All right, we're good? All right. All right, good morning, everybody. This is, for those of you looking or watching the webcast, this is Doug Schenkel again from the tools team and diagnostics team here at Wolfe Research. It's my pleasure to welcome Mike Brophy, the CFO of Natera. I have worked with Natera, I think going back to pre-IPO days, and I've always thought very highly of you and the team, but it is just amazing what you guys have built and what you've been doing over the last few quarters. So I'll pause there first, but thank you, Mike, for being here with us.
I distinctly recall quarters in 2015 with polite forbearance from the dean of the tools analyst community explaining to me how one should guide and why maybe what I did wasn't maybe the best thing, but we could learn from this, and so I very much appreciate the dialogue.
I'm sure it was very optimistic.
Over a decade plus of working with you, Doug, it's been fun.
It's been fun. Well, you guys are crushing it right now. I mean, I wanted to kick off with a state of the union, state of the company for you. And we've asked everybody to start there, largely because of what's been going on with the election. But I think the tone, those guys did a very good job of answering questions that are almost impossible to answer right now. But obviously, the state of the company when it comes to Natera isn't a much different place. So you reported a really solid quarter again last week. You beat revenue expectations by $80 million. You increased full year guidance by over $100 million. This has been a consistent theme, certainly over the last several quarters throughout this year.
Can you just tell us what's going on and really what have been the biggest surprises as we think about what has gone right for the company over the last several quarters?
Well, yeah, and thanks again for having me. It's great to be here. So yeah, we just reported our third quarter results. I think one could make the case that those might have been the best results that we've put up as a public company in the decade that we've been public. Had fantastic top line results. Gross margins crested above 60% for the first time, probably 58%, 59% ex true-ups, but nonetheless, a very strong result. After a long period of making the necessary investments to create a new category of cancer care, raising capital along the way, and a lot of patience from investors, we were very pleased to actually generate a significant chunk of cash in the quarter, generated $35 million of cash in the quarter.
So significantly increased the guide for the year in excess of the magnitude of the beat on the top line, increased the guide on the gross margin line, improved the guide on cash, flipped from expectations of cash burn of $50 million to cash generation this year after having been break- even for a couple of quarters. So pretty transformative year for the company. The main drivers for that have been that the core products in the business just continue to play a critical role in the healthcare system. So something like a third, don't quote me on that exact number, but something like a third of pregnant women in the United States get prenatal care from us, get their NIPT from us. It's a very important carrier screening franchise that runs alongside of the Panorama NIPT. We'll run more than a million 22q screens this year.
That franchise continues to perform extremely well and play a very important role in the system for prenatal care. We added earlier in the year. We added about 30 sales reps from Invitae just shortly before their bankruptcy and were able to provide continuous service of NIPT to those accounts, which we're very proud of and I think worked out quite well for us. That kind of just continues the pace. Signatera has continued to ramp, I think, above even our internal expectations. We had another very, very strong growth quarter for Signatera clinical units. We did something like a little more than 11,000 growth units sequentially over Q2.
We spent a little bit of time just breaking out, I mean, this was always calculatable, but just to highlight just the change in clinical units year over year. I think that you have a very clear indication of just the ramp that we're on. It had kind of a record quarter year over year in terms of growth units for Signatera. As we just continue to ramp towards Signatera really increasingly becoming the standard of care in the United States, which is great coming from a category that didn't exist before we launched the product a few years ago. So that's on the volume side. In a diagnostics business, the realized pricing is always an important item to diligence, as many of you in the audience know, at least as well as I do. That has been a real bright spot for us over the last year plus.
In the women's health business, we've made substantial investments in automation and engineering to pursue and get reimbursed for covered services in a way that we really weren't in a position to do as a younger company, and the results from that have outperformed my own expectations. It's been a huge focus of the management team, so the realized pricing in the women's health business has actually improved pretty meaningfully over really the last two years. That continued in Q3. Signatera, as it's launched and has become a little bit more mature as a product, the reimbursement has also matured quite a bit, so if you rewind a couple of years ago, the cost of goods sold per unit for Signatera was $600, and the ASP wasn't much better than that.
And so the bean counter CFO is kind of raising his hand saying, "Hey, I'm not sure how this works," and we've been able to really improve the margin of the test, and that's important because that allows us to continue to serve more and more patients in a sustainable way, so realized pricing continued to improve in the quarter for Signatera, and the cost of goods sold continues to get more and more lean, so really across the board, we're really excited about where the company's headed. It's been heartening to kind of be on this journey. I mean, Doug, it's fun that you and I just kind of chatted about that. You've been around the company for 10+ years. Look at our management team, a lot of our employees, and the management team has really been in place for that entire run.
When we go and do a call with our director-level folks in the company, a lot of familiar faces. I mean, a lot of people that have been there for that entire run, and so it's been a lot of fun to do that as a team, so that's a quick summary.
A few follow-ups, and thank you for that. In no particular order, really, just what I was jotting down as I was listening to you. The COGS progress on Signatera, you talked about the improvement there. How much of that is change in mix, meaning adjuvant versus surveillance versus improvements in procurement and just making changes internally on a same-store sales basis, if you will?
No, it's been both. I mean, I think when we launched Signatera, obviously, everyone is kind of a first-time patient. And so you've got to incur the setup costs to build a personalized blood test for each patient. And now that's become much more of a balanced mix between first-time patients, I would say patients in the adjuvant treatment window at least, and patients kind of more in a recurrence monitoring indication, where the repeat plasma tests obviously are not as expensive as kind of doing the patient setup. So that's been a meaningful driver over time. I'd say this year, the more important driver has been kind of getting to the results of a lot of hard work on improving the workflows.
Yep. Yep.
So we've launched the exome capability internally. We've been able to shave meaningful COGS off of the kind of the blended COGS for the test. Like I said, I mean, just a few years ago, the COGS were $600, closer to $400, something like that. So that allows you to kind of offer the product in a sustainable way. So it's been both, Doug.
Okay. On ASPs, there's been some improvement, but if you take true-ups out, ASP improvement hasn't been - I don't think it's been a record for the company in terms of what we've seen in terms of tailwinds from ASP improvement. Where I'm going with this, though, is I think part of the true-up momentum is you guys are getting better at collecting. And true-ups could be from a year ago. They could be from a quarter ago. My sense is it's not years ago. It's getting tighter. And where I'm going with this is true-ups could actually equate to - actually, these are meaning these are sustainable ASP durable improvements as we think about the next few quarters. If I'm making any sense there, is there something to that?
Yeah. I mean, and we touched on this on the earnings call. I mean, we actually do feel like we're in a reasonably good position as it relates to expectations for ASPs being relatively stable or even seeing some continued improvement in the ASPs. The true-ups are coming from units that were delivered really in 2023 and 2022, where there's a lag between when a provider kind of provides a service like Natera will deliver a blood test within a few days, and then it can take us six months to actually get paid on that test. The word reimbursement, that's a descriptive word for what we're trying to get done there. Right? So at the time when we're accruing the revenue, we've got to make an estimate of what the cash flows will be for a service that was provided in the quarter.
The only way to make that estimate is to look at the history. So as you think about kind of our cash collections improving rapidly, the history is going to understate what the actual reality turns out to be. So that's what we've seen. That's what yields a true-up. Okay?
Yep.
So that's not coming from Q2 2024 units. I mean, that's pretty recent in time, but it is coming from the 2023 units. The ASPs we accrued in Q3 2024, I mean, do kind of reflect all the information we have available to us at the time. And we feel quite good about where we're at as it relates to cash collections against that accrual.
Another high-level question. How do you balance the opportunity to invest in growth with the opportunity to drive free cash flow and margins?
Our primary focus is on making the service as good as it can be for the patients. That's our primary focus. With the constraint that none of us really have the appetite to come back to investors and say, "Good news. We have lots of cool ideas to work on. We're going to burn $500 million this year on all the cool ideas." We understand that there's a desire and an imperative that we kind of operate in a sustainable way.
But I think it's much, much better for the kind of long-term vision of the company to just be sustainable, meet that bar, and then take any cash flows that are generated and reinvest into more clinical data, better patient experience, nurse coordinators, commercial operations, new features, new versions of the product, a menu expansion, all the things that we need to do to continue to improve not just cancer care, but also prenatal care. And I think 2025 can shape up to be a year where we have some exciting product launches to kind of further that mission.
I do want to talk about pipeline momentarily, but just a few more numbers questions. So I think it's from the 2022 analyst event where you talked about longer-term EBIT margin goals of 25%. I don't think there was a time there wasn't a, "This is going to happen by." Yeah, it was just out there. In a world where you're above $2 billion in revenue and your gross margins are moving well into the 60%, is that the point where mathematically you're going to be getting closer to that target, or do you think there are sufficient things to invest in pursuant to making the patient experience optimal?
I think in the immediate term, I think the answer is there are some very obvious things that we must invest in. I think that if you guys could sit with us in kind of the meetings where we're kind of looking at the projects and making the trade-offs, I don't think there'd be a lot of disagreement, honestly, with most shareholders on this. But over the longer term, I think it's not enough just to be cash flow breakeven, even if we understand that. I think the business sets up well to be a business that is scalable and one that we can get meaningful operating leverage on. And that's largely driven by kind of the acute nature of the test.
I mean, all of our products are really time-sensitive, and they need to be returned to the patient very, very quickly in order to participate in kind of an actual time-sensitive diagnosis and treatment plan for the patient. And so that yields its own momentum. When you build a great product and you deliver great data, it's not necessary to have Super Bowl ads kind of reminding people to order the product because, I mean, this is an absolutely critical part of kind of the healthcare infrastructure in the country. So that lends itself to reasonable leverage. We've demonstrated that time and again. I mean, there was a time before the pandemic where it was important to demonstrate that we could get to cash flow break- even in the women's health business, for example. And we were able to do that.
We kind of set a goal that we'd get to cash flow break even for the women's health operation, and we were able to do that in 2019, which I was very heartened by. I think that was an important kind of proof of concept for us that we could build to a certain level of commercial operations and data and clinical evidence and then see the revenues justify that investment. We've just done that again on the whole company basis because we kind of restarted that effort with Signatera, and we were able to do it on the whole company basis, so I think over time, certainly, Doug, that's important to us, but over time.
Where you are investing some of the upside the last few quarters, I mean, I think you bumped up your sales and marketing expectation in terms of what you're investing there. I think you took up R&D spend by about $20 million. At least you told us the model $20 million higher in Q4 than Q3. Is the investment largely to go after things like indication expansion for Signatera, fortifying the sales force, or are you investing in adjacencies that are a little further afield?
No, no. The investments that we're making are very, very centered on the women's health channel, the transplant channel, and Signatera. I mean, they're very, very centered on making sure that those products are as good as they can be, that the clinical data is as good as it can be, and that just the operation, the patient experience, and physician experience is absolutely as good as it can be. I mean, that is really the focus. The quantum of spend on things that are interesting but further afield is minuscule relative to the P&L and wouldn't be something that I think most investors would consider material.
Okay. All right. Let's get into some specifics on Signatera. So can you just give us a lay of the land in terms of where we are now in terms of indication expansion and what's up next?
Yeah. I mean, I think the good thing about Signatera is that out of the box, it does work as a pan solid tumor assay. I mean, the lab techs really don't care if it's a head and neck patient or a colorectal cancer patient insofar as that, of course, we care, but insofar as the workflow is the exact same. We are building a personalized test that's tailored to the variant profile in the tumor, regardless of which type of solid tumor it is. And so that has lots of interesting realities for the business. I mean, you do end up seeing a little bit of a network effect in the volumes where when you have compelling data in one indication, that does tend to increase the confidence that physicians have in adjacent indications.
Now, it's important to have data kind of tumor type by tumor type, but we still really believe that, and we have that. But that's been critical. In terms of additional indications, I think we'll just continue to build more and more data sets, but they'll be concentrated in these big four tumor types that are most common in the world and particularly in the United States. I mean, colorectal cancer, breast cancer, lung cancer via the immunotherapy response monitoring are all going to be critically important. So you'll have incremental reimbursement decisions in subsets of these tumor types that will be helpful, but there's not some reimbursement decision sitting out there that we don't have yet and we really have to have in order for the business to be successful.
Okay. 40% of oncologists have ordered Signatera. How would you characterize penetration at those accounts?
I mean, it falls along a normal distribution. I mean, in any of our accounts, and this is kind of across products, your regular users emerge from a cloud of dabblers. And so it's important to serve those dabblers, and it's important to understand what translates dabblers to consistent users of the product. And a lot of times, the driver there is really just time on task. There's just enough opportunities to interact with the product and with the company and with the operation that physicians kind of get more comfortable. And this is understandable, right? I mean, it's true of anything. I think you just get more comfortable with the service, and they have more time to honestly, I mean, these folks are busy. They just have more time to read, understand what the data means, and use it in their own toolkit.
And that leads you to more and more penetration over time. I'm not sure if that really answers your question, but it's kind of the.
No, it's helpful. And then building off of that, is it pretty promotion-dependent? How often do you have to be in there with the docs?
I think it's important. I mean, the sales reps really are kind of servants to the physician. There's an incredibly important part of just kind of being available to make sure that the physicians kind of understand how to use the test and what is the available data and just make it easy for them to understand it. But there's not a, I wouldn't call it promotion-sensitive really at all. If anything, when we've seen big step-ups in new patient starts of the business, invariably, it's been on the back of some really important data. So, for example, the IMvigor010 data that we had with Roche Genentech in bladder cancer, muscle-invasive bladder cancer, back to this kind of network effect concept. I mean, that was in a very important event for the overall franchise just because it gave people real confidence.
I mean, this is a phase three clinical trial that's well understood, and the data was outstanding, and so that drove a lot of excitement. I think in retrospect, we can now see that the 24-month data from ASCO GI in the GALAXY study, the prospective data that we read out in January last year was very, very important, and we saw a very, very big step-up in new patient starts, and so it's hard to predict exactly which data set is going to kind of drive that as you get more and more penetrated and you get more and more physicians that are already comfortable. They've already had that moment where they're comfortable with the test, but we have very recently, and we've got now three-year outcomes data via the GALAXY study that has overall survival data for the first time.
That's going to be important to some tranche of the community. Going into next year, we're going to have a second phase three trial with Roche Genentech, IMvigor 011 in muscle-invasive bladder cancer that can be very important. At ASCO GI, we're going to have a couple of additional really important readouts. I mean, we have the ALTAIR data, which we've talked about at length. And then also, really ahead of our expectations in terms of timing, we were kind of flagging to folks on the earnings call that we've got this CALGB 80702 study that evaluates use of Celebrex among Signatera-positive patients in phase three colorectal cancer, which could be a very big deal because of the easy availability and well-understood safety profile of that drug if you can show a big effect there. So looking forward to a lot of those coming up.
Yeah, I mean, collectively, that gets at when we talk to clinicians, when we just read what's out there, "Okay, I'd like to do recurrence monitoring, but what do I do? And what's the evidence to suggest that you can get actually a change in outcomes and survival benefit?" A lot of these studies get at that next year.
Yeah. I mean, I think there's a big desire to have a tool that provides recurrence monitoring in an effective way. I mean, patients do routinely get CT scans for years into remission for understandable reasons. And I think Signatera is going to continue to put up data that shows that Signatera can play an important role there. It's important to realize, I mean, that's an incredibly kind of juicy kind of set of readouts we have coming in the fairly near term. It takes years to get to where those readouts kind of come as a drumbeat. I mean, each one of these studies that I referenced have been things that we were working on in 2019, 2020. I mean, it takes years and years to have these prospective studies read out.
And so kind of back to what the investments are, a lot of the investments are topics that we're really working on hard internally that really won't be interesting topics to investors until 2025, 2026, 2027. But that's the lead time required to kind of generate the kind of prospective evidence that is needed by the community.
So building off of that, that's one of the things that makes me feel pretty good about Natera from a competitive standpoint. And I think next year is a year where we expect to hear a lot more from some of the folks that are trying to move into MRD. When you think of competitive moats for Natera, could you maybe walk through data infrastructure? In general, really, I'm trying to get at how you're feeling about what could be a more noisy environment from a competitive standpoint.
Yeah. I mean, it's very heartening to come to conferences and academic investor conferences and see MRD and recurrence monitoring as an industry vertical when this was a category that didn't really exist outside of liquid tumors just a short time ago. And honestly, it's been a surprise that there have been so few other players that have been able to produce quality prospective data. It's been a real dearth. I mean, I think the rest of the field has published a handful of papers versus our we have a huge number of studies. I can't remember the exact number, but it's 75 or it's a large number of data sets that just can kind of continuously read out. Beyond that, I mean, I totally welcome that. I mean, this is important. This is a huge, huge unmet need.
There has to be, there will be many interesting companies with innovative ideas to help address the unmet need. So completely welcome it. I mean, it's not the worst thing in the world to have lots of well-capitalized players working on a problem and extolling the virtues of solving that problem. I mean, that's just not a bad thing necessarily. In terms of the new entrants, I think on balance, it can be a net positive for us just for those reasons.
In terms of the angle that a lot of the new entrants are talking about taking, sometimes it's tumor-informed, but broader panel. Sometimes it's tumor-agnostic. You talked about potential new products next year. You have initiatives in both of those areas to the extent that clinicians want them, correct?
Yeah. I mean, what we've learned over the years, I mean, it's interesting to have been in some very competitive markets for a very long time. There are some lessons that I think that we've learned that can be generalizable. I mean, one of them is when you have a product that we think is best in class, whether that's Panorama or Panorama NIPT or Signatera, it's very important to just work backward from what the patients need. And I think that's a pretty good guide for what you ought to be spending your time on. I mean, regardless of what competitors are doing, what do the patients need to have a better experience? Well, in the case of NIPT, I mean, offering a carrier screening test at the same time turned out to be very important and very well received. I think there are opportunities like that in oncology.
Offering a twins capability for Panorama turned out to be extremely important, even though twins is, it's fairly uncommon for twin pregnancies as a percentage of total pregnancies in the United States. It's like a couple of percentage points. For years, we only had a singleton pregnancy capability for Panorama, and we were building this twins capability. Again, the bean counter here was explaining to the team, like, "Why does that really make sense?" The team responded back to me and said, "Hey, look, this is a need that the customers have, and we're here to serve these customers. When they have a problem, you solve it, and that will kind of take care of itself." That's true. I mean, when we launched a twins capability, that was a huge win for the franchise for the next couple of years.
So menu expansion for kind of niche needs that a user might have, whether that's a patient that needs a tissue-free MRD, that's a possibility. Whether that's a physician that has an interest in using a genome backbone, that's a possibility. What we've typically done with respect to announcements of product launches is that we've just put them in the field, put them in the field, educated the reps, educated the customers, and then once launched, then come back and talk about them in depth with investors. And that'll be our plan here again.
All right. We're over time. Any closing remarks?
No, I feel like I've droned on a ton, but I appreciate the time, and it's great to see everyone.
All right. Thanks for being here, Mike.
Thanks.