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Edited Transcript of NTRA earnings conference call or presentation 7-Aug-19 8:30pm GMT

Q2 2019 Natera Inc Earnings Call

San Carlos Aug 14, 2019 (Thomson StreetEvents) -- Edited Transcript of Natera Inc earnings conference call or presentation Wednesday, August 7, 2019 at 8:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Michael Brophy

Natera, Inc. - CFO

* Paul R. Billings

Natera, Inc. - Chief Medical Officer & Senior VP of Medical Affairs

* Solomon Moshkevich

Natera, Inc. - General Manager of Oncology & Transplant

* Steve Chapman

Natera, Inc. - CEO, President & Director

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Conference Call Participants

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* Alexander David Nowak

Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst

* Catherine Walden Ramsey Schulte

Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst

* Doug Schenkel

Cowen and Company, LLC, Research Division - MD & Senior Research Analyst

* Mark Anthony Massaro

Canaccord Genuity Corp., Research Division - Senior Analyst

* Tycho W. Peterson

JP Morgan Chase & Co, Research Division - Senior Analyst

* William Robert Quirk

Piper Jaffray Companies, Research Division - MD and Senior Research Analyst

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Presentation

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Operator [1]

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Welcome to Natera's 2019 Second Quarter Financial Results Conference Call. (Operator Instructions) As a reminder, this conference call is being recorded today, August 7, 2019.

I would now like to turn the conference call over to Michael Brophy, Chief Financial Officer. Please go ahead.

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Michael Brophy, Natera, Inc. - CFO [2]

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Thanks, operator. Good afternoon. Thank you for joining our conference call to discuss the results of our second quarter.

Also on the line is Steve Chapman, our CEO; Bob Schueren, Chief Operating Officer; Paul Billings, Chief Medical Officer; and Solomon Moshkevich, General Manager of Oncology and Transplant.

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.

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 guidance for the full year 2019; our assumptions for that guidance; 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-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 from those contained in or suggested by 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 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.

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Steve Chapman, Natera, Inc. - CEO, President & Director [3]

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Thanks, Mike. Good afternoon, everyone, and thanks for joining us.

I will cover our recent highlights and progress on the business side since we last spoke in May and Mike will provide additional detail on our financial progress. As Mike mentioned, we will be referring to slides that were just posted at investor.natera.com.

A quick review of the highlights and then I will go into more detail on each topic. We processed over 195,000 tests in the quarter, which represents roughly 20% year-on-year growth versus Q2 2018, consistent with the very strong growth rate we saw in Q1 of this year. We're seeing the improvements we discussed in ASP and we're continuing to hit our COGS milestones along our path to $200 per test. The volume, ASP and COGS are helping drive toward our goal of getting the reproductive health business cash flow breakeven while maintaining our strong leadership position.

Total revenues in the quarter were up $74.4 million, up 18% from this time last year, and Q2 is actually a challenging comparison because if you recall, we had a onetime spike in reported volumes in Q2 of 2018. Included in our revenues for the current quarter is approximately $5 million in revenue generated from the achievement of significant milestones and for development work we had performed for BGI, and we are optimistic about the commercial launch of Signatera in China.

We do not believe this revenue from a partnership is a onetime event for us. In fact, now that we've signed and expect to sign several multiyear development and commercialization partnerships, we expect to see a future stream of revenue from upfront payments, milestones and royalties, making a meaningful contribution to our financials. The strength of Natera's technology and our investment in innovation has unlocked these revenue streams with more to come.

We've also made significant progress toward achieving Medicare reimbursement for Signatera in patients with local or regionally advanced colorectal cancer, an opportunity that we believe is 4x to 5x larger than the kidney transplant market. On the heels of our pre-submission meeting, we have submitted our formal coverage dossier to Medicare and we anticipate a response in late 2019 or early 2020. We see a particularly acute unmet need in colorectal cancer that Signatera is very well positioned to address, and we'll spend a few minutes on that later in the call.

In addition to the major publications we announced in this spring in colorectal, breast and bladder cancers, we also presented data at ASCO demonstrating Signatera's ability to measure patient response to KEYTRUDA across a range of 10 different cancer types. Therapy effectiveness monitoring is an enormous opportunity, and increasingly, we're seeing interest in this from pharma. We believe we're on track for a target of $40 million to $50 million in cumulative total contracted value for pharma this year. Our goal was to generate revenue growth in the oncology business through successful commercialization of Signatera. We're pleased with our trajectory in pharma, and now we're very excited about the clinical opportunity in colorectal cancer as likely the first among many future indications.

On kidney transplant, we're well along our goal of achieving coverage in commercializing Prospera in 2019. We are very pleased to announce that we've secured one of the premier researchers and physicians in the industry, Dr. Jonathan Bromberg, from the University of Maryland, a top center in the United States, to be the PI for the ProActive trial. Our study is one of the largest known prospective kidney transplant trials ever announced and represents another step towards commercializing Prospera.

We also received a favorable draft local coverage decision from Noridian, our local Medicare contractor. As expected, this determination was consistent with the MolDx draft coverage decision we received in the spring. We believe we are on track to receive a final positive LCD and commercialize the test later this year.

Now let me jump into the details. Onto volume growth, the 195,000 tests processed in the quarter represents roughly 20% growth versus the same quarter last year, consistent with our year-on-year growth and our strong Q1 and consistent with the overall volumes in Q1 despite the fact that Q1 was one of the best quarters that we've ever had. You could see here on the first slide that our first half growth represents yet another step function up from last year, which itself was very strong relative to 2017.

The next slide shows the year-on-year growth trends for our business. You could see here that in Q1, we grew roughly 20% year-on-year versus Q1 2018. And in Q2, we saw a consistent performance with that very strong growth that we saw in Q1. As we have discussed on seasonality, in Q2, we typically only get about 90% of the volume received from our existing customers in Q1 so we need a very strong new account growth just to be flat sequentially. That's exactly what we got in Q2. We were very pleased with our growth in new accounts, which sets us up to achieve our performance objectives in the second half of 2019. You may recall, this is how our volume growth unfolded in 2018 and we expect a similar progression this year.

There have been some significant changes in the competitive landscape over the last 6 months, but this space has always been very competitive and we're pleased with how we're performing. Panorama and our SNP technology are highly differentiated and extensively published in the top peer review journals. This scientific leadership, combined with our commercial strength and focus on user experience, has distinguished us amongst the field of massively parallel sequencing licensees. In fact, we're now quickly moving toward our 2 millionth NIPT test. We're able to leverage our leadership position and extensive volume to further improve the performance of the assay and lower our COGS with discrete projects we intend on announcing in the future. We will stay vigilant in protecting our market share.

The next slide covers average selling prices. I'm sure many of you are interested in the progress we're seeing with average-risk NIPT. The average-risk market remains largely an untapped market opportunity. As we have described previously, it's only 15% to 20% penetrated, and we think the key driver for unlocking that market is a revision to the ACOG guideline on NIPT that was withdrawn last year. We continue to believe that the update will be positive and, of course, the timing of the new guideline remains uncertain. In the meantime, we believe there is significant improvements to be made, ensuring that we are reimbursed for every test that ought to be covered today.

As we've described on our last 2 calls, we saw an expected dip in pricing in Q1 due to a variety of factors like changing prior authorization policies. We expected that pressure to continue in Q2 and then hope to see some progress in the second half of the year. We placed a lot of focus on execution in this area, and we were pleased to see some positive results ahead of schedule.

As you can see, our estimated revenue per test reported increased from Q1 and many of our improvements only hit partway through the quarter and wouldn't be fully reflected in our revenue accrual until Q3. This increase is being driven by a reduction in denials related to prior authorization, pricing negotiations and improvement in Medicaid coverage and reimbursement.

Note that for the calculation of ASP, we have excluded revenue from BGI derived from our development work. Obviously that work is valuable, but the goal here is to give you a sense of the expected cash collections per test in the core business. Mike will talk more about these topics shortly, but in summary, we try to be conservative in our revenue accrual and the recent trends we have seen bode well for the second half of the year. And I'll mention again, we don't want to dismiss the potential significant impact of our long-term strategic partnerships.

The next slide describes our blended cost of goods sold progression. As you could see on this slide, we made significant progress over the past year and have a long track record of reducing our COGS over time. We posted $232 per unit in Q1. And this quarter, we were at $236 pro forma for a onetime vendor charge. We were slightly higher in Q2 due to product mix, but the underlying operation is clearly running much leaner than the $260 to $270 range we posted last year and we remain on track to reach our goal to bring blended COGS below $200 per unit. As we have described in the past, we think the next wave of savings will come from larger projects underway that we think will hit in early 2020.

Now switching gears to oncology. I think it's worth a reminder on where we are positioned. We're not focused on asymptomatic cancer screening or early detection as seen here on the left side of the slide. Moving over to the right to therapy selection, mostly in a metastatic study, this is typically what people talk about when they're referring to liquid biopsy and where many of the commercial tests today are positioned. Moving to the middle, we think the biggest opportunity is monitoring and MRD assessment, which we estimate to be a roughly $15 billion market opportunity, and that's exactly where our Signatera test is focused.

There are 3 key intended uses within this segment: First, patient stratification where minimal residual disease status can be used to determine the risk of recurrence and support better treatment decisions; second, serial testing after definitive therapy to detect recurrence earlier than imaging; and third, therapy effectiveness monitoring, how well is my immunotherapy working, for example. We're making meaningful progress in each of these areas.

And now let me turn it over to Solomon Moshkevich to discuss the ongoing oncology opportunity and our progress in more detail.

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Solomon Moshkevich, Natera, Inc. - General Manager of Oncology & Transplant [4]

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Thanks, Steve.

The MRD space in solid tumors is definitely heating up. In time, we believe MRD testing will become as routine as CT imaging is today across multiple cancer types. The first indication we're pursuing for Signatera is in local or regionally advanced colorectal cancer.

As you can see on the slide, while we are obviously excited about the kidney transplant opportunity, we estimate that the addressable market in CRC is up to 4x or 5x larger. The American Cancer Society estimates that about 145,000 people will be diagnosed this year with colorectal cancer and that 1.4 million people are living in the U.S. today with a previous CRC diagnosis. If you only count local or regionally advanced disease, that amounts to approximately 100,000 annual incidents and over 1 million prevalence.

Based on current testing schedules using standard biomarkers like CEA plus our discussions with experts, we believe patients will test 4 times per year in the first 2 years after diagnosis and at least 2 times per year thereafter. The CRC monitoring opportunity is compelling. The market is large, our data is strong and we're now making significant progress with Medicare toward establishing reimbursement.

We see 2 major unmet needs in colorectal cancer, which leads to 2 natural intended uses for Signatera. First is the early detection of recurrence. Approximately 25% to 30% of patients with local or regionally advanced CRC will relapse, and colorectal cancer is a cancer type where early relapse detection is known to improve outcomes because some patients are eligible for curative surgery. For this reason, patients today are monitored closely using a combination of CT imaging and the serum biomarker, CEA, for at least 5 years. Unfortunately, the vast majority of recurrences today, over 85%, are caught too late for curative surgery with most cases being diagnosed after clinical symptoms have already appeared.

In our JAMA Oncology paper, among the 16 relapsed patients who had serial ctDNA testing, Signatera detected relapse up to 16.5 months earlier than standard tools and 8.7 months earlier on average. This is a significant lead time that can result in more patients having a chance at curative treatment. Therefore, for a patient in remission who tests positive with Signatera, the physician could recommend a reflux to higher resolution imaging such as PET or MRI to locate the lesion as soon as possible.

In addition, CEA and CT imaging suffer from high false positive rates, with one recent study showing 71% of all positive CT scans as false positives, implying a PPV as low as 29%. By contrast, in our JAMA Oncology paper, Signatera reported only 1 false positive test result, demonstrating a positive predictive value over 97% per test. In this regard, Signatera could significantly reduce unnecessary clinical and diagnostic workups and the anxiety associated with false positives. This extraordinary specificity is made possible because of our personalized and tumor-informed approach.

The second major unmet need in colorectal cancer is around treatment decision-making in the adjuvant setting. Most local or regionally advanced patients are cured with surgery alone, so the objective of chemotherapy after surgery is to eradicate any micrometastatic disease that may remain in the body after surgery. The problem is that physicians today do not know who has micrometastatic disease, so the guideline is to recommend, identifying and treating patients at high risk based on prognostic factors like tumor stage or lymph node status. But these are just proxies and they are often inaccurate. As a result, patients today are significantly overtreated with toxic regimens that lead to treatment-related mortality in up to 1% of patients and grade 3 or 4 toxicity in another 10% to 31%.

In a status quo, we estimate that 11 patients are treated to benefit just 1. Using Signatera to stratify patients can lead to more patients getting treatment who need it and a significant reduction in unnecessary treatment, potentially improving treatment efficiency to roughly 3 patients treated to benefit 1.

We're getting very positive feedback from our initial physician interactions on these 2 key use cases, MRD after surgery and recurrence monitoring.

The next slide shows our progress toward Medicare reimbursement for these indications. Armed with the data we published in JAMA Oncology and the results we've demonstrated in other cancer types, we recently submitted our dossier to Medicare for a local coverage decision. This plan is similar to the one that we have filed in our kidney transplant effort and we are working with the same team at MolDx for this submission.

We have a small focused effort underway now to begin driving adoption in colorectal cancer and we would anticipate an expanded effort timed roughly in line with the coverage decision from Medicare, which we think can happen in late 2019 or early 2020. Once the CRC indication is secured, we look forward to rolling out and pursuing reimbursement for a significant number of additional indications, both directly and, in some cases, through collaborations with pharma as we've described previously.

One additional opportunity is highlighted in data that we recently presented at ASCO showing the ability of Signatera to evaluate a patient's response to immunotherapy. In this case, Merck's drug, KEYTRUDA. In this study led by the Princess Margaret Cancer Centre in Toronto, we evaluated 70 metastatic patients with head and neck cancer, breast, ovarian cancer, melanoma and others. And we showed that Signatera outperformed standard of care imaging in 2 ways.

First, Signatera can differentiate between actual disease progression and pseudo-progression, which is what happens when the treatment is working, but the tumor initially looks bigger on a scan. The graphic on the right shows an example from the study where the green line shows tumor volume as measured by CT scan and the blue line shows tumor DNA levels in the plasma.

In this regard, Signatera is more accurate than imaging, but it's also faster. That's the second advantage. Signatera provides an earlier readout than imaging, often months earlier. This has significant implications for pharmaceutical companies who are looking to use Signatera as its target end point in clinical trials to get a faster readout on treatment efficacy.

This study also shows significant potential for Signatera in a clinical metastatic setting for earlier identification of patients who are not responding to treatment and who may proceed to alternative treatment options sooner as well as identification of complete responders who may safely deescalate therapy or take a drug holiday while under continued surveillance. We believe this can lead to better outcomes and significant cost savings for the health care system.

Handing it back to Steve now for details on the organ transplant business.

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Steve Chapman, Natera, Inc. - CEO, President & Director [5]

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Thanks, Solomon.

We've also made steady progress toward our transplant launch later this year. Many of you saw the announcement of the ProActive registry trial. This will incorporate more than 3,000 patients across a broad range of leading transplant centers. To our knowledge, ProActive is the largest prospective registry trial ever launched in kidney transplant monitoring, and we've been very pleased with the response we've gotten from the community for what we think will be a landmark trial. There are several key differences between this trial and the KOAR study, including its size and its following of high-risk patients for up to 5 years post-transplant. As I mentioned, we are very pleased to welcome Dr. Jonathan Bromberg from the University of Maryland as a principal investigator for this study. We're hitting our internal milestones on the trial preparation and look forward to enrolling patients later this year.

We are also announcing a second prospective study using Prospera to assess kidney transplant rejection that will include an assessment on each patient's biopsy with the novel Molecular Microscope Diagnostic System. The Molecular Microscope uses a gene chip array to measure transcript levels in biopsy tissue and then it applies a proprietary algorithm designed to more accurately assess rejection as well as other histologies. The system was developed by Dr. Philip Halloran from the Alberta Transplant Applied Genomics Centre, and Dr. Halloran will serve as the PI on our study. We anticipate that the study of at least 300 patients with biopsy-matched blood samples will provide further evidence of our assay performance, including new subgroups, and it will generate key insights into the benefits of monitoring patients with a full suite of molecular testing.

As we've announced previously, we signed a partnership with Thermo Fisher's One Lambda division to commercialize Prospera. One Lambda holds exclusive license to commercialize the Molecular Microscope System.

The next slide shows our progress towards Medicare reimbursement. We are ahead of the schedule on this slide. And with the Noridian draft LCD now complete, we are closing in on our final LCD and release of final pricing, which we still anticipate happening in 2019.

With that, let me turn it over to Mike to walk through the financials. Mike?

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Michael Brophy, Natera, Inc. - CFO [6]

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Thanks, Steve.

Now to summarize our results for the quarter. The results for the quarter crossed the wire this afternoon. And for brevity on the call today, I'm going to focus on the key points of the Q2 results.

As Steve mentioned, revenues for the quarter were $74.4 million, up 18% versus Q2 last year. Gross margins were 41% in the quarter, up 600 basis points versus the same period last year. We benefited from our development efforts with BGI in the quarter, as Steve described, but even without this development revenue, we estimate gross margins were better versus last year given the significant drop in cost of goods sold we are seeing.

It's also worth noting on both revenues and margins that we did not materially benefit from recognition of cash-based revenue from older appeals. In 2018, as a reminder, we booked approximately $10 million in revenues from older appeals. And although I do think that we can see some benefit from our efforts in 2020, we don't have any older appeals revenue in the guidance for this year.

Steve referenced average selling prices in the quarter. As a reminder, we calculate that metric by dividing total revenues by tests reported out of our lab and we try to be conservative in stripping out variables such as reserves and true-ups that we don't think are consistently recurring events.

In the last 3 months, we've seen a significant improvement in our metrics related to prior authorization denials. And if those trends hold, we think there is potential to see more of that benefit reflected in the revenue accrual in Q3 and beyond. As discussed on our last 2 earnings calls, we expected pricing to be down in the first half of the year, so we are pleased to be ahead of schedule in this area.

Panorama revenues for the quarter were $36.5 million compared to $35.7 million in the second quarter of 2018, an increase of roughly $800,000. Horizon revenues for the quarter were $24.3 million compared to $21.4 million in the second quarter of 2018, an increase of roughly $2.9 million. As Steve mentioned, we had a spike up in Q2 2018 tests recorded out as we caught up from some delays in Q1 of last year, so that has muted the year-on-year revenue comparisons to a certain extent.

Total operating expenses for the quarter were $59.2 million compared to $49.3 million in the second quarter last year. Stock-based comp charges related to the share price increase and litigation expenses that we don't think are permanent ongoing expenses contributed significantly to the increase, but we did see the expecting operating expenses ramp up consistent with our guide as we prepare to launch transplant and expand our commercial footprint in oncology.

At the close of the quarter, the company held $238 million in cash, cash equivalents, short-term investments and restricted cash compared to roughly $129 million as of March 31, 2019. The capital structure remained in the same place at the end of Q2. As you know, we closed an equity offering that brought in net cash of roughly $108 million and received roughly $28 million in net cash from BGI in the second quarter as part of our collaboration.

Turning to our future outlook. We are raising the top end of the range slightly to $305 million. This accounts for the BGI revenue and reduces the impact of average-risk NIPT reimbursement in the second half of the year. Previously, the guide for the full year anticipated a positive ACOG guideline driving ASPs higher in the second half of the year. Given that we are into August, however, we think it's appropriate to modify that reimbursement assumption. We are pleased with the volume performance and encouraged by the organic ASP trajectory in Q2 and expect to make more progress with BGI. The remainder of the guide remains the same.

So with that, I'll hand it back to the operator for questions. Operator?

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question comes from Bill Quirk from Piper Jaffray.

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William Robert Quirk, Piper Jaffray Companies, Research Division - MD and Senior Research Analyst [2]

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A couple of questions on the ProActive study. Appreciate the additional details on the call today. Can you maybe fill in a few missing pieces here? So is Medicare going to be paying for this? Or is this a self-funded study? And do you know yet how many centers you're going to be targeting for that?

And then I guess separately, Steve, with respect to the timing of the draft LCD going final, any feedback or any indication from Palmetto at this point? And it certainly sounds like it's on track, but just curious if you have any additional color there.

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Steve Chapman, Natera, Inc. - CEO, President & Director [3]

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Yes. Thanks, Bill. This is Steve. So I'll just comment briefly on sort of the reimbursement time line that we outlined in the slide deck. We feel things are very positive. We announced previously we had this MolDx draft local coverage decision that was very positive. That was followed up by a draft local coverage from Noridian that was also very positive. So we feel like things are on track and going well.

There's sort of a set time line out there for how these things go and we feel like we're following that trajectory. We've said previously, we think that will be announced at some point in the second half of the year. We're in that now. And we're engaged with MolDx and we're eagerly awaiting a final coverage decision.

With respect to the registry trial, I'll let Paul talk about the number of centers and the size of the study.

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Paul R. Billings, Natera, Inc. - Chief Medical Officer & Senior VP of Medical Affairs [4]

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Right. So thank you for the question. First of all, we're delighted to have Jonathan Bromberg as the lead PI for this study. He's a renowned transplant medicine specialist and will certainly add to our ability to do the study.

This is an enormous and exciting study. We've had great response from centers who have participated in previous studies who are new to studying this issue. KOLs have been very excited about the ProActive study. So it's a large study, 3,000 patients. We expect to have many centers enrolling in the first quarter of its rollout. And there are long end points. Well, there's a 5-year end point here but we also have very important utility measures that we have to gather significant data on. So there will be interim readouts, but this is a really exciting long-term study.

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William Robert Quirk, Piper Jaffray Companies, Research Division - MD and Senior Research Analyst [5]

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Sorry. Any comments, Paul, with respect to -- is Medicare involved in this? I mean I know they're participating in the other registry study. I guess that wasn't clear.

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Solomon Moshkevich, Natera, Inc. - General Manager of Oncology & Transplant [6]

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Sure, Bill. This is Solomon. I'll take that one. So when any tests are ordered in this study that are in line with the intended use and the coverage criteria under Medicare, which we expect to be the vast majority of the tests in the study, then we will bill Medicare.

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Operator [7]

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Our next question comes from Tycho Peterson from JPMorgan.

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Tycho W. Peterson, JP Morgan Chase & Co, Research Division - Senior Analyst [8]

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Maybe I'll start with guidance. So you've pulled ACOG. Can you just remind us what you had baked in for the back half of the year?

And then just thinking a little bit about ASPs, can you talk to what drove the improvement and what the trajectory of ASPs should be going forward for the back half of the year?

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Michael Brophy, Natera, Inc. - CFO [9]

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Yes. Thanks, Tycho. Yes. So what we had baked in -- we hadn't broken out a specific kind of revenue guide for what average-risk was worth. We just presumed that there would be kind of steady but unspectacular improvement in the NIPT ASP as a result of average-risk reimbursement improving in the second half of the year. So that's been taken out of the guide.

The trends that we've seen in Q2, I think, augur well for the back half of the year. And so we do expect to see kind of stable to -- stable -- steady increases in the overall ASP in the second half of the year, and that's what's implied in the guide and the slight raise.

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Tycho W. Peterson, JP Morgan Chase & Co, Research Division - Senior Analyst [10]

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And you maintained the gross margin guidance of 35% to 41%. You're at 41% this quarter. Any reason margins would take a step down in the back half of the year?

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Michael Brophy, Natera, Inc. - CFO [11]

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I think the gross margin guide still is like an appropriate range for -- to cover the range of possible outcomes in the business, but I would say that we're kind of positively biased towards the top half of the range of the gross margin guide.

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Tycho W. Peterson, JP Morgan Chase & Co, Research Division - Senior Analyst [12]

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Okay. And then thinking about Prospera and the commercialization plans, first, on pricing, I guess the initial LCD was positive and cross-walking to ctDNA is $2,500 to $2,800. But can you comment on exactly how you're thinking about pricing? And then just any comments you can make on the government push around kidney transplants, the cost reduction initiatives?

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Steve Chapman, Natera, Inc. - CEO, President & Director [13]

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Yes. Thanks, Tycho. This is Steve. So I think on pricing, I mean there's -- with our code, we have a z-code modifier that's unique to our test and then we'll be using a miscellaneous code, similar to what others in this space are doing. And we're having individual discussions with MolDX about how the test would be priced. We believe it will be priced similar to the AlloSure test, but that discussion is ongoing and that will be made available later in the year after the local coverage decision comes out in its final form.

I think on the government initiative, of course, that's something that we're very excited about. And I think others have commented that it could increase the number of organs that are available for transplant by roughly 15%. And then of course, it highly incentivizes the centers to improve their outcomes, which we think bodes very well for a product like Prospera. So we're very excited about this.

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Tycho W. Peterson, JP Morgan Chase & Co, Research Division - Senior Analyst [14]

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All right. And then just lastly, on BGI, did you recognize some revenue from the partnership in the quarter? You mentioned hitting technical and commercialization milestones. And then how do we think about pacing of additional BGI revenues and thoughts on the Signatera launch in China with them?

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Michael Brophy, Natera, Inc. - CFO [15]

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Yes. Thanks, Tycho. So we did -- we booked $5 million in the quarter in BGI revenue in recognition of the hurdles that we cleared in the quarter. We do expect some marginal revenue from BGI through the rest of the year. It's just a little bit hard to predict because this is driven by the technical efforts of both teams.

As to kind of pacing of royalties and commercialization for BGI, that's going to be something that's going to be a 2020 event and beyond. We do think that's a strong long-term driver to our business, but not in the guidance for '19.

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Steve Chapman, Natera, Inc. - CEO, President & Director [16]

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Yes. This is Steve. I'll mention just with respect to the launch in China, as we've outlined before, the Chinese oncology market, the number of patients is 4x as large as the United States. And we really think BGI is the premier partner because they really are the dominant experts in China on cell-free DNA testing. And so they do, out of their lab today, over 1 million cell-free DNA tests in the prenatal space. So they really have a massive reach all throughout China and we think that they are really the premier partner for us to have in that region to deliver the Signatera test.

So we're making a lot of progress. As we announced, we've met some key technical and commercial milestones that allowed us to recognize some revenue, but there's a lot of progress being made both on the prenatal side and on the oncology side. And we really look forward to launching Signatera in China.

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Operator [17]

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Our next question comes from Doug Schenkel from Cowen and Company.

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Doug Schenkel, Cowen and Company, LLC, Research Division - MD & Senior Research Analyst [18]

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So I guess just a couple of follow-ups on BGI to start since that's where Tycho left off. So as you guys know, in the 10-Q and describing the relationship with BGI, it says that you will, and I quote, "Receive a total of $50 million compromised of $35 million in upfront technology licensing fees and prepaid royalties and $15 million in future milestone payments." So was the $5 million in revenue recorded in the second quarter, I guess, what category did that fall into? Royalties, license payments or milestones?

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Michael Brophy, Natera, Inc. - CFO [19]

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Yes. Thanks, Doug. So that is basically a portion of the -- that's revenue recognized out of the cash that we received in the quarter. So as I mentioned, we've received net cash from BGI now of about $28 million. And for the full year, we expect to get about $30 million in cash from them. And then the question is, how does that then flow through the P&L? And we will recognize revenue on that cash from the licenses and the other components as we do work with them on the development plan to launch the products on their platform. And so that work came from the upfront payments we received.

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Doug Schenkel, Cowen and Company, LLC, Research Division - MD & Senior Research Analyst [20]

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Okay. And I know there's been a few questions on BGI revenue cadence. There's been also sort of related a couple of questions on guidance in terms of just bridging the change in guidance, given now the acknowledgment that ACOG guidelines probably aren't going to happen in a time frame that's really going to help you this year, at least from a revenue standpoint. Could you get a little more specific on the puts and takes there? It sounds like it's just ACOG down, BGI up. But could you tell us if there's any other variables and provide more specific quantification?

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Michael Brophy, Natera, Inc. - CFO [21]

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Yes. So it's ACOG down, BGI is a contributor, but then also just the trends we're seeing in the business. Volume growth and the ASP trends that we've seen in the business recently are also a contributor as well.

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Doug Schenkel, Cowen and Company, LLC, Research Division - MD & Senior Research Analyst [22]

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Okay. And any dollars you'd assign to those 3 categories?

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Michael Brophy, Natera, Inc. - CFO [23]

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No. I'm not -- I can't really assign the dollars to it, Doug, just because the contributions from those 3 variables will inevitably evolve over the course of the year.

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Doug Schenkel, Cowen and Company, LLC, Research Division - MD & Senior Research Analyst [24]

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Okay. And then Steve, early in your prepared remarks, you indicated we shouldn't view the BGI payment as a onetime event. I mean clearly, we're expecting more from BGI, but I think what you were getting at is that there is a funnel of additional partnerships. Could you provide a little bit more color on what that funnel looks like? And what's a reasonable target for number of partnerships per year over the next few years? How many could you handle?

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Steve Chapman, Natera, Inc. - CEO, President & Director [25]

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Yes. Thanks, Doug. So you're absolutely right. I mean we're seeing this now as sort of an ongoing stream of revenue from upfront payments, milestones that we're achieving and then royalties from these deals that we're doing. So we launched a -- or we've announced previously a really major global partnership with QIAGEN and now a very significant partnership with Beijing Genomics Institute. We're going to be announcing another major partnership in the second half of the year. And we have a very unique and proprietary technology that is highly protected with a very significant suite of intellectual property that we've invested a lot in developing, and we think we're an ideal partner for many companies that are out there that want to have access to this complex testing. So we should expect an ongoing stream.

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Michael Brophy, Natera, Inc. - CFO [26]

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And Doug, to your question on capacity, I think we've got plenty of capacity to do these kinds of deals. What is required from the different partners is not always the same. Some require access to the technology, some require development efforts and some we're actually going to be commercializing in tandem with them. And we've got the right mix of people and skillsets to accommodate all of the above.

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Doug Schenkel, Cowen and Company, LLC, Research Division - MD & Senior Research Analyst [27]

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Okay. Last one. I apologize if I missed this in the prepared remarks. In terms of MRD efforts, what's the next milestone or 2 we should be looking for there? And when might we get a little more data on the assay across different cancer types?

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Steve Chapman, Natera, Inc. - CEO, President & Director [28]

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Yes. Thanks, Doug. This is Steve. I'll make some comments and then hand it to Solomon. So we had some very significant publications in the spring, which really was published in multiple top journals. And these are very large trials that would have taken several years to have done prospectively if we were starting from scratch. So we feel like we generated a lot of really amazing data.

We're now in a position where we are preparing to commercialize aggressively our colorectal cancer MRD test. So we submitted a very significant dossier to MolDx for a local coverage decision. We expect to have a draft at some point later this year or early next year. At which point, we will really ramp up that field team in anticipation of having Medicare coverage. But we're not stopping there. I think that's really the first indication clinically that we're going after. There's multiple other ones that we think are going to be super exciting.

Solomon, do you want to just reiterate again the therapy effectiveness data that we talked about on the call and some of the other indications?

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Solomon Moshkevich, Natera, Inc. - General Manager of Oncology & Transplant [29]

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Sure. The -- I described some of the opportunities in therapy effectiveness monitoring. In this case, during the call, on immunotherapy treated patients, we think there is an opportunity there that I outlined.

And the other key step is hitting on our objectives with pharma. And we described we're on track to achieving what we had set out to do this year. And I think that is the other major next milestone.

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Operator [30]

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Our next question comes from Catherine Schulte from Baird.

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Catherine Walden Ramsey Schulte, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [31]

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First, on transplant, I know you've talked about adding 10 or so direct reps to complement One Lambda. Have those reps been hired yet? And if not, what's the expected timing on those hires?

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Steve Chapman, Natera, Inc. - CEO, President & Director [32]

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Yes. Thanks, Catherine. So as what -- as we said, I mean we plan on commercializing the test in the second half of the year. And we're not announcing the exact number of salespeople that we're planning on hiring and the exact launch date, but of course, we'll make that available when we launch, but for competitive reasons, we're just not announcing that right now. What we have said is that we think a very focused team is appropriate. I mean there's roughly 100 meaningful centers and maybe 200 in total. We think we can target that with a very focused team, combined with the partnership that we've outlined with One Lambda.

We're also very excited, as we mentioned, to have this new clinical trial announced where we're collaborating with One Lambda and their exclusive relationship with a molecular microscope product. So there's multiple things that we're going to be doing in the transplant space. They're going to set us apart completely from what others are doing. And so this trial is one of the first things that we're announcing, but we have other very big initiatives that we're going to be announcing later this year and early next year related to unique offerings in the transplant space.

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Catherine Walden Ramsey Schulte, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [33]

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Okay. Great. And then on Signatera, Steve, you mentioned ramping up your field organization once you have Medicare coverage in place. How many reps do you think you would need to launch the colorectal indication? And any other color on your go-to-market strategy? I know you've talked in the past about potentially finding a partner to penetrate that clinical market. So is that still your thinking?

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Steve Chapman, Natera, Inc. - CEO, President & Director [34]

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Yes. So just to be clear, I think we would -- right now, we've announced the CLIA launch of the Signatera test, and that was largely to support pharmaceutical partners that need a CLIA product to enroll patients in their prospective trials. And we have a very low-key effort right now from a clinical standpoint, interacting with key opinion leaders and really sort of in a pilot phase for rolling out the clinical assay.

What we've said is when we get the draft local coverage decision, which we think will happen toward the end of this year or early next year, at that point, we're going to really build up a broad sales team that covers the United States that will allow us to presell, so to speak, via the colorectal assay before the final Medicare coverage comes in. You can get the sense of sort of what those teams look like from looking at some of the other companies out there. I mean we'll probably take a phased approach where we go sort of midsize and as things are working well and we're gaining volume and then we start to see the final LCD come in, we'll expand that team even further.

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Operator [35]

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Our next question comes from Mark Massaro from Canaccord Genuity.

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Mark Anthony Massaro, Canaccord Genuity Corp., Research Division - Senior Analyst [36]

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My first one is on the Signatera reimbursement strategy. So you submitted the dossier to CMS for the colorectal cancer indication. My understanding is that Signatera is really one assay that can test for up to 18 cancers. So are you going to have to go cancer-by-cancer submission? Or do you think that perhaps your colorectal indication could lead to some type of pan-cancer reimbursement later?

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Solomon Moshkevich, Natera, Inc. - General Manager of Oncology & Transplant [37]

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Great question. I think we are going to have to start with a couple of specific indications, really prove out the story, prove out the utility. And then we do expect there to be an inflection point where it becomes something that people want to use and understand how to use and understand how to cover and reimburse much more broadly. And we're not exactly sure how quickly that will happen, but I think if you look at other oncology assays, they've taken a similar approach and had huge success in a similar way.

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Mark Anthony Massaro, Canaccord Genuity Corp., Research Division - Senior Analyst [38]

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Okay. Great. And then Steve, you mentioned that you expect to announce another major partnership later this year. I just want to clarify. Are you thinking it's with another platform instrument company? Or were you referring to maybe a pharmaceutical partner?

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Steve Chapman, Natera, Inc. - CEO, President & Director [39]

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Yes. So first, let me just comment again back on the sort of indication-by-indication approach. I just want to reiterate how very, very large this colorectal indication is that we're going after. I mean there's a lot of excitement about this kidney monitoring opportunity that we're super excited about. And it's really a multibillion-dollar market. This colorectal cancer opportunity is 5 -- 4x to 5x larger than that kidney opportunity as we outlined on the slide. So although we will be going indication-by-indication initially, it's really super exciting and it's a very big opportunity. And we've actually made a lot of progress this year. So we're excited about that.

As far as the other opportunities, look, I mean the -- we can't go into details right now, but I think the point is we're very unique in this space in that we've developed a technology that now works across multiple different areas of health care and is highly protected by IP and is very, very effective at testing very small quantities of DNA. So we're excited about having launched 2 very significant partnerships with sequencing companies. And we have other partnerships that we're going to be announcing that are going to be very significant, but we just can't go into details on those right now.

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Mark Anthony Massaro, Canaccord Genuity Corp., Research Division - Senior Analyst [40]

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Okay. Understood. And then obviously you've sort of de-risked the ACOG as it relates to 2019 revenue guidance. Just curious if you've had dialogue with ACOG or if it's more of this black box situation where we're just kind of waiting and hoping, but not -- don't have a line of sight.

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Steve Chapman, Natera, Inc. - CEO, President & Director [41]

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Yes. So we've had discussions with ACOG. It goes up and down with the sort of amount of communication that we're having, but we're certainly connected with the top folks on the various committees and leadership. I think generally, there's a very positive relationship. Of course, they're not permitted to give any specific information to us on the timing of such things, although we have heard that an updated guideline is coming and that it's supposed to be positive for broad NIPT usage, but we really have no understanding at this stage of what the exact time frame is going to be, but we do still hear very positive things.

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Mark Anthony Massaro, Canaccord Genuity Corp., Research Division - Senior Analyst [42]

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Okay. That's helpful. And then a question for you, Mike. When we think about -- if I have this correctly, the volumes were really outstanding, especially on the carrier screening side. The revenue growth rate was below the pacing of volume growth. So as we look at Panorama, I think revenues were up 2% and volumes were up 18%. Can you just help me bridge why it wasn't like a one-for-one?

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Michael Brophy, Natera, Inc. - CFO [43]

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Yes. I made a quick reference to it in the script. In Q2, it's basically because it's a tough comp versus Q2 of '18 because Q2 of '18 had a bunch of onetime things in it. The 2 major onetime events for Q2 of '18 were, one, we had a spike up in the number of tests that were reported out in our lab because of a delay in the -- in our lab at the end of Q1 of '18. So those of you who've been around for a while, maybe you can remember that deep in the past. So that juiced the revenue in Q2 of '18 and that makes it a tougher comp.

The second thing is that we had an unusual amount of kind of what I would call onetime appeals revenue coming in from older tests that we recognized as revenue in Q2 of '18 that we didn't have this year. So usually, when we get that kind of stuff in a quarter, I'll strip it out of that ASP slide for you guys so you have a sense of what's kind of the go-forward organic pricing, but when you're just looking at product revenue year-on-year, it won't be stripped out obviously because we do count that as revenue and we do like to get that cash in. So those 2 things really just make it an unusual compare.

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Mark Anthony Massaro, Canaccord Genuity Corp., Research Division - Senior Analyst [44]

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Awesome. Just one last one for me, if I can. You -- I believe you did launch Signatera at ASCO. I get the sense that it's probably a soft launch until you get Medicare. But can you guys just talk about your funnel and what type of demand you're seeing for utilization of the test clinically?

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Solomon Moshkevich, Natera, Inc. - General Manager of Oncology & Transplant [45]

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Sure. This is Solomon. I'll take that one. So you're correct. We launched it at ASCO. And we, as Steve described, have had a really focused effort on driving initial adoption in colorectal cancer where we're seeing very, very good feedback from academic centers and physicians who we've spoken to. So that's very promising and, therefore, we're feeling very positive about expanding that effort once the LCD comes in.

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Steve Chapman, Natera, Inc. - CEO, President & Director [46]

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And just a reminder, Mark, as I mentioned earlier, the launch at ASCO was the launch of the CLIA product specifically to move forward pharmaceutical partnerships where they require a CLIA product for prospective trials, and that launch has been received very well and that's unlocked some opportunities for us that weren't previously available. As far as the clinical launch that Solomon is referring to, that is in sort of a pilot mode now where we're primarily focused on key opinion leaders and we have a very small presence doing that initial development because we're sort of waiting for the initial draft LCD.

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Operator [47]

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Our next question comes from Alex Nowak from Craig-Hallum.

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Alexander David Nowak, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [48]

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Just 3 quick ones for me. Steve, it's been about 18 months since announcing the QIAGEN Panorama partnership. We haven't seen QIAGEN launch that test yet. So what's the current timing for the launch?

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Steve Chapman, Natera, Inc. - CEO, President & Director [49]

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Yes. So we haven't announced the timing specifically. I think there's a lot of very positive development work that has been done and the teams are working very nicely together. At this point, the launch and when the system is made available, I mean broadly is really up to QIAGEN, and we'll look for them to really take the lead on announcing that.

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Alexander David Nowak, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [50]

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Okay. Got it. And then in your pre-submission meeting with MolDx, did you get any indication of what pricing could be for the colorectal cancer screen? I mean should we assume something similar to Prospera pricing? Or what makes sense there?

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Solomon Moshkevich, Natera, Inc. - General Manager of Oncology & Transplant [51]

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Yes. This is Solomon. There are a few comps you can look at. There're other companies who have recently had success launching and getting reimbursement for MRD assays for use in sequencing component. I think you just named another potential comp. So we're feeling like if we -- in our continued discussions with MolDx, that will get sorted out.

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Alexander David Nowak, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [52]

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Okay. Got it. And then with the cost improvements you're making here early 2020 with the few big programs you mentioned, are you saying COGS per test will get to $200 by the middle of 2020?

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Michael Brophy, Natera, Inc. - CFO [53]

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Hey, it's Mike. Yes. We haven't given a specific time line for that, but we do think that 2020 is the right time line where we can get under that target.

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Operator [54]

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And I am showing no further questions from our phone lines.

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Steve Chapman, Natera, Inc. - CEO, President & Director [55]

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Great. Thanks, everyone.

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Operator [56]

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Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program. You may all disconnect. Everyone, have a wonderful day.