Natera, Inc. (NTRA) Q1 2017 Earnings Report, Transcript and Summary

Good day, and welcome to Natera's 2017 First Quarter Financial Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded, May 9, 2017. I would like to turn the call over to Michael Brophy, Chief Financial Officer. Please go ahead.

Thanks, operator. Good afternoon. Thank you for joining our conference call to discuss the results of our first quarter 2017. Also on the line is Matthew Rabinowitz, our CEO; Steve Chapman, Chief Commercial Officer; and Solomon Moshkevich, Senior Vice President of Product and Strategy. Today's conference call is being broadcast live via webcast. We will be referring to a slide presentation that has been posted to investors.natera.com. A replay of this call will also be available at investors.natera.com. During the course of this conference call, we will be making forward-looking statements regarding future events and our anticipated future performance such as our operational and financial guidance for the full year 2017, our assumptions for that guidance, our market size, opportunities, and strategies and expectations for various current and future products, including product capabilities, expected release dates and related effects on our financial and operating results. We caution you that such statements reflect our best judgment based on factors currently known to us. And that actual events or results could differ materially. Please refer to the documents we file from time-to-time with the SEC, including our most recent 10-K and the Form 8-K filed with today's press release. Those documents identify important risks and other factors that may cause our actual results to differ from those contained in the forward-looking statements. Forward-looking statements made during the call are being made as of today. If this call is replayed or reviewed after today, the information presented during the call may not contain current or accurate information. Natera disclaims any obligation to update or revise any forward-looking statements. We will provide guidance on today's call, but will not provide any further guidance or updates on our performance during the quarter unless we do so in a public forum. We will quote a number of numeric or growth advantages as we discuss our financial performance. And unless otherwise noted, each such reference represents a year-on-year comparison. And now I'd like to turn the call over to Matt. Matt?

Thanks, Mike. Good afternoon, everyone, and thank you for joining us. We are going to follow a different format in today's call. I will first review the highlights since we last spoke in March, and then we are going to review the fundamentals of our company with you, describing the markets we chose to be in and why we believe we win. As Mike mentioned, we will be referring to slides that we just posted on investors.natera.com. First, a brief summary of our recent highlights on Slide 1. We processed a total of 121,000 tests in the quarter, which represents 12% growth versus Q1 last year. Given our decision to exit our commercial relationship with BioReference Labs in late January, we are particularly pleased to have delivered sequential volume growth versus Q4 of 2016. As a reminder, BioReference accounted for approximately 12% of our total volume and 16% of Panorama volume in 2016. We chose to pursue those accounts through our direct channel and we have had a lot of success so far. Within our direct sales channel, volumes grew 16% over Q4. So we have effectively replaced lost Panorama channel volume with higher-margin Panorama and Horizon Carrier Screening test by direct channel in 1 quarter. A key reason why we chose to exit the BioReference relationship, was our expectation that we could grow Horizon Carrier Screening units in the account we retained through our direct channel. And that expectation was proven out in Q1. We accessioned approximately 27,000 Horizon tests in the quarter, which represents a growth rate of 39% compared to Q1 2016, and 22% growth rate compared to Q4 of 2016. Mike will talk more about the financial impacts of these volumes and our strong revenue performance later in the call. But we believe increasing the proportion of carrier screening volume in our product mix is valuable to us, given the stable reimbursements and the significant carrier screening cost reductions we are expecting to realize in Q4 of this year. We were very pleased to announce the recent publication of the results from the first 100 patients from the TRACERx lung cancer study in Nature. Measured by impact factor, Nature is the leading science journal in the world. This groundbreaking study is the first demonstration of circulating tumor DNA, ctDNA analysis to detect relapse and minimally residual disease in patients with early-stage non-small cell lung cancer. I will spend more time on this later in the call. We recently announced our initial launch of Vistara, our newest addition to our NIPT franchise. Vistara screens for new mutations in 30 genes that have a combined incidence rates of nearly 1 in 600, which is higher than that of Down Syndrome. We previewed this project with you on the Q4 call, and I will plan to go into more detail today. Finally, I am very pleased to note that we have now launched Evercord, our new cord blood banking products, broadly to our full OB/GYN sales force. As we discussed in our last call, our Evercord cord blood and tissue venting service is a new cash pay product that enables expecting parents to collect, store and retrieve their newborn's cord blood and tissue for potential therapeutic uses in roughly 75 established diseases and host of potential regenerative medicine applications, such as growing new tissue or organs for an individual without risk of rejection. This service also places Natera in a position to generate the full genome of an individual right after birth in the future. We typically spend a lot of time on earnings calls, diving into the details of our progress. But today, I would like to take a step back and revisit the core investment thesis and strategy of our company with you. Slide 4 is a snapshot. We have rapidly become a leading women's health genetic testing company in the United States. We are the clear NIPT market leader by volume in the U.S. And we offer a comprehensive suite of products in the OB/GYN channel and IVF channels that you see on the right. Based on this extensive suite, each a cutting edge offering, we've gone from being the 4th NIPT company to enter the market in 2013 to our leadership position. Our core Panorama NIPT and microdeletions franchise offers analysis of cell-free DNA from fetuses to detect chromosomal structural abnormalities early in the pregnancy -- earlier in the pregnancy than any competitive test with, to the best of our knowledge, industry-leading accuracy. Our Horizon carrier screening panel screens for up to 274 conditions, and is one of the most extensive panels available in the market. We operate Duchenne Muscular Dystrophy, which has historically been very difficult to offer as a frontline screen. Although it has birth incidence rates in males roughly similar to that of cystic fibrosis. To our knowledge, we were the first lab to offer DMD on a frontline screening panel, and we have roughly 90% detection rate for the inherited disorder. Anora analyzes the DNA of products of conception in order to identify the reasons for miscarriage and rule out chromosome structural problems as the cause. If cause of the miscarriage is determined to be due to a chromosomal abnormality in fetus, parents can usually be reassured that the chance of recurrence is low, and avoid costly medical workup. Other abnormalities such as inherited translocations can be addressed through IVF, using our spectrum products, which are specifically for the in vitro fertilization channel. Spectrum pre-implementation genetic screening evaluate embryos for extra or missing chromosomes. Spectrum pre-implementation genetic diagnosis test embryos for specific inherited genetic disorders. We continue to see uptake of Constellation, our platform for licensee labs where U.S. and international customers can run samples in their own labs and process the data with our proprietary algorithms in the cloud, to generate clinically meaningful information. Constellation efficiently takes care of procuring resources, data storage, security and software upgrades for our lab licensees. Finally, we are very excited to be launching Evercord and Vistara, and we'll discuss both in more detail on today's call. How did we achieve such a leadership position in women's health market so quickly? We have delivered superior test performance covering a very broad range of diseases. When a doctor orders all of our prenatal screening tests, 9 weeks in the pregnancy, she is screening the patient from a range of diseases that have a combined incidence of 1 in 85 pregnancies. That covers a substantial proportion of the issues that can go wrong in a pregnancy and offers patients substantially more comforts that they won't be blindsided by genetics issue. We believe our test performance is best-in-class as evidenced by just a few examples we could fit on the right side of the page. Compared to our competitors, all of whom some variation on the same quantitative technology. As shown in all studies referenced here, our proprietary SNP-based approach yielded significantly fewer false positives and fewer false negatives for people and employees. Because we distinguish between maternal and fetal DNA, we are not aware of an instance when we have ever given the wrong fetal sex call in a commercial low risk panorama case. Because sex is called on every sample, not only on rare and [indiscernible] samples. And these gender calls provide a clear indication of our improved performance versus competitors. This is also noticeable to the typical busy OB/GYN working within larger practice. When a competitor gives the wrong fetal sex call between 1.5% and 1% of the time, that throws the other results into question and is very frustrating for the patient and the doctor. Finally, these differences pale in comparison to our performance difference in sensitivity from microdeletions, microdeletions are very small deletions within a chromosome that cause a range of disorders such as organ abnormalities, schizophrenia and cognitive impairments. The impact of some of these conditions can be lessened if you know the child is affected, and in case of 22q11.2 deletion syndrome, for example, you treat the child with calcium immediately at birth. Our sensitivity for 22q11.2 deletion syndrome, the most common microdeletion is above 95%. While the only sensitivity that we know to be published by our competitor is roughly 30% at a typical fetal fraction of 10%. We think this advantage is particularly relevant for younger patients, as we estimate the incidence of 22q is actually higher than Down syndrome for women under the age of 28. Now we are adding to this coverage with the launch of Vistara. As I mentioned on the top of the call, Vistara is a noninvasive prenatal test that screens for de novo or new single gene mutation, by sequencing study genes based on fetal DNA in the plasma and identifies risk for severe skeletal, cardiac and neurological conditions that have a combined incidence of roughly 1 in 600. This incidence is higher than that of Down syndrome, and higher than that of cystic fibrosis, which are ubiquitously screened by OB/GYNs and are both very well reimbursed. These are conditions such as Rett syndrome, where ultrasound findings are not a reliable indicator, and current NIPTs and even standard invasive tests do not offer screening for the associated mutations. Although the incidence of Vistara looks to be roughly 1/3 relative to the carrier screening on the slide, many of the children with inherited conditions are detected with parents screening, while the diseases Vistara screens for typically cause cognitive disabilities or require surgical intervention that may have otherwise gone undetected until afterbirth or into childhood. Because they are commonly caused by de novo mutations in the fetus, patient or family history are also typically not a good indicator of risk. But there can be a slight increase in the frequency of these mutation at the age of the father increases. Early screening with Vistara enables patients to be referred to an MFM and other specialists for targeted evaluations such as fetal echocardiograms, MRIs, targeted anatomic surveys and invasive test analyzing the particular gene affected. Prenatal diagnosis of birth defects allows providers and patients to plan delivery in centers equipped to provide prompt evaluation and treatment, and learn about these complex genetic disorders before birth, enabling families to mobilize resources, ask questions and anticipate future needs. Initially, we plan to launch this test in a limited fashion with maternal fetal medicine specialist and KOLs to understand usage patterns, gather feedback and continue to improve performance parameters like we do with all of our tests following a broad rollout in the United States later this year. Now I'd like to hand the call over to Steve to summarize our commercial efforts and the market we're targeting. Steve?

Great. Thanks, Matt. Slide 7 describes a competitive advantage of our commercial channel. Our customer experience mirrors that of a technology company rather than a traditional clinical diagnostic company. At 9 weeks into a pregnancy, with 1 blood drop from the patient, we are able to offer a full suite of genetic tests. Our simple user experience allows OB/GYN physicians to offer complex genetic tests in a streamlined way and patients to interact with us quickly and conveniently. Patients can log into our portal to track your tests, access the results, estimate their out-of-pocket costs, schedule a mobile phlebotomist and access over 2000 brick-and-mortar phlebotomy centers. In addition, any patient can go online and schedule an informational session with a board-certified genetic counselor before or after receiving their test results. These information sessions can be scheduled for the same day in most cases. We market our streamlined offering in the United States with a force of roughly 125 sales reps calling on OB/GYN physicians. We have one of the largest OB/GYN forces in the entire country. Our highly trained sales reps exclusively focus on the premium genetic testing segment. The combination of leading products, a focused specialty sales force and excellent user experience makes our offering very sticky. Our account retention rates are generally greater than 95%. It's very difficult and costly for competitors to replicate the infrastructure we have built. During the testing process, we engage directly with patients, building trust and relationships we can leverage to later offer additional services such as Evercord. With Evercord, we have the opportunity to start a conversation with our patients very early in the pregnancy after they have completed other Natera testing. This is usually much earlier than our competitors in the space, and we believe will result in our patients being more receptive because we have an established relationship with them. As genetic testing evolves, it becomes more consumer-driven, we are positioned to offer additional genetic testing services through our platform directly to patients. Now that we've built a market-leading field infrastructure and an engaging user experience, we think we can grow both organically and from new product introductions, driving more revenue and more volume per sales rep. We have successfully done this already, for example, when we launched our Horizon carrier screening test, in July of 2015, to our NIPT customers. This slide shows our units per sales rep over the past 2 years. As you can see, we rapidly grew the volume sold per sales rep through the introduction of Horizon carrier screening midway through 2015. In Q1 of 2017, we accessioned 27,000 Horizon carrier units, taking our units per sales rep to record levels in our most recent quarter. We believe we still have significant capacity in our channel to sell additional products. Through the introduction of Evercord and Vistara, we are again leveraging our existing infrastructure to increase the productivity of each sales rep. We will offer Vistara 9 weeks into pregnancy from the same blood draw as our other test offerings. We estimate that the Vistara market opportunity is similar in size to that of NIPT, roughly $2 billion per year. We estimate the cord blood market to be over $1 billion per year, and think we're well positioned there to become a market leader in the future. Even at conservative ASPs, our current products have very large addressable markets, where there is significant greenfield opportunity for growth. In addition to Evercord and Vistara, we think there are more products that we can add to our bag without significant incremental investment. And we plan to provide more details on more products later in the year. We estimate that our current implant products in women's health represents a total addressable market of over $15 billion in the United States. We believe that the worldwide market will in time be roughly 4x that of the U.S. On Slide 10, you can see the prime example of a greenfield opportunity in our core NIPT market. We've seen a major change in the standard of care within the high-risk patient market, which is generally pregnant women over age 35. 5 years ago, very few high-risk women were prescribed NIPT, and now that market is 65% penetrated with very broad reimbursement from payers. We see the opportunity for a similar shift to occur in the average-risk market, which is roughly 4x the size of high-risk, but only about 10% penetrated today. One of the key barriers to further penetration is limited insurance coverage for NIPT in the average-risk patient population. But that is changing rapidly. Based on the latest practice bulletin issued last year by the American College of Obstetricians and Gynecologists, we believe that cell-free DNA screening is now clearly an option for all patients regardless of maternal age, and now about half the covered lives in the United States has a plan that offers average-risk NIPT coverage. We expect this reimbursement trend to continue, and have been driving market share within the average-risk setting in anticipation of increased penetration in insurance coverage. As a result, we have not been reimbursed by insurance for a lot of the NIPT volumes we accessioned today. But as Matt will describe later in the call, we have enormous future earnings power we can unlock within our current book of business. Similarly, the Horizon market has a very large expansion opportunity. Historically, the majority of physicians have offered single-gene carrier testing limited to just cystic fibrosis. This market has predominantly been served by big clinical labs in regional hospital labs. Over the past few years, expanded multi-gene carrier screening has been taking market share. But single-gene cystic fibrosis testing still represents roughly 60% of the orders in the United States. Recently, AACR issued updated guidelines, recommending physicians to offer more than cystic fibrosis. Spinal muscular atrophy is now a recommended offering for all pregnant women in the U.S. This new guideline may disrupt the current status quo, as many physicians will be prompted to reevaluate their practice patterns. We see this as an inflection point for expanded carrier screening and expect to see a large shift in ordering patterns away from single-gene cystic fibrosis testing to a broad multi-gene panels. This disruption is favorable for Natera, as we have the premier expanded carrier screening offering, and we're leading the education to physicians about this change. Now I'd like to hand the call over to Solomon Moshkevich, Senior Vice President, Product and Strategy, to summarize our recent Nature publication and our near-term opportunity in oncology. Solomon?

Thank you, Steve. I would like to shift gears a bit and tell you about the near-term opportunity in oncology. Matt touched on our recent publication in Nature, which is a perfect showcase for how we have adapted our core NIPT technology for oncology. First, let me describe how the test works and its advantages which are shown on the left side of the page. Based on a solid tissue sequencing of the patient's tumor, we build a personalized assay tailored to the specific mutation profile for each patient. Our proprietary PCR technology that we first developed for Panorama, allows us to quickly and cheaply build these personalized assays, or as we often call them bespoke assays to quantify and characterize any tumor DNA in the blood. Our multiplexion capability allows us to test for dozens of mutations simultaneously without splitting up the plasma samples. And our bespoke targeted approach means we can achieve very high sensitivity on the variants that matter for each patient without costly sequencing of many unnecessary genes as one might do with the generic liquid biopsy panels available on the market today. The summary of all this, is that we believe we have an inexpensive, fast and highly sensitive methods that will finally make liquid biopsy affordable and clinically useful. We intend to make this liquid biopsy service available for research use in the second half of this year and for latter clinical use in 2018. The Nature paper demonstrates the capabilities of our technology. Reporting results out from the first 100 early-stage lung cancer patients to be analyzed without a liquid biopsy as part of the TRACERx study. As a reminder, TRACERx is a national collaboration in the U.K. between over 10 centers of excellence as intended to study the evolution of the tumor heterogeneity in the lung cancer patients over time. Our lead investigator, Professor Charles Swanton and his team selected Natera to provide the cell-free DNA analysis for the patients in this study. Based on our unique ability to design the bespoke personalized assays for each patient to reflect the clonal and the subclonal genetic signatures in that patient tumor. The key findings in the Nature paper were #1, our performance in detecting relapse early. And #2, predicting patient response to adjuvant chemotherapy. We were given serial blood samples from a subset of 24 from these 100 patients and asked to identify on a blinded basis, which of these patients showed signs of molecular relapse, which we defined by presence or absence of tumor DNA in the blood. As the green line in the graph shows, all patients who tested positive for circulating tumor DNA at some points after treatment, all went on to relapse, all within a year of the positive blood test. As the blue line shows, out of those patients who tested negative for tumor DNA after treatment, approximately 90% of them remained relapse-free through the time of publication. This shows the power of Natera's test to predict outcomes with extraordinary accuracy, and to potentially change how these patients are managed. We aim to replicate these results across multiple other cancer types. Another important way the Natera bespoke technology can be used, is to identify whether patients are responsive or resistant to treatment, and to change patient management by continuing or changing or stopping therapy at the right time for that patient. In the Nature paper, there was 1 patient for example, where tumor DNA was detected immediately post surgery, but this patient then underwent adjuvant chemotherapy and follow-up blood testing after completion of therapy showed that tumor DNA levels have fallen to 0, and they stayed at 0. This patient remains disease-free. Here Natera's test basically showed that the treatment was successful. On contrast, there were 3 other patients in this cohort, who received adjuvant chemotherapy, but where our test showed that circulating tumor DNA levels remained positive throughout and after treatment. And all 3 of those patients relapsed within 1 year. We have publicized that if our tests had been adopted clinically for those 3 patients, they might have changed their treatment regimen, maybe even with the tailored therapy to reflect the particular tumor subclone that we were detecting in the blood. And those patients may have achieved better outcomes. Such personalization of therapy is simply not possible with today's diagnostic tools. Our collaboration with UCSF in the I-SPY 2 trial, which was announced previously is expected to further validate this application of our technology. In that case for patients with metastatic breast cancer. Moving to Slide 13. There is a lot of hype today in the discussion about liquid biopsy. Michael here is to drill down into just the market for residual disease, recurrence monitoring and treatment response monitoring, which is different from the markets that many of our other prominent players are chasing. We estimate that MRD and recurrence monitoring is approximately a $12 billion market in the United States alone, plus an additional $2 billion opportunity in the U.S. with monitoring for treatment response and resistance. We believe that the worldwide market in time can be roughly 4x that of the U.S. We expect our technology to have broad applicability across a range of cancer types and to generate interest from pharmaceutical companies who may benefit from offering earlier therapeutic interventions for patients who are either relapsing or for switching faster to second line therapies. The potential test volumes in the left column represent our estimate for the number of patients who are currently in remission from these cancers, and assumption of 2 tests on average per year and the conservative assumption of $500 price point per blood test. Many players in the liquid biopsy space have a cost of goods that require price points well above $3000 to make money. Because they are running big generic panels with over 50 genes that require deep sequencing. Our experience in NIPT has taught us that molecular diagnostic tests that reach meaningful penetration must be offered at a relatively modest price point to be sustainable, especially in the context of repeated testing over time as we envision here. Given our estimated variable costs are well below $200 per blood sample, we believe we are well positioned to serve these markets upscale. You can see from the market sizes we have here that penetration in just a few of these markets represents a meaningful opportunity in the U.S. and even greater opportunity globally. We plan to offer our technology first as a research service for academics and pharmaceutical companies this year. And then look to commercialize a clear version for clinical use in 2018. In addition, when we offer our clear test, we will be generating clinical utility data that will help us secure reimbursements. Now I would like to hand the call back to Matt to discuss our path to cash flow breakeven. Matt?

Thank you, Solomon. Looking at Slide 14, we are on track to substantially reduce our quarterly cash burn through the course of 2017. We expect to get there by improving reimbursement for our existing test volumes, realizing continued improvements in our cost of goods sold, launching new products that generate revenue without requiring significant additional investments and continuing to grow volumes on our operating expense line, remain stable. I will touch on each of these points in turn. First, on Slide 15, we have faced 3 distinct price reducing events in the past. We are seeing pricing stabilized now, and we expect pricing to improve from here. At the beginning of 2015, we transitioned from billing a procedural code for NIPT to a dedicated NIPT code. Often with a new diagnostic test reaching the critical level of clinical adoption and test volume, labs applies for a disease specific codes with the American Medical Association and then bill exclusively under that new code. That start the process in which payers negotiate rates for that new code and are -- that are often lower than what they have previously paid in recognition of the growing test volumes of that disease. That exactly what happened with the industry-wide adoption of the new NIPT code in 2015. We played a key role in gaining that code. In Q1 of 2016, we made the strategic decision to negotiate in-network agreements with essentially all of the largest payers in the United States. As we discussed previously, going in-network is a crucial step to lock-in multiyear pricing contracts with payers, and secure ongoing access to in-network positions. In return, payers negotiate wholesale rates that are lower than the retail out of network rates they we're paying previously. Finally, on January 1, 2017, we made the transition from a procedural code from microdeletions test to a disease-specific code. Similar to NIPT, we led the efforts to achieve disease-specific coding recognition from the American Medical Association. I will spend more time on the new reimbursement for that code in a moment. While this obviously didn't had the effect of reducing ASPs in the immediate-term, transitioning to this disease-specific code sets us up for consistent reimbursement from microdeletions as volumes grow over time, much as we had seen for NIPT. So while it appears that there has been a steady decline of ASP, that decline in line is in fact the result of these discrete events, each of which play out over roughly a year as the insurance payments are elected over time. Now going forward, we have steady multiyear contracts with payers, representing roughly 200 million covered lives. So these contracts have generally been in place for roughly a year or more, the effect of going in-network should no longer be a headwind for the average selling prices we report each quarter. So now we can expect as we have predicted in the past, revenue growth to track along with volume growth through the rest of 2017 and beyond. As I will discuss on the next slide, increasing reimbursement for both average-risk NIPT and microdeletions represents 2 significant sources of upside for pricing going forward. As Steve mentioned earlier, there is a huge amount of earnings power embedded in the test volumes we run today, but are not currently reimbursed by insurance. There are 2 hurdles to clear to receive consistent insurance reimbursement for tests. Step 1 is having a negotiated rate for a specific code, and the second is getting the test included in the payers medical coverage policy. Steve described the rapid changes we have seen in NIPT reimbursements, where now insurers representing over a 105 million covered lives have a medical coverage policy that reimburses for average-risk NIPT. We think that ubiquitous coverages is inevitable, but in the meantime, we estimate that in Q1 alone we processed roughly 26,000 NIPTs that will not be reimbursed by insurance. If you assume that pricing for average-risk NIPT settles at $450 over time, and it could be above that, that would imply $12 million in quarterly revenues and cash flow from currently unreimbursed volumes. Microdeletions represents an even larger opportunity. As we described in our last earnings call, the Center for Medicare Services has priced the new microdeletions code at $802, and we have seen many payers negotiate in-network rates with us in the same range. However, we are receiving positive coverage determinations on slightly more than 10% of our microdeletions volumes today, which implies that roughly 40,000 microdeletions tests performed in Q1 will not be reimbursed. If you assume that we can increase that allowed rate over time and achieve a $450 ASP, that would drive $18 million in revenue and free cash flow per quarter from our current unreimbursed volumes. We expect to drive broader reimbursement for microdeletions by delivering more data that shows the incidence rates of these diseases in the population and our test performance. Specifically, our smart trial is a more than 10,000-patient prospective clinical trial for focusing on microdeletions. Based on current enrollment, we expect enrollment of 10,000 patients to be completed in Q3 and initial data to report out in 2018. It has taken some time to set up the infrastructure to be collecting born child genetic samples at all these centers. Now that we've established this infrastructure, with more centers on-boarded or on-boarding, and given the value of having born child genetic samples coupled with prenatal samples, we may choose to extend that trial to thoroughly demonstrate the clinical utility of our broader genetic testing panels. In the interim, we, of course, try to appeal every insurance denial with the raft of clinical evidence we've developed so far and we are continuing to develop more clinical evidence based on ongoing utility studies. We continue to discuss with professional societies what data they need to see to support microdeletions testing, and will deliver additional analysis if we think anything beyond the existing studies is necessary. A final note on pricing. We do not need to see a sea change from our current reimbursement levels to reach a breakeven cash flow position, largely because of the COGS improvements we're making and leverage we're getting out of our commercial channel. So let's discuss the progress we have made in cost of goods sold so far and the improvements we expect to realize in the near term. On the left, you see a chart that shows our blended COGS at the beginning of 2015. This number is calculated by simply dividing our cost of product revenues by our test successions in the quarter. So this includes our smaller higher-COGS IVF channel products. Our NIPT COGS are well below this blended number, but this will give you directional sense of our progress. As you can see, we continue to innovate with technology to improve test performance while substantially reducing cost of goods. If you annualize our Q1 test succession, you will see these cost improvements represents $42 million in annual savings, which will, of course, continue to grow as volumes grow and we continue to reduce COGS. Given our spend on R&D since the beginning of 2015, at current volumes, we are seeing a 51% return on that investment solely from the COGS-reduction efforts, and excluding all the new products improvement and our work in oncology. Since much of the R&D is focus on product enhancements and new products, the actual ROI is much higher than 51%. We said previously that we think we can get the blended COGS to the mid-$200s by Q1 of next year based on projects we're currently working on in the lab. These are 2 key projects -- there are 2 key projects that drive most of that reduction: Version 3 of our Panorama test and our carrier screening automation project. We launched Version 3 in late January. We took an additional noncash write off to [ lead ] to equipment, and we expect -- we expanded additional resource in monitoring the launch in February to confirm all is running smoothly. So we really only achieved one month of COGS benefit from V3 in Q1, and expect COGS to come down in Q2, where we'll see a full quarter of benefit. We expect to launch the first carrier screening automation model in Q4, followed by a second wave in Q1 of next year. So we expect to see the benefits of that project by Q1 of 2018, and we think we can still reduce COGS significantly beyond that point. Finally, I'd like to comment on our R&D investments for the year. One key point here, is that a majority of our R&D spend is focused on projects that yield very meaningful COGS reductions in the near term. We like these projects because the technical risks tend to be lower than basic research and they pay dividends over the life cycle of our leading products. As we conclude these projects, we have significant flexibility to reduce spend in R&D or redeploy these resources to new products. Second, we've followed a capital-light strategy in oncology, where we leverage and refine our existing core technology and piggyback on large oncology trials with very valuable samples that have already been collected. Often these trials will look to add a liquid biopsy arm, and we have to compete based on technology performance with other labs to be the provider for the trial. We've been successful in being chosen for a number of the preeminent trials in cancer research, like TRACERx and the I-SPY 2 breast cancer trial with UCSF, which allow us to demonstrate our performance before committing significant resources in a particular area of oncology to productization. The performance of our technology, as demonstrated in the Nature paper, is driving more trials to request to add our technology in order to improve their results. With that, let me hand over to Mike to review our financial performance in the quarter. Mike?

Thanks, Matt. Our first quarter financial results are included in our press release that crossed the wire earlier this afternoon. Our first quarter total revenues were $46.9 million compared to $61.9 million for the first quarter of 2016, a decrease of about 24%. The current quarter is not really comparable to Q1 of 2016 because we were charging retail out-of-network rates in Q1 last year, as Matt described. A second impact to revenues in the current quarter is the shift in volumes from BioReference to our direct channel. In the second half of 2016, we were recognizing revenues from BioReference on an accrual basis, meaning we booked the revenues immediately when we reported the test results. In our direct business, we don't record revenues from our test volumes until we actually receive the cash from insurance companies. As expected, that shift caused a onetime slowdown in our revenue recognition, because we don't receive all of that cash in the same quarter that we accession the test. Roughly 51% of the revenue recognized tests in the quarter were also accessioned in Q1. Historically, about 80% of the revenue we derived from the cohort of tests accessioned is collected within 2 quarters, and almost all of the revenue we derive from a cohort of tests accessioned is collected within three quarters. So we estimate a onetime timing delay from this transition of volumes to our direct channel of roughly $3 million in revenues derived from Q1 direct test volumes that we expect to record in future periods. Given that total revenues in Q4 2016 were $49.3 million, we've essentially replaced revenue from BioReference in 1 quarter, despite the fact that they represented about $17 million or 8% of our total revenues last year. This timing delay, of course, also artificially depressed gross margins in the quarter, since we incurred all of these expense related to these expected future revenues in Q1. I will talk about gross margins in a moment. Panorama revenues for the quarter were $31.4 million compared to $38.6 million in the first quarter of 2016, a decline of about 19%, which again is driven primarily by the shift to in-network contracts in Q1 of last year. We recognized revenues on greater than 47,000 Panorama tests in the quarter compared to greater than 40,000 Panorama tests in Q1 of last year. Horizon revenues for the quarter were $11.5 million compared to $18.8 million in the first quarter of 2016, again primarily due to the change in in-network rates. We recognized revenues on greater than 13,000 carrier screening tests in the quarter compared to greater than 7,000 tests in Q1 of last year. This scale of the in-network price discount was larger in our carrier screening business than in Panorama, but we have seen robust volume growth for Horizon over the past year, and we expect to be more than making up that discount with volumes within 2017. Gross profit for the 3 months ended March 31, 2017 was $13.2 million, representing a 28% gross margin compared to $29.6 million, a 48% gross margin in the same period of the prior year. Gross margins were unusually low due to the revenue issues I described and also because of the final component of noncash charges associated with our switch to V3 of Panorama in the quarter. These adjustments had approximately a 7% impact on gross margins -- that's 7 percentage points, meaning that we estimate the steady-state Q1 gross margin would have been roughly 35% absent these onetime impacts. Research and development expenses were $12.7 million in the quarter compared to $8.8 million for the same period in 2016, an increase of roughly $3.9 million. The increase in research and development expenses was primarily attributable to increases in personnel-related costs associated with an increase in research and development headcount. Selling, general and administrative expenses were $37.6 million in the quarter compared to $30.4 million in the same period in 2016, an increase of $7.2 million. The increase over the prior period primarily reflects additional personnel and facilities expenses across all of sales and G&A. As we've discussed, we are satisfied with our current direct sales footprint, and we'll continue to optimize that channel as appropriate. Net loss for the 3 months ended March 31, 2017, was $36 million or a $0.70 diluted loss per share compared to a net loss of $8.7 million or a $0.17 diluted loss per share in Q1 of 2016. Diluted weighted average shares outstanding were 53 million shares for the first quarter of 2017. At the close of the quarter, the company held $116.6 million in cash, cash equivalents, short-term investments and restricted cash compared to $147.2 million as of December 31, 2016. As of March 31, 2017, we had drawn down $49.8 million, including accrued interest under the $50 million line of credit in place with UBS at a variable interest rate of 30-day LIBOR plus 65 bps. This line of credit was drawn down primarily to repay previous indebtedness at a significantly lower interest rate. The line is secured by our investment portfolio, which is designed to yield higher returns than the borrowing rate we incur in order to fund operations. Turning to future outlook. As you can see on the slide, we're holding our guidance largely the same compared to the guidance we provided on the Q4 call in March, with the exception of cash burn. We expect 2017 total revenues of $210 million to $230 million; cost of product revenues to be approximately 60% to 65% of revenues; SG&A cost to be approximately $135 million to $140 million; and R&D costs to be $45 million to $50 million. During the quarter, we executed a targeted reduction in headcount and planned expenses that we do not expect to impact volume and revenue growth this year. And we have been pleased with the early results from our planned COGS reduction so far this year. As a result, we would like to revise our prior cash burden guidance of $75 million to $85 million. We are now improving that guidance to $65 million to $75 million. We will continue to evaluate our operating expenses and look for ways to reduce our spend further without disrupting the business. We described the components of our guidance in detail on our Q4 earnings call, but let me summarize them again now. First, reimbursement in the average-risk NIPT setting. Matt commented on the pace of adoption thus far, where more than 105 million covered lives are now reimbursed for average risk. Based on our conversations with payers, we believe we will see significant initial payer coverage policies change in 2017. However, because a significant portion of the covered lives that still do not enjoy average-risk NIPT coverage reside in just 2 remaining large national plans, we feel we must err on the side of caution as it relates to the specific timing of these coverage decisions. So we're assuming steady, but not rapid, changes in medical coverage policies accommodating average-risk in 2017. As these changes take place in the second half of the year, a lot of the financial benefit we will see will occur in 2018. Second, reimbursement for microdeletions. Matt reviewed with you the significant embedded earnings power we believe our microdeletions business represents and the rationale for why we feel that payers will catch up to the view of the vast majority of our physician clients, that microdeletions testing is essential and medically necessary. We've outlined in the past that we believe our published clinical experience, coupled with data from our smart trial and the recently issued CPT code for microdeletions, are the key milestones toward achieving stable reimbursement for this test. As Matt mentioned, the trend in price negotiations have been positive. Our experience with reimbursement on the new microdeletions code has improved slightly since the Q4 call, and we could still see improvements based on the appeal of denied claims as our data set on appeals is still limited. The change we've seen to date is not large enough to change our revenue guidance today. Third, we discuss our transition from BioReference Labs. We were very pleased with our performance in capturing some of that business through our direct channel in the quarter, and it is currently in line with our expectations. We continue to expect that within 2017, this transition will be accretive to gross margin dollars. Fourth, improvements in cost of goods sold. Matt already covered that our target is a blended COGS in the mid-$200s based on R&D efforts currently underway. The V3 launch is an important piece of that plan, but we expect the largest benefit will come from our next wave of lab automation efforts that we expect to implement in modules from early Q4 2017 through Q1 of 2018. Finally, new product launches. Matt and Steve talked about Evercord and Vistara. We now broadly launched Evercord and have begun collecting samples. As we described previously, because our strategy with this product is to leverage our existing touch point with the physician and patient at the beginning of pregnancy, we expect early account conversions to start generating revenue late in this year when the babies are born and we collect the upfront fee. We expect the start of revenues to be similarly weighted toward the end of the year as we learn from our initial roll-out with key opinion leaders and then follow up with a broader launch. As Matt described our plans on oncology regarding an RUO offering in the second half of this year, followed by CLIA products for clinical use next year, the current guidance does not include any oncology revenue as we will firstly focus on building evidence as Matt described. Just a reminder on the pacing of the quarters through the year. Given progress on average-risk NIPT coverage through the year, new products generating revenue primarily in Q4 and significant COGS reductions from automation improvements later in the year, we expect revenues and gross margins improvements will be weighted toward the latter part of 2017. Due to all these near-term factors described above, we expect revenues and gross margins to significantly increase and cash burn to meaningfully decrease in Q2 and in the remainder of the year, as reflected in our guidance. I'll now turn the call back to Matt for final comments. Matt?

Thanks, Mike. I'm very pleased to see ASP stabilizing, and we expect those ASPs to start growing over time. We are now in a position to see our strategy pan out and expect to see revenues in our core business tracking volume growth through the rest of the year. That strategy will be augmented by additional products in women's health through our leading channels and our powerful, highly differentiated offering on oncology coming out this year. We'll now open for questions.

[Operator Instructions] Our first question comes from Bill Quirk with Piper Jaffray.

First question is just, maybe give us an update on Medicaid reimbursement for NIPT. Certainly our diligence would suggest it's gotten better of late with more states looking at covering the test. I would certainly think, given the timing of your original guidance and the timing of some of these decisions that, that should be incrementally positive relative to original expectations?

Sure. So I'll make some comments, Bill, and then, Mike, you can come in. So just on the state Medicaid side, since the beginning of the year, we've seen some improvement on roughly 7 to 8 plans where they've either started covering high-risk NIPT or they've reworked their rate for the 81420 code. So we see that positive. And then separately, on the managed Medicaid side, we've had some direct wins where we've got a network with clients where we were previously receiving volume but were out of network and not able to get reimbursed, and now we're in network. So we're making progress on both the state side from coverage standpoint and also on the managed Medicaid side from a contractual standpoint.

Bill, just on the financials, I think we actually had a pretty good handle on what our expectations were for Medicaid improvements reimbursement versus where we see ourselves today. So we again, we expect that's going to be just a kind of steady improvement as we go through the year and into 2018, so consistent with our guidance.

So I'll just make one more comment though. We've got about a 108 million covered lives now, covering low-risk, which is pretty consistent with where we thought we would be. So we are seeing a steady ongoing trend from low-risk reimbursements. And that's not materially different from what our own guidance was, but it is looking as we expected it to look.

Okay, got it. And then just 2 quick ones from me. One, Matt, I think I heard -- if I heard your comment correctly, when you said that volumes and revenue should start tracking each other. So I assume that that's a signal here that you guys think you've found the bottom in terms of overall reimbursement? And then secondly, and maybe this is a question for Steve, given the expected new product launches as well as things in the pipeline, how many products do you think your sales team can carry and effectively sell?

Thanks, Bill. Great questions. So as far as the revenues tracking volume, this is something that we said a while back, and that strategy is now panning out. So that is what we expect to happen roughly for the rest of the year. I don't want to be tied to saying that the ASP has exactly bottomed out. So you will see from that curve, it's possible that the ASPs might come down a little bit more. But we are definitely seeing them stabilize. And referring back to the NIPT question, we do have in the model that the base NIPT ASP should actually start to grow quite nicely as we are in-network, and we're seeing more people reimbursing on that code. So I think the modeling has been very good there. And generally the answer is, yes. We should see the ASPs coming up, and we should see the revenues tracking the volumes pretty well. Steve?

Yes, thanks, Bill. So yes, I think we've announced now 2 new products that we're adding. And then something additional that will be coming later in the year. So we feel like we have some leverage left within our existing sales infrastructure to continue to add more products and grow the revenue that we're seeing per sales rep and per account. But there's also some advantages, I think, to having a diverse portfolio that the sales reps can sell. One, they can focus on what the doctor is interested in learning about. So they are not sort of pigeonholed into just talking about one product, and that may open up doors. Whereas maybe we were blocked out for NIPT, for example, we're now in front of the customer talking about another product, and it gives us an opportunity to then re-pitch them on NIPT. But there's also something that I think is nice for the office to have really one provider for all of their genetic testing. And that allows them to work with one sales rep, one laboratory, one FedEx pickup, one set of internal genetic counselors, one portal. So they get comfortable with one lab as their one-stop shop for really everything sort of complex in genetic facings. And it's a nice package and nice offering for the office.

I think there's something else worth mentioning there. On average, our sales reps are handling about 20 accounts per rep now. But they can handle up to 40 accounts per rep. So there is lots of room for additional growth with the existing SG&A spend, roughly.

Our next question comes from Steve Beuchaw with Morgan Stanley.

I'll honor your request to keep it to one, but I'll make it a 2-parter. And I'll preemptively apologize for this. So the decision to give a fairly comprehensive review of the business and how you think about the strategy, I believe the comment there was, we saw some feedback from investors that suggested that this might be the right thing for us to do at this point. Can you, Matt, just dial all the way down to what you think the 1 or 2 critical things were there? My sense is that there must have been a view out there that the company or the stock wasn't reflecting an appropriate amount of credit for the growth potential that you might now feel more confident in saying you have -- a confidence you have, given the pricing stabilizing. And then the follow-up in this incredibly long question is, why not give a framework for '18 -- for 2018 growth now that we have some visibility on pricing, visibility on guidelines and carrier screening, a reasonable idea how things are progressing within the reimbursement structure around NIPT. Why would it not be reasonable to think about 20%, 40% growth, as a fairly wide band, as a reasonable starting point for 2018?

So one, I think the first -- I'll take the second question first, and then I'll hand to Matt.

Okay, fine.

So it's a good question, Steve. I can give you a general framework now. And I think it's something that over the course of the year, that we'll continue to refine and fill in. I think there is still, as we referenced on the call, there is still a lot of variables here to work out. A lot of them are positive. But I mean, if you just -- you're assuming kind of steadily improving but not rapidly positive changes in ASPs, and we would expect revenue growth to [ track ] volume growth through '18. If you take our target COGS that we've alluded to here, that should have you operating at roughly 50% gross margins or better just given the projects we have already underway in the lab and nothing that we have on the whiteboard right now. And then the new products should be additive to that as well. So if you see, as we expect quarterly cash burn to be going down for the course of 2017, that would imply even less cash burn for next year. So that -- I think that's where we are right now on the kind of financial framework for '18, and we'll continue to fill that in as the year progresses. So Matt, you want to just summarize the 1 or 2 points you wanted to lead with?

Sure. Thanks, Steve. I think I'll give you 3 key bullets to take home. The first is that the investment thesis is panning out as we expected. We took a risk on low-risk. We thought low-risk could get reimbursed. We've seen the ASPs coming down, but those ASPs have not been steadily coming down; they are the result of 3 discrete events, like I mentioned. And you see the waterfall effect of that over the course of the year while we get the reimbursement. So now we are seeing the ASP stabilizing as we see more low-risk reimbursement, as we see Medicaid coming online more and more, and we're seeing the microdeletions reimbursement roughly stabilizing. We hope that will start to pick up over the longer time frame. So that's fundamental investment thesis, that we can become the market leader, be growing volumes and then start to have revenues tracking the volume is a key part of why we wanted to do this presentation. The second key bullet, I think, is just the strength of the channel that we've got. We've got all these great products coming in women's health. They are cutting edge products. And they also have leveraged the existing channel and the control of the OB/GYN, I shouldn't say controlled, but the access to the OB/GYN channel as Steve described. So the strength of the channel, I think, is a key component to the investment thesis. And that's the second thing I wanted to highlight here. And I think the third thing is, we wanted to talk about oncology. We've done a lot of clinical trials looking at what would be the big play in oncology. And we want to come up with something which really works. We don't want to come up with a me-too product which kind of works and takes a long time to change oncology practice. So I think we've got that now. We will publish in the leading journal in the field. And we're going to be seeing some real traction in the liquid biopsy going forward. So I think those are the 3 main things. And we felt that putting together the slide presentation would give a good overview, better than a lot of words.

Our next question comes from Catherine Schulte with Robert W Baird.

Just on the oncology offering, can you talk about that go-to-market strategy, both for the RUO version and then once you launch the CLIA version next year? Who is the primary target customer there? And then are you getting interest from pharma companies to potentially use this in their clinical trials?

Okay. I'll take the first part and then I'll hand -- I will take the second part, actually, then I will hand over to Steve for the first part. So yes, there is a lot of interest with the pharma companies. The performance of our assay, as described in the Nature paper, is generating a lot of interest, both for understanding how patients responding to therapy, looking at residual disease during clinical trials, but also in terms of helping pharma market their offerings that are commercial today. I think in time, a lot of patients are going to be treated upon molecular relapse. Because if you treat those patients earlier, you expect that the outcomes are going to be a lot better. And this is relevant for a lot of new therapies that are in the market as well immuno-oncology. So you should be hearing more about this going forward. That said, Steve, do you want to take the first part?

Yes, sure. So the initial RUO launch, as Matt indicated, we're targeting pharmaceutical companies and also researchers as we move into the CLIA launch. We will expanding that to physicians in addition to continuing pharmaceutical researchers. We're not planning on building a big sales force. We've been successful previously with hybrid models that include distribution partners. We have many distributors today, over 70 around the world. And many of our existing partners are already calling on oncologists in their home countries. But also in the U.S., we do have a targeted strategic accounts team that today calls on hospitals and strategic accounts. And they can expand and start calling on some of the major oncology centers. Many of those folks already have oncology experience. And we think that might be a nice way for us to have a targeted team that we can augment with an expanded distribution strategy.

Our next question comes from Mark Massaro with Canaccord Genuity.

This question is probably for Matt. Your liquid biopsy strategy is essentially to build personalized assays, custom to the patient's tumor. Can you speak, just to a high level, how quickly you can build these assays? Speak to your confidence that you can customize these assays that can be clinically effective despite whatever mutation a particular patient has?

Well, that's a great question. So I wouldn't say that this is our entire oncology strategy. We're still doing a number of trials that are related to reflexing imaging for ovarian cancer, lung cancer, breast cancer. There's a lot of other cancers that we're doing early detection reflex studies on. We're collecting a lot of samples on those trials. But this is the first oncology assay that we think really works, and that we're going to be productizing. So in terms of how quickly the assays can be customized for a patient, that's one of the strengths of the Multiplex PCR technology. You are able to have a targeted set of probes which go after up to 30 -- actually, up to several hundred mutations per an oncology patient. And you can do that without doing much iteration. That can be done within a couple of weeks. It's not really a technology issue, it's more of an operations issue what the turnaround time is going to be. For a long time, we were saying that we had this ability to build these customized panels, but now we've taken that to the logical extension of actually customizing per patient. And that's why we can do this at very low COGS, which we think is going to be very important for wide-scale adoption of these tests in oncology. There's a lot of liquid biopsy companies out there that have these COGS which are several thousand dollars to run their panel. But by customizing it for the patient, you can go down to single molecule sensitivity with very low sequencing costs, and that's going to be key.

Great. And if I can get this one in. Could you just, for housekeeping, what percentage of microdels were you paid on in the quarter? And then related to that -- related to your commentary about how revenues will track volumes, I'm not sure if you're implying that revenues will track volumes perfectly. So any more clarity as to how close those 2 could track volumes?

Well, let me take the last part if I could. So they will roughly track. They will track I think better than they have tracked in the past. As I said earlier, we can't say that ASPs are immediately going to start picking up. But we are seeing them roughly stabilize. So we should see them roughly tracking. And that's as much as I can say here.

And I think, Mark, the point is that we've had quarters of volume growth, but revenues declining as -- the point here is that, as we go forward, when we grow volumes, they should logically follow that revenues grow as well, as you'd expect for most companies. So that's kind of the larger point there. On the microdeletion, so we said on the last call that we were getting reimbursed on circa 10% of the claims so far. And here we've said, we're doing slightly better. I don't anticipate on a quarterly basis revising that number. I think it can be more confusing than helpful actually to track that to a precise number. But we're seeing slightly better than we saw in Q4. And we think that can be stable, and as I alluded on the call, there's ways that it could still improve through the year.

Our next question comes from Raymond Myers with Benchmark. Did you want me to go ahead and continue since you're not responding?

Sorry, Ray. I'm here offline if you want to talk.

Okay, thanks very much, everyone.

Thanks, guys.

Ladies and gentlemen, that concludes today's presentation. You may now disconnect, and have a wonderful day.