Good afternoon, ladies and gentlemen, and welcome to the Veracyte's First Quarter 2018 Financial Results Conference Call. [Operator Instructions]. As a reminder, today's conference call is being recorded. I would now like to turn the conference over to your host, Ms. Bonnie Anderson, Chairman and Chief Executive Officer. You may begin.

Good afternoon, everyone, and thanks for joining us today for our First Quarter 2018 Financial Results Conference Call. Joining me today are Keith Kennedy, Chief Financial Officer; and Chris Hall, President and Chief Operating Officer. Before we begin, Keith will take us through the safe harbor statement.

Good afternoon, everyone. I would like to remind you that various statements that we may make during this call will include forward-looking statements as defined under applicable securities laws. Forward-looking statements include statements regarding our future plans, prospects and strategy, financial goals and guidance, product attributes and pipeline, drivers of growth, expectations regarding reimbursement and other statements that are not historical fact. Management's assumptions, expectations and opinions reflected in these forward-looking statements are subject to risks and uncertainties that may cause actual results and our performance to differ materially from any future results, performance or achievements discussed and/or implied by such forward-looking statements, and the company can give no assurance it will prove to be correct. In addition to today's press release, those risk and uncertainties are described in the company's filings with the Securities and Exchange Commission. Additionally, non-GAAP financial measures will be discussed on this conference call. Please refer to the tables in our earnings release in the Investor Relations portion of our website for reconciliation of these measures to their most directly comparable GAAP financial measure. Prior to this call, we announced our first quarter 2018 results, which are available on our website, veracyte.com, by clicking menus on the top right corner of our website and clicking through to our Investors landing page, and then Press Releases. We also released a financial presentation, which I will reference later in the call when I cover our financial results. You may find a financial presentation in the same Investors section under Events & Presentations. I will now turn the call over to Bonnie.

Thank you, Keith, and thanks everyone, again, for joining us today. We delivered very strong results this quarter with revenue of $20 million, which was a 22% growth over prior year and the highest revenue in any quarter since we launched our first product seven years ago. We also entered the second quarter with momentum across the business, strong test volume growth driven by the reacceleration of the Afirma GSC and in-network contract with Anthem and a significant uptick in Percepta orders. Other important highlights include, the introduction of our Afirma Xpression Atlas platform; our research collaboration with Loxo Oncology, which provides a strong validation of our technology depth; and our continued progress with our Envisia classifier, as we initiate an early access program and progress toward Medicare reimbursement. We are excited about our progress and believe we are realizing the upside from the significant foundation we have built for our business. I'll walk you through the highlights of the quarter using the key metrics by which we measure our success. The first is commercial growth. We saw renewed growth this quarter with our reported genomic test volumes increasing to 6,864 tests, marking an 18% increase over the same period last year. We attribute a significant amount of this growth to the previously anticipated reacceleration from our next-generation Afirma GSC, which our customers are quite excited about. We have now converted approximately 70% of our volume to the Afirma GSC, which is ahead of plan, and expect to have all accounts converted, with the potential exception of those in New York State, by the end of the second quarter. The Afirma GSC has been positively received by the physician community because of its ability to keep potentially 70% of benign patients from unnecessary surgery and its improved performance on more…

Thank you, Bonnie. As mentioned earlier, you may find our financial presentation on our website at www.veracyte.com under Investors and then Events & Presentations. I plan to speak about our first quarter 2018 results, and to conclude with an update on our 2018 guidance. Turning to Page 3 of the presentation. Our performance against 6 KPIs, or key performance indicators, for the first quarter of 2018 as compared to the prior year quarter are as follows. Revenue of $20 million increased 22%. As noted in the highlights of the bottom of the page, Afirma revenue, including variance, increased 24%, driven by a 14% increase in reported test volume plus a 10% positive impact from rates and improved cash collections. On average, we accrued between $2,600 and $2,700 for the Afirma Genomic Classifier tests, including variance, meeting our revenue recognition standard, which was between 90% and 95% of the reported Afirma Classifier test volume. We collected $19.7 million in cash this quarter, and we recognized $0.7 million of revenue that was in excess of original estimates for claims outstanding as of March 31, 2018, principally from Blues plans. In cytopathology revenue of $2.1 million increased 3% over the prior year. Moving to our second KPI. Genomic volume of 6,864 tests increased 18% and included 6,649 Afirma reported test results and 215 Percepta reported test results. Our third KPI, gross margin was 61%, declined 100 basis points. Gross margins were positively impacted by our ability to get paid for our tests, offset by the cost of running dual platforms as we transition our customers to our next-generation Afirma GSC. Our fourth KPI, operating expenses, excluding cost of revenue, were $21.1 million. Operating expenses increased $3.5 million over the prior year, driven by a $3.6 million increase in sales compensation as we continue…

Thanks, Keith. To summarize, we had a great quarter, in which we surpassed revenue and genomic test volume growth expectations, executed an in-network contract with Anthem, accelerated Percepta adoption, moved Envisia toward Medicare coverage, launched our Afirma Xpression Atlas platform and entered into our first agreement with Loxo Oncology that will leverage our technology depth and market leadership to help advance physician medicine. In the coming quarters, we expect to continue our strong momentum with key catalysts that include completing the conversion of all of our thyroid accounts to the next-generation Afirma GSC, increasing Percepta adoption and gaining Medicare coverage for Envisia. We will also continue to advance our pipeline. Specifically, we look forward to sharing more on our research and clinical trial progress to develop a nasal swab test that can detect lung cancer earlier when it is more treatable and thus more lives can be saved. Needless to say, we are excited about how 2018 is shaping up and for what lies ahead. I would now like to ask the operator to open up the call for questions.

[Operator Instructions]. Our first question comes from the line of Bill Quirk from Piper Jaffray.

So Bonnie, a quick question for you on the Afirma Xpression Atlas product. Maybe if you could help us think a little bit about the timing here? And it sounds like there's kind of two tracks. One, obviously, your collaboration with Loxo, and I would imagine you'd be recognizing some revenues associated with that. And then presumably the longer-term play here is to have this on market to help with thyroid cancer therapy selection, I think, if I understand it correctly.

Yes. So I think when we transitioned from our original Afirma GEC to the GSC, part of the benefit of that transition was moving to a deep RNA sequencing platform that provides much more extensive content than could be achieved while we were on an array-based platform. And I think we're one of the early companies to actually move to deep RNA sequencing, and the benefit there is that we can pick up all of these variants, whether they are DNA variants' expression, fusions, et cetera. And that will be true -- that content is actually part of build of the classifier for the Afirma GSC. It also, by the way, is the basis for the Envisia classifier for IPF, so -- where we've been moving things over to this platform. Because we can collect all this information as we run that testing, that then gives us another vehicle of informing for targeted therapies where it makes sense. And that was the basis of our collaboration agreement with Loxo Oncology. And while we're starting with in thyroid cancer and, certainly, are excited about that collaboration. But I think, it's new, and we're early and these variants are very rare. So we do expect a small amount of revenue, but it will be very small as we look through the end of this year. But this platform can definitely be leveraged, we believe, in the future in lung cancer and IPF as well.

And Bonnie, maybe just taking that, I guess, extending it, how important was the recent CMS decision around NGS assays for therapy selection in terms of how you're thinking about this longer term?

Yes, well, I think for us and our core business, the classifiers that we're building are being used to diagnose early lung nodules as benign or malignant. And so that NGS coverage decision was uninforming on advanced cancers, which is actually not what we do in our core business. And then we would just need to see, as we extend it, if we end up focusing on that part of the business, then that could be an opportunity. But right now, we see it just as an extension in informing surgery and treatment decisions for physicians in thyroid cancer diagnosis and workup.

Of course. Yes, I know, that's actually -- that's I was referring to just kind of the longer-term opportunity around informing treatment decisions. Okay, and then, Keith, just a question for you as well. Just thinking about the raised revenue guidance, but no change to cash flow. Can you help bridge that for us?

Yes. So we continue to build out our sales force, and we run various models out. We're playing this out, but I tried to give you guys some more guidance on what our spend would be on a quarterly basis for the three, sort of grouping, sales and marketing, G&A and R&D. When you run those models through the midpoint of the range, you'll see there plus the noncash charges that are fairly stable quarter-to-quarter. It comes out in that range. We obviously internally are taking measures to improve that. Some of this will have to do with ASC 606 and untangling that web of what was meant to be simplistic is not turning out to be as simplistic. So for example, we didn't give you a lot of thought around Loxo at this point, primarily because we're still working through those kind of models. But as time goes on, we learn more and we'll be able to tell you more about that story and our cash burn story, but it'll probably be next quarter.

Our next question comes from the line of Sung Ji Nam of BTIG.

Bonnie, would you be able to comment on kind of the progress you're making with the commercial payers for Percepta? I was wondering if you guys might be able to move the needle meaningfully this year on that front.

Well, as I said in the prepared remarks, we've sort of completed that journey with Afirma now and have definitely turned our attention to bringing Percepta through. Maybe Chris could just, since he leads that effort, give a little more color.

Yes, so we started the commercial journey, and we started to bill payers. We are starting to get paid by commercial payers for Percepta, which is great news and great progress. I think what has to happen really to drive progress, and our goal is to do it -- that this year are two things, One is, we've got to have physicians around the country ordering the product because when you do that, then you can start to have those physicians engage with payers to help underline the importance of making sure that the product is covered for their patients; and secondly, you've got to be able to start billing for the claims and winning some of the appeals, so that when you sit down with the payers, you've got a track record of both success of winning the appeals and they can see that that's happening, and secondly the physicians are underlining to support the community. So we're on that journey now. We feel good about it. And I'll remind everyone that what we really are excited about is because we're now widely in network with all these payers. We believe that we'll be able to accelerate the coverage faster than what we've been -- we were able to achieve with Afirma.

And then from a -- as you all are thinking through your models, I think Bonnie gave through -- gave you guys some sense of the volumes, which we talked about in a lot of detail last quarter, that is our revenue per reported test on that product was between $600 and $700 this quarter, and we like to build that obviously throughout the year and the years somewhere in the plus or minus $1,000 per test, $100 here or there on either side, but we sure are going to have to track that progress realtime because we don't -- we're developing the evidence collection based on the cash collection history and it's just too early to give you a lot of confidence in that number, but we are setting expectations internally and pushing that forward.

Okay. And then just one follow-up. I was wondering on your Afirma ASP ended up being higher than I had expected, at least, and with -- it's already within the range that you had provided or guided -- you had provided for the year. And so do you continue to expect that range for the remainder of the year or should we also expect some upside potentially?

I think we came in higher than we thought. We collected about $0.5 million in excess of claims that we already thought we had collected on this quarter. And that resulted in, obviously, a reevaluation of what our accrual rates were, which resulted in a $700,000 increase we got through with the auditors. We expect that range will hopefully improve. We've done a lot of things on the billing side, cash collections were very, very good this quarter and are trending very, very well. But I think we're probably up 100 hours than where we were last quarter in terms of those estimates.

Our next question is from the line of Puneet Souda of Leerink Partners.

So just wanted to understand in terms of the sites currently you have for Percepta, how many extended in the quarter? And essentially it's -- with the current order rate, do you see -- do you have the sales reps, enough sales reps in place that you remain confident for reaching the 500 to 1,000 run rate by fourth quarter? And then I have followup.

Yes, we're very confident in the guidance and the underlying overall volume supports that. Chris, do you want to talk a little bit about the sales?

Just a few thoughts. I mean, first of all, we've -- we started making the push this year, early this year with all of the sales reps. And our overall goal was to make progress and enabling this multi-product selling organization. We think we really made a lot of progress in doing that. We were really, really excited that almost all of our reps, nearly all of them, were able to close and get a sample from a doctor and driving Percepta, while at the same time, keeping their ball on Afirma and driving the product -- driving the success of the product. So we felt really good and as we move through the year, we feel like we're well positioned there. Secondly, we continue to believe that the test is being used the way we are positioned in the marketplace. There's a great demand for physicians to do less invasive procedures on these patients and they're embracing that test to do this. And so as we get more experience and we engage with more doctors and more institutions, we're hearing feedback that the test is positioned exactly where it should be and that gives us a lot of confidence. In terms of the number of sales reps, we're sitting -- we're just shy of about 80 in the field right now. We've moved the needle significantly as we move through the quarter. We added a lot of people at the end of March, and we feel like we're in really good spot to continue to drive through the year. We'll layer some more people in as we go through the year. There's always some ins and outs at the sales organization, but feel like -- we feel like we're really well positioned to achieve the guidance that we've talked about, given the way the first quarter came together.

Okay, great. And then just a broader question on overall field of injury studies that you're doing, and should we expect some meaningful data from that in the year? And maybe just around liquid biopsy, there are a number of projects that are pointing in this direction as well for identifying and diagnosing similar to Afirma. Just wanted to understand how you're looking at those and your overall view on the space?

Yes, I mean, I think the science is early, but progressing nicely. And of course having the backbone of data underlying Percepta continue to emerge, it's the -- it really adds a lot of validation to the idea that you can detect lung cancer from a genomic signature from epithelial cells and not need a sample from the nodule. And so as you know, we do have early data suggesting this can be extended to the nose and we'll be advancing all of those programs. When we acquired Allegro Diagnostics back in 2015, a lot of these nose samples were part of the library of samples that we were able to collect there, and our collaborations have continued very strong with Boston University and the team up there. So yes, I think data and probably just progress on how the clinical studies are going we'll certainly report on before the end of the year.

And our next question is from the line of Amanda Murphy of William Blair.

I just actually had a follow up to Bill's question in terms of the opportunity with the deep sequencing you're doing now on the thyroid side. So I guess quickly, are you able to -- I don't know how much of your historical samples you have access to, are you able to go backwards in time and either offer that service to patients or maybe I don't know how long you bank the samples for, but build -- continue to build out that data set historically? And then I guess following on to that I was wondering if you could just give us a quick idea of the thyroid development market? I am just thinking about the opportunity to expand beyond Loxo and TRK fusion in terms of additional partnership opportunities in thyroid?

Right, well, I would say that we can't inform on Loxo's programs and how they are unfolding what they're doing there. But we obviously have a very, very extensive biorepository that we've built, not only with the research access to clear stream, but from all the samples that were accrued even during our VERA001 clinical study that validated the GEC back to the New England Journal paper. So we probably do have the world's largest reach into thyroid cancers and some of the nuances in science that can be learned from that, And that's what our research collaboration is all about. So we're really excited that we can leverage that and have this type of relationship. Thyroid cancer, as you know, has -- and it's a type of cancer that has not had a lot of drug development focus over the years because we had [indiscernible] over a bullet called radioactive iodine that was sort of uptake and was the treatment for all these cancers. But now we know that some of the newer types of drugs are being developed in pan-cancer modes to also attack those that are recurrent or aggressive or metastatic thyroid cancers, and that's the small place in that bigger universe that we can play in. And we'll leverage our capabilities potentially to other agreements, but I think the more exciting thing is what we can do with the fundamental platform technology that we're now on and how we can leverage that to extend the business in our other indications as well, not just thyroid cancer.

Right. And then Keith, just a quick one for you. I think last quarter, you talked a little bit about the 14-day rule and I think that may be helping just from a billing perspective. I don't know if it's too early, but maybe can you comment on that if it has had any effect at this point?

Well, I mean I was aspired by the...

Amanda, it's Chris. I mean, I would note that as that evolved at the end of the year, we do believe that it removed a friction in the commercial relationship with the hospital because we had to go in and contract with a hospital to do the billing to the hospital, and then the hospital would bill the local Medicare intermediary and all of that process played out, and we got good with doing that and trying to figure it out. That slowed the entire process down. And so we do believe that the acceleration that we've seen this beginning part of this year is partly due to turning the full firepower of the commercial organization of the product. But secondly, it's the removal of that friction that occurs when you have to do a contract within a hospital, which just slows the process done. So we feel like the progress we made this quarter shows that it's what we think was going to happen is actually happening. So we feel good about it.

[Operator Instructions]. Our next question comes from the line of Paul Knight with Janney Montgomery Scott.

This is Carolina Ibanez on for Paul Knight. For the institutions that have adopted Percepta, does this adoption mean that an internal protocol has been established in the center and that you would expect a lung cancer expert in the particular center order the test?

That's a great question. I mean that's clearly the commercial goal, right, is to be able to have the test building as a protocol. So that it's done on every patient as they're getting assessed for long nodules by every physician. And we've had success in doing that. I think we're early stage, and I think what happens in an early-stage launch is you start to have physicians working with it and getting experience with it and then moving it into a protocol-driven situation. So I don't want to say that we don't have. We certainly have clients doing that, but I don't want to misrepresent and say that that's standard at this stage because really as you get going, new people get experienced with the product, they feel confident about it, and typically you enlarge your presence in an institution, and then total commercial success is, obviously, a protocol where it's done on all the patients. But that's the goal, Carolina.

Okay. And then, how would you describe these institutions in terms of the volume of bronchoscopies they process, I mean, relatively to other centers, just to an approximation? And if there are also screening centers for lung cancer, meaning that if they do a lot of follow-up with any intermediate nodules detected?

Well, I think we've seen commercial -- this is what -- one thing that I really thought has been exciting is we've seen commercial success in early adoption at centers across the range that you would see. We've seen it in some of the big institutions around the country, which do a lot of lung cancer bronchoscopies. We've seen it at academic medical institutions where they've installed as and implemented as some of the early registry clients that we've had that have been long-term users in the registry and even switching to commercial and even academic medical centers, and then we've seen it in community hospitals. One of the -- one of our hypothesis was that clients that were using Afirma, our sales reps would have relationships that would allow them to accelerate the launch of Percepta, and one of the things we noticed is that nearly half of our Percepta clients are using Afirma. It's really underlying the strategy of having the rep with the relationship carry both products. So I think we've seen it across the lung cancer continuum. These patients are typically still managed locally. So when the doctor does a bronchoscopy, that pulmonologist typically is the same who decides on the follow-up and manages the process -- the patient through that process. So we don't usually see them being referred on. We see them being kept at that center. Hopefully, that's helpful.

I would now like to turn the call back to Ms. Bonnie Anderson, Chairman and Chief Executive Officer, for closing remarks.

Thank you all, again, for joining us today. We certainly appreciate your ongoing support, and look forward to keeping you updated on our progress. Thank you.

This concludes today's conference call. Thank you for your participation. You may now disconnect.