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…

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…

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…

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…

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…

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.