are investing pretty heavily in expanding our capacity as we see such volume gains. And so when you think about our margin profile exiting the year will be on a full year basis in that mid- to high 60s. And on the testing side of that, that's being brought up, right? So the testing margin in the second half is going to be closer to that high 60, low 70s range that we saw in the first half of the year. So lower but close. So I think when it comes down to it, we have a great gross margin story, and I know we're also out of time. I think another piece of our financial profile that's meaningfully differentiated is the fact that we are generating cash this year. And that is something that we're doing while also investing in the many growth drivers that Marc cited. And so when it comes down to it, we're very excited for both the long-term growth trajectory of the business, but also with a balanced financial profile that we have, and we can -- we're dedicated to continuing to have it.

Got it. Marc, last question for you. The FDA, perhaps you might have a bigger push here in terms of LDT regulation. What's the latest you've heard on that? And how do you see that impacting Veracyte?

Yes, nothing different than what everybody else has heard. We've been dealing with this for many, many years in this industry. I've been talking about this for more than a decade. And in every instance of this, we've seen, there's clearly grandfathering of existing tests in place in every iteration I've seen so far. If we need to go down an IVD pathway, we have at Veracyte incredible experience of doing that and including tests that we're launching in Europe. And so we have the optionality. But like you would expect, as an industry, we'll engage in those conversations and help to shape the right outcome for patients, which ultimately is what matters at the end of the day.

Got it. Well, this is great. So thank you so much both for your time there.

Thank you.