Welcome to Natera's 2022 Third Quarter Financial Results Conference Call. At this time, all participants are in a listen-only mode. Following management’s prepared remarks, we will hold a Q&A session. [Operator Instructions] As a reminder, this conference call is being recorded today, November 8, 2022. I would now like to turn the conference 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 third quarter of 2022. On the line, I'm joined by Steve Chapman, our CEO; and Solomon Moshkevich, General Manager of Oncology. Today's conference call is being broadcast live via webcast. We will be referring to a slide presentation that has been posted to investor.natera.com. A replay of the call will also be available at investor.natera.com. Starting on slide two. During the course of this conference call, we will make forward-looking statements regarding future events and our anticipated future performance, such as our operational and financial outlook and projections, our assumptions for that outlook, market size, partnerships, clinical studies, opportunities and strategies and expectations for various current and future products, including product capabilities, expected release dates, reimbursement coverage 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 Form 10-K or 10-Q 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 materially from those contained in or suggested by the forward-looking statements. Forward-looking statements made during the call are being made as of today, November 8, 2022. 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 we'll 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 changes 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 Steve. Steve?

Great. Thanks, Mike. Let's start with our Q3 highlights. As you can see from the press release, we had another strong quarter in Q3. Revenues grew approximately 33% over Q3 last year and we processed 518,000 tests this quarter growing 27% year-over-year. We're seeing strong momentum across all product lines and I'll spend more time on that in a moment. We are pleased to be able to once again raise our 2022 guidance to $810 million to $830 million. At the midpoint, this represents an increase in our revenue guidance by over $40 million, compared to our initial guide in March and this new range implies annual revenue growth of 37%, excluding the one-time QIAGEN milestone in 2021 of $29 million. We are exercising caution in forecasting some of the early results from the launch of the California prenatal screening program. There have been a few legal developments with the program in the last few days and we are evaluating the impact. But for now, we are being careful with our forecast. In addition, we've recently integrated our Empower and Signatera sales teams to focus on centers where both Signatera and Empower in demand. I'll get to the expected benefits of that move later, but we are being cautious with the guide to account for the disruption in the immediate term. One of the key reasons for the revenue raise is the strong momentum we are seeing with Signatera, which is performing well above our internal volume forecast for the year. We processed roughly 132,000 oncology tests this year, and we think we are on track for roughly 175,000 units this year. We will expand on our Signatera volumes further in a moment. The breadth and depth of our data generation for Signatera across multiple tumor types is a key…

Thanks, Steve. Today I will touch on some of the key drivers of our commercial success in Oncology; highlights from our clinical data pipeline; and I'll dive a bit deeper on the key investments that we're making for the future. Steve described the incredible growth that we've observed with the Signatera MRD test. As a reminder, this personalized tumor-informed test has been shown to detect cancer recurrence in many months earlier than standard diagnostic imaging. It can help inform treatment decisions and monitoring the quantitative dynamics to help identify early whether a treatment is effective. The product has been very sticky for both physicians and patients with high rates of repeat testing. We believe our commercial success is attributable to four key strengths. First, we have a large industry-leading team of tenured sales professionals, and we combine that with a team of more than 50 in medical and scientific affairs, including four board-certified physicians, who've practiced oncology. This team is calling on oncologists and surgeons, and we've recently started to gain momentum with large strategic accounts around the country, including the VA and other leading groups. We are really very proud to have been selected as a partner to the veteran community, especially heading into Veterans Day later this week. Number two, our market access team has a strong track record of execution with MolDX, as we've repeatedly secured both coverage and good pricing. For example, our colorectal coverage includes both adjuvant and recurrence monitoring, rather than being limited to just adjuvant. In bladder, it includes neoadjuvant, adjuvant and recurrence monitoring. We think these distinctions are important and are a competitive advantage. On pricing, we've received ADLT status, which is hard for other MRD labs to replicate. And the pricing we've secured this past quarter for the IO monitoring service…

Thanks, Solomon. The first slide is just our standard view of the Q3 results. Steve covered the key trends on volumes and revenues. Our Q3 gross margins were similar to our Q2 levels. Steve touched on the fact that we were able to deliver strong revenue growth despite some headwinds in transplant and germline ASPs, and the fact that we are blowing out the Signatera volume forecast this year. With the strong volume growth we've had, we continue to experience some backlogs and test sessioning, although we do expect to have that fully resolved during Q4. All of those variables together modestly held down gross margins in the quarter, compared to what we think they can be in the future. R&D expense was lower in the quarter, due to a change in accounting treatment of expenses related to the small technology acquisition we made last year. But pro forma for that, operating expenses were basically flat sequentially. Since the last quarter, we fielded a few questions on our increase in receivables this year. For context, if receivables trends had remained constant to Q4 2021 levels, we would have collected roughly $80 million in additional cash by this point in the year. We think about $50 million of this cash can be collected between now and Q1, and the remaining $30 million would flow in over time as we collect from Medicare on a longer collection cycle. To provide a bit more detail, there are two primary drivers for the increase in receivables. One, is the temporary issue we described on the Q2 call in which we held a one-time bolus of accrued Women's Health claims in our system prior to submitting to payers for reimbursement. That initially represented about 60,000 claims, all of which will be billed out by the…

Thank you. Before opening the lines for questions, I would like to turn the call over to CEO, Steve Chapman. Steve?

Yeah. Thanks, operator. Just one quick clarification, so earlier in the call on the prepared remarks, I said that we expect to do about 175,000 Signatera tests this year. It was actually meant to be greater than 185,000. And I just want to reiterate that we're expecting to see robust quarter-on-quarter growth between Q3 and Q4 in Signatera. Thank you. Let's open it up for questions.

[Operator Instructions] Your first question comes from the line of Puneet Souda with SVB Securities.

Yes. Hey, guys. Thanks for taking the questions. So a couple of questions. The first one on the 53,000 oncology test, I mean, that was well ahead of us. And more than 185,000 that you are guiding to here and that implies 145% growth year-over-year. So real -- the first question really is how do you think the ASP growth is going to trend now as a result of the ADLT Medicare payments that you're getting obviously different payments, different indications? So how should we think about ASP? That's number one. And then number two is really, I think the big question here is given one year of experience that you have had with this assay and the remarkable growth that you're seeing here sort of how should we think about the 2023 growth here? Because obviously, you -- this is -- you have a leadership position here and you're continuing to grow very meaningfully in this market.

Yes. So let me make a couple of comments, and then I think Mike you can dig into the ASP and, I think ‘23 growth trends. But I'll just say, first of all, we're obviously very pleased with the rapid growth and the uptake that we've seen both in colorectal and then in indications beyond colorectal. And we think this is just the beginning. I mean, if you look at the momentum that we have, I think we're really building a great flywheel here, especially with the data. So we've got a lot of opportunity ahead of us. And we certainly are seeing a shift over time into that recurrence monitoring indication as you'd expect, it's more and more patients come into the pipeline. But at the same time, we're also seeing very robust growth in that initial time point for new patients coming in. So as we mentioned in the prepared remarks, last quarter, we had 25% of U.S. oncologists to order the product. And I think that's really incredible based on where we are now. And I think that's going to continue to get better over time. So as more patients shifting to recurrence monitoring as we start to get commercial coverage, as we start to get a broader array of coverage beyond colorectal, IO and bladder. I mean, all of these things can have a positive impact on ASP. So Mike, do you want to touch maybe briefly just on some of the ASP trends and then on ‘23.

Yes, sure. Thanks, Steve. And thanks, Puneet. Just to level set, like where we've been and where we're going on Signatera ASPs, we started last year with the $500 on ASP and we've rapidly grown that ASP as we've gotten coverage for Medicare and the mix shift has continued to improve, both in terms of mix of Medicare reimbursed CRC patients and also a steadily improving mix recurrence monitoring patients as well. I think that mix shift is something that's a pretty durable trend into next year. So we exit 2022 in that mid-$700 range. I think there's room to grow another $50 to $100, just purely on the mix shift dynamics alone. And then beyond that, Solomon touched on, the favorable reimbursement we've now formally secured in terms of pricing on immunotherapy response monitoring. So we'll start to build out those claims as well. And then we've got a lot of opportunities to significantly broaden reimbursement both in terms of, for example, breast cancer reimbursement for Medicare's a possibility as a broader commercial reimbursement in colorectal cancer. So a lot of really positive drivers that I see as kind of multiyear drivers for the ASP.

Got it. That's helpful. And then on the early screening programs, Steve, I mean, I appreciate the RS data and the FDA discussions which you've had. But this market already has two liquid competitors. There's this tool competitor that could also launch a liquid test. And so just help us think about how do you want to position in this market. And obviously, that -- my assumption is that, that will involve addition to cash burn. So what does that mean for then for 2023 when you are expect to moderate that cash burn in ’23. So just walk us through how that's going to happen. So thank you. Thanks for taking my questions.

Yes, thanks. So I think, look, we've been in a position before where we're not the first entrant into the market. And I think we did really well in that position. I think there's an opportunity, I think, now to kind of take a step back and look at the landscape and what's happening as different products get commercialized and then tailor our launch strategy to that. And that includes I think some things on tailoring the road map and sort of doing the design in a way to pick up certain aspects of the detection that I think would be important. So in some ways, there's an advantage to being in the position that we're in. I’ll also just sort of reiterate, we do have a big one sales team. I think somewhere kind of in the range, commercial team members all in, I don't know, maybe 300 people or something like that. So we're covering a broad swath of the primary care practices, because most women see their OB-GYN for primary care. We think that's an opportunity for us as we look to commercialize product in the future. But when it comes to kind of figuring out the trial plan and the opportunity for us there and which path we're going to have to go down we've already gotten that sort of built in to our budget plans over the next couple of years. So when Mike and I talk about a path to cash flow breakeven that had a very significant reduction in ’23 that includes the necessary spending on the clinical trial that we think we may end up ultimately having to do in early cancer detection. So we've already been built in. And I think we -- you just have to kind of stay tuned to the data as it reads out, and we'll go from there.

Your next question comes from the line of Tejas Savant with Morgan Stanley.

Hey, guys. Good evening. So sticking on the cash burn theme there, Steve, just beyond the pan-cancer push for Signatera and the bets you laid out in oncology here on this slide. Is there anything else we need to be keeping in mind? And how are you thinking about that mid-‘24 sort of breakeven time line? Is there any sort of like slippage there? Or do you still feel really confident that you can hit mid-‘24 for breakeven?

Yes. So maybe let me make a couple of comments and then I'll turn it over to Mike. And as I'd say, first, when you look at the projects that we have to get executed, to get to cash flow breakeven, I think, first of all, we're taking cost management very seriously. I think many of you saw we recently had a workforce reduction, probably about 115 people. And we've looked at ways to create synergies across the business by integrating the Empower sales team with the Signatera sales team. So we're taking this initiative very seriously. We also have many COGS reduction projects that includes things like building out new lab capacity in Austin that includes things like moving to more higher throughput, lower cost sequencers. So these are projects that aren't difficult to do, they just have to be done. And they just take manpower and time and planning development work to get done. So we could see that path pretty clearly ahead of us. Then there's the execution on the ASP, there's things like getting more indications covered for Signatera, getting commercial coverage for some of the colorectal tests that includes improving ASP coverage in other areas of the business. So as all these things come together, there’s obviously some puts and takes, and there are some things that are directly within our control and there are some things that are a little less within our control, what we've set up, I think, nicely for. And when you put all that together, I think we expect to see a very significant reduction in cash burn in ‘23, followed by a very clear path to cash flow breakeven. We do think that, that 2024 time line is achievable. I think mid-‘24 is achievable and we're putting all these pieces together and kind of seeing where we hit on that road map. If we did get in a position where we wanted to accelerate things, there's a lot of levers that we can pull some of the big bets, I think they that Solomon outlined. I mean look, we're doing a lot of things that cost a lot of money, because we think they're important for the future of the business. Now if we said, look, we want to pull in getting cash flow breakeven by one quarter or by two quarters. We could pull a bunch of levers and we can do that very quickly, but we don't think that's the right move necessarily. We think being prudent sticking to the plan, executing the COGS, executing the ASP, keeping the expenses relatively flat is the right strategy, and it's good that we're seeing this line of sight in our model clearly at this stage. Mike, do you want to add anything?

No, that was quite comprehensive. Thanks, Steve.

Got it. That's helpful. And then one on Signatera for me. Steve, can you give us a sense of, 185,000 tests that you hope to do this year. How are you thinking about the fraction that you anticipate sort of getting paid on at the moment? Obviously, it's going to go up as reimbursement broadens and you submit these -- the prior claims to Medicare as well. So curious on that bit. And then on the NCCN process, given that you have this Nature Medicine paper here, are you still feeling good about the sort of April, May time frame next for guideline inclusion. And do you think it should be a relatively straightforward process now that you have this marquee publication out there?

Yes. So maybe let me comment on NCCN. And then Mike or Solomon, you guys can talk a little bit about sort of the mix that we're seeing between covered and non-covered indications. So on NCCN, I think we all know that they sort of met in August. We haven't seen the readout from that meeting. We think it will come out in the near future. But I think the unfortunate part was that the circulate paper wasn't included, obviously, because it wasn't accepted and pure reviewed at that stage. So now that it has been accepted in Nature Medicine, which is one of the highest impact journals in existence in the entire field of medicine, I think that being very prominently featured. I think we'll obviously allow that to be included in future reviews of the guidelines. So we just kind of have to see how things go. But I think the results of the August meeting, just unfortunately are going to be including that publication in a significant way. I do think there's line of sight as we turn the corner into next year, but we really just have to kind of see how things pan out. Then one, I think, really big upside surprise that was a big win for us was to see these Japanese society and medical oncology guidelines come out. I think this is a great step forward to see a national guideline like this be formally put in place. And obviously, I think it's something that committee members around the world will be looking at. And I think that's a great step forward. And I think there's a positive read-through there as we look for the future of MRD testing. Mike, Solomon, do you want to cover kind of what we're seeing from a indication mix, which we covered and non-covered?

Mike, do you want to take that?

Yes, sure. So I think that the overall mix is roughly stable to what we've talked about previously. I mean, I think there's kind of some modest improvement that we are glad to see on a sequential basis. So what that means is roughly half of the volumes are falling into indications where we have a Medicare coverage. Now, that doesn't mean that half of the volumes are reimbursed, because not all of those patients are obviously Medicare patients. For example, what we're seeing in the colorectal cancer indication is something like high-30s percent of those people are actually Medicare reimbursed patients. And we've seen some really nice progression there from the low-30s to the high-30s over the last year. I think there's potential scope for our Medicare mix within colorectal cancer to continue to improve. So that's one way to think about mix and the way to think about mix is upfront testing versus serial monitoring, and that's progressing really nicely, perhaps as you'd expect. We had a really strong launch year where a lot of people got their initial Signatera tests and set up last year and then they're coming back, they're staying on protocol and getting repeat monitoring tests. And so that mix continues to improve in our favor. So that's kind of a high-level view of the mix, and those trends are modestly above, I think, where we would have hoped to be at this point.

Your next question comes from the line of Max Masucci with Cowen.

Hey, thanks fior taking the questions. First one, just curious, what are the key time lines or checkpoints that we should keep on our radar for the build-out, the refresh of your internal sequencing infrastructure and capabilities. And I'm curious if the mid-2024 profitability target assumes that the updated or enhanced infrastructure is in place or if you're still outsourcing a bit?

Yes. So let me comment there first and then we can open it up further. So there are several projects that we have right now that include both, kind of, scaling up our lab infrastructure, particularly, I think, our tissue infrastructure and then also moving up to more high throughput, scalable sequencers for Panorama. For example, there we're still wanting despite the number of Panorama tests we're doing, we're still running on the next seat. So advancing the sequencing system there, obviously, is a pretty straightforward project. There's other areas where we have significant COGS reduction opportunities in the range of $20 million plus per project. Now the vast majority of these are in progress right now and are going to be the primary projects that we work on throughout ’23 along with several technology advancement opportunities. Actually, we've got some really exciting stuff coming as well. It's not just COGS reduction. There's some really, I think, cool technology advancements that we're working on as well. But I would say these things will, kind of, come in more towards the end of ‘23 and as we kind of turn the corner and then in the beginning of ‘24, just given the scale and the size of some of these projects. Now some of them are, kind of, hitting right now and will be phased in throughout the course of ‘23 and get up to full capacity by the end of ‘23. But then many of the other ones will, sort of, hit in that kind of late ‘23, early ‘24 time frame. Mike, do you want to add anything further to that?

No, I think that covers it.

One moment. Your next question comes from the line of Julia Qin with JPMorgan.

Hi, good afternoon. Thanks for taking our question. So on cancer screening, you know that the two potential FDA approval pathways. Could you talk about kind of the pros and cons for each and what the product's competitive positioning would be under each pathway? Obviously, the two scenarios would have very different cash burn implications as well? So when you said earlier that your current cash flow expectation already fully invest that investment, are you referring to the more cost-efficient scenario using the oral health data with those market studies? Or are you embedding a potential need for a prospective trial before the product launch? And how should we think about the general time frame on that side?

Yes. Thanks for asking further there. So I think from a -- look, from a positioning standpoint, it's always been our focus to lead with technology and lead with performance. And that's what our goal is here as well. As I mentioned, we have an opportunity to kind of take a step back and see what's important, adenomas, for example, that maybe if those that started the development multiple, multiple years ago, didn't really kind of have that opportunity to kind of take a step back. So we're designing our product in a way that I think leverages the strength of our core technology and the capabilities that we have, but also what we know about how the market is developing. And then also the unique data that we have access to. Now we have 50 plus thousand tumor exons that we ran uniquely early-stage tumor excellence that we can leverage as far as mining data and understanding what's important. So we think leading with technology and leading with performance is always a great way to go. Of course, COGS and distribution is also important to him, and we'll be focusing on that very clearly. So when we look at the different pathways, I think that one pathway of running the oral health samples as the FDA validation study and then doing the post-market surveillance study or the other is running oral health as sort of an initial validation and then doing the prospective FDA level study. Actually, the cost associated with both of those, we think, will be roughly about the same. I think in both cases, we'd be enrolling kind of similar number of patients and we expect the enrollment to take kind of a similar amount of time. And actually, I think as we start to kind of look at the landscape and some of the newer ways of doing studies, there's been some companies recently that have done prospective trials in the range of 10,000 patients that are, sort of, matched with gold standard colonoscopy and they've executed those studies in the range of, kind of, $15 million to $20 million and took in the range of kind of one year. So I think there's some newer designs and newer ways to do studies that we intend to, kind of, leverage some of these newer trends, and we think we can do it in a pretty expedited manner in a pretty cost-effective manner. But either way, it's going to cost us kind of roughly the same amount.

Got you. That's very helpful. And then another one on Signatera, does your current guidance assume any meaningful contribution from the VA contract and the IO monitoring reimbursement? And if not, it's still how much? And how should we think about the magnitude of those incremental revenues going forward in ‘23?

Yes. So I'll just mentioned briefly, we do include IO monitoring, that's something that although we just got the pricing in. And I think, obviously, there's actually some upside in the pricing versus what we had initially expected. I think there's some -- I think that is generally part of our guidance, and we're seeing good growth there. The VA is really a new win. And this is something that I think does represent upside. It's not something we had kind of plugged in Solomon, do you want to talk about the VA and kind of what our expectations are there?

Yes. So we're really excited about working with the Veterans Administration. This was a public RFP process that was initiated earlier in the year. It was a competitive process that Natera was selected through. The process was narrowed to only labs, who had a tumor-informed test were eligible, which I think was a good signal of kind of where the market is going with its perception of tumor-informed testing as the standard -- as the emerging standard-of-care. And so we were selected for this contract. It is sort of as many testing contracts with the VA have gone, it's an initial step. It's in the range of $5 million to $10 million in size, and we expect that Natera is going to provide great service as we have to our other customers and that that's going to lead to re-up opportunities in the future. The contract does cover serial testing. And it is pan cancer in nature. However, we do expect the initial rollout to be heavy on colorectal cancer, as we've seen with many of our other customers. And I think the VA is an important example of strategic account adoption that we're seeing with many other leading large oncology groups around the country and I think it's going to contribute to our -- achieving the mission and to our first-mover advantage.

Your next question comes from the line of Catherine Schulte with Baird.

Hey, guys. Thanks for the questions. First, for the IO $7,500 pricing, how many tests on average are you seeing in that bundle as we try to think about the impact there? And then can you just give an update on where Signatera COGS stand today and the path forward for that?

Solomon, do you want to take the first one?

Sure. Yes. I don't think we've previously talked about average number of tests per patient, but what I can say is that the pricing for that service does reflect an expected higher testing frequency and slightly longer time frame on average than what you would see with the service that was priced for patients with colorectal cancer, for example, for Signatera, where the pricing was just under $6,000. So that's what the pricing did reflect. Now I think we'll -- when we're announcing more information, more granular data about average test per patient and then we will be able to give more detail on that.

Yes. Let me comment on the COGS question. So just on a blended basis, our COGS, again, just a level set. Historically, we had COGS upwards of $600 on a blended basis per unit that's dropped down through the course of ‘22 to now that's kind of in the low to mid-$500s here in Q3 and expected in Q4. And then based on some of the improvement projects and in-house projects that Steve was -- we're seeing earlier in the Q&A, we think that can drop down below -- lower again to below $500 on a blended basis per unit next year and just going to continue to get lower as your mix continues to shift towards repeat monitoring, and we just continue to get more efficient.

Got it. And then for the California NIPT program, if it turns out that, that program is not allowed to stand, are you locked into your pricing with the state? Or is that something you can renegotiate?

Yes. Let me kind of talk on that. So I think the program, the way was kind of initially devised, there was an RFP process, and we were selected, I think a lot of companies applied and they all had to make decisions about what they thought was best for them. But in the end, it was Austin and Quest, we're the only ones really allowed to offer NIPT testing in the state. We thought that, that would be, I think, okay, given that we're taking a lower price and we're expanding the volume and there's some opportunities to cross-sell other products. So we decided to go ahead and participate. Now obviously, it's a lower margin opportunity. It wasn't ideal, but we decided to kind of go ahead with it because we thought it was important to be in California. Now with this recent legal happening where there's an injunction that's been given against the program that prevents them from, kind of, implementing certain aspects of the program. I think it's not clear exactly we're still, kind of, understanding what that means. So that I think one of the likely path is that we kind of go back to the way things were. And that's, I think, frankly, a positive for us. But we're also fine being in the program. So I think we just have to kind of see how things pan out. For us modeling goes, we've obviously been very conservative in our guidance both for the, kind of, rest of the year and as we turn the corner into ‘23, assuming, sort of, the worst-case scenario. So any improvement to that worst-case scenario would be upside.

All right, great. Thank you.

We have reached the allotted time for questions. This concludes today's conference. You may now disconnect.