Michael Brophy - CFO Matthew Rabinowitz - CEO Steve Chapman - COO.

Doug Schenkel - Cowen & Company Bill Quirk - Piper Jaffray Companies Steve Beuchaw - Morgan Stanley Catherine Schulte - Robert W. Baird & Co. Mark Massaro - Canaccord Genuity Raymond Myers - The Benchmark Company.

Welcome to Natera's 2017 Fourth Quarter and Fiscal Year Financial Results Conference Call. At this time, all participants are in a listen-only mode. Following management’s prepared remarks, we will hold a Q&A session. [Operator Instructions] As a reminder, this conference call is being recorded today, March 13th, 2018.

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

Thanks operator. Good afternoon. Thank you for joining our conference call to discuss the results of our fourth quarter and fiscal year 2017. Also on the line is Matthew Rabinowitz, our CEO; and Steve Chapman, Chief Operating Officer. Today's conference call is being broadcast live via webcast.

We'll be referring to a slide presentation that has been posted to investors.natera.com. A replay of this call will also be available at investors.natera.com.

During the course of this conference call, we will make forward-looking statements regarding future events and our anticipated future performance, such as operational and financial guidance for the full year 2018, our assumptions for that guidance, market size, partnerships, clinical studies, opportunities and strategies, and expectations for various current and future products, including capabilities, expected release dates and related effects on our financial and operating results.

We caution you that such statements reflect our best judgment based on factors currently known to us and that actual events or results could differ materially. Please refer to the documents we file, from time-to-time, with the SEC, including our most recent 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 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 Matt..

Thanks Mike. Good afternoon everyone and thank you for joining us. I will first review the highlights since we last spoke in November, and Steve and Mike will provide additional details on our commercial and financial progress. As Mike mentioned, we will be referring to slides that we just posted at investors.natera.com.

First, the summary of our recent highlights on slide three. We processed over 137,000 tests in the quarter, which represents 17% growth versus the same quarter last year and over 6% sequentially versus the third quarter of 2017.

For Panorama in particular, we're very pleased to return the strong and sequential growth in the quarter, along with continued momentum in our Horizon carrier screen volumes, which grew 5% sequentially and 56% year-over-year.

We have given a lot of detail on tough regarding the recent improvements we have been making to both our product offering and our user experience. Those initiatives are bearing fruits and we continue to see strong volume momentum so far in 2018.

We have stated in previous calls that around this timeframe, we expected to see revenues start to more closely track our strong volume growth as ASP stabilized. We are pleased to see that this trend is starting to occur as we predicted and we believe that in 2018, we will see a return to strong revenue growth.

This will be elaborated further by Steve in a few minutes and by Mike, who will provide our revenue guidance for 2018.

We generated total revenues of $53.8 million in the quarter, which was impacted by a one-time delay in cash collection as we estimate to be roughly $4 million, the one-time delay submission of about $3 million or roughly 6,000 units, and roughly $1 million from the more than 2,000 claims that took longer to adjudicate than usual to the payers new launch review system.

With the launch of a number of prior authorization programs in Q4, we took extra precautions with our claim submissions, which resulted in a temporary slowdown in submissions to payers. For example, if we submit a claim to a payer prior to obtaining a prior authorization from the physicians for the test, we risk getting denied payment on the claim.

So, we took a bit longer than usual to submit claims to ensure our systems were working smartly and in compliance with these new requirements. In January and February, we substantially eliminated this billing backlog and expect to collect cash on these claims consistently with our past history. Mike will provide more detail later in the call.

Our progress with Signatera RUO continues as well. We now have 12 pharmaceutical studies, which include more than 10 of the leading pharmaceutical companies with many more in the pipeline and I will ask Steve to spend more time on our progress on oncology.

Finally, I'm very pleased to discuss our recently announced partnership with QIAGEN to develop NGS-based test clinical use. This strategic partnership combines Natera's cell-free DNA leadership, including in prenatal testing with QIAGEN's GeneReader NGS System and sample handling leadership.

Assays will be designed for use on GeneReader, the first fully integrated Sample to Insight Next Generation Solution to support the dissemination of Natera's cell-free DNA test on a broad basis to hospitals and laboratories.

Natera's Constellation cloud software platform would be accessible for uses of these assays in combination with QIAGEN Clinical Insights QCI bioinformatics solution. Under the agreement, $40 million will be paid upfront to Natera in the first quarter of 2018, consisting of a technology access fee and prepaid royalty.

Additionally, $10 million will be delivered upon achievement of key milestones. We believe that the value of this deal is likely to be substantially more than $50 million as it includes recording royalties on QIAGEN's sales of sequences and reagent kit, enabled by Natera's proprietary technology once the prepaid royalties have been earned.

$5 million of the milestones are tied to Natera support activities and the balance of the milestone payments are tied to commercial milestones. Since our IPO, we have been describing piggybacking on the emergence of next-generation sequencing to offer our content to patients around the world as a core part of our strategy.

Our Constellation cloud software addresses cloud computing resources, storage, software upgrade, data security, and other streamlining to enable laboratories and hospitals around the world to efficiently set-up cutting-edge genetic diagnostic tests on sequencing platform of their choice.

We believe that this platform, together with our core molecular and bioinformatics technology makes us an ideal candidate for partnerships with companies that have emerging NGS platform and our partnership with QIAGEN is an excellent case in point.

As a global leader in latescence tools and diagnostics, QIAGEN is very well-positioned to help Natera capitalize on the emergence of next-generation sequencing globally and to make Natera's assays broadly accessible in many territories around the world.

This is an historic and precedent setting deal where a leading genetic laboratory enables a sequencing platform provider with technology to enable highly impactful clinical test. We look forward to updating you on our partnership in the future. Now, I'd like to hand the call over to Steve to summarize our commercial progress in the quarter.

Steve?.

Thanks Matt. As Matt mentioned, we saw strong sequential growth in our volumes in Q4. We spent a lot of time on our last earnings call talking about the activities we were engaged in to drive volume growth.

In particular, we have had some real successes in our user experience efforts and the launch of our twins capability has been a significant driver of new account growth. Twins pregnancy themselves are relatively rare, but many physician offices, particularly maternal field medicine specialists, prefer to use an NIPT that offers the twins capability.

Since we launched our twins product, we've seen a lot of doors opening. From Q3 to Q4, we saw a 40% increase in the number of new committed accounts won in a period. Adding a new base of customers bodes well for future volumes. For user experience, we launched several initiatives described on prior calls that removed barriers to growth.

For example, we launched an automatic redraw program and introduced workflow improvement that have further cut our redraw rate. We also executed a national rollout of the pricing transparency program we've described on prior calls and the response has been very positive.

We are also gaining access to new accounts because of the new products we launched last year and we expect our new products to have a meaningful impact on revenue in 2018. We are continuing to refine these products as well.

For Vistara, just last week we launched a new requisition form that integrates Vistara on a single requisition form with our other products. We will continue to bring this product along carefully, but we think this change will allow us to broaden access to more accounts.

We are very encouraged with the progress we've seen on cord blood in Q4 and so far this year. Overall, we expect roughly $15 million in revenues in 2018 to come from products we launched in 2017. Mike will speak more about this later in the call. Matt touched on Signatera and we're pleased to be seeing progress in our oncology business.

We've now gotten 12 deals signed with the top pharmaceutical companies compared to the eight we announced last quarter.

We think positive results from these collaborations, along with readouts from our 10-plus academic partnerships, would validate our value proposition and open the door to a larger portfolio of clinical trial opportunities within each of the pharma companies, from which we expect to generate revenue this year.

The next major milestone for us will be the AACR Conference this April, where three of our abstract submissions have been accepted for presentation. These will include preliminary readouts from our previously announced studies in bladder cancer and colon cancer, in collaboration with our Danish colleagues from Aarhus University.

As a reminder, these studies with over 1,000 plasma time-points being analyzed across the two of them, are hugely valuable because our collaborators have been collecting tumor tissue, longitudinal plasma samples and full clinical data and outcomes on all patients with the first patients enrolled in each study over three years ago.

We are doing the same thing with several studies in breast cancer and more. This effectively means we're condensing many years of expensive clinical trial and analytical work into less than a year.

We are optimistic that the results of those studies could replicate the success of our lung cancer work published last year in Nature and could accelerate the adoption of our technology across all cancer types, initially by pharma companies and academics.

Soon thereafter, we would expect this to be followed by adoption in the clinic across a list of clinical indications where we have identified significant unmet needs. On our last call, we reviewed a few examples of CLIA indications for colorectal cancer and lung cancer. Here, I would like to review the plan for stage-two colon cancer.

In this early stage setting, the patient has just had surgery to resect the tumor, and now the oncologist is deciding whether to give chemotherapy to eliminate any potential residual disease.

Among the 30,000 patients per year in The United States with stage-two colorectal cancer, about 20% will receive adjuvant treatment, although clinical studies suggest that only 2% to 4% of them will benefit from it. Determining who should get adjuvant treatment is a real diagnostic dilemma for physicians today.

And while current NCC and practice guidelines support the use of adjuvant therapy in this disease, the guidelines are ambiguous as to who should receive it. We think that circulating tumor DNA analysis of a postoperative blood sample can help treat out patients more effectively.

Such that circulating tumor DNA positive patients who are likely headed for relapse will be better candidates for adjuvant therapy, while circulating tumor DNA negative patients may avoid unnecessary treatment and the associated hospital expenses and be monitored for relapse with repeat blood samples.

We really like this indication because it may help physicians make a decision that is already supported by guidelines, which will likely lead to faster adoption. We think this may lead to as high as a 60% reduction in the number of patients receiving adjuvant chemotherapy and reduce the cost of unnecessary hospital care.

The health economics of this change would imply test value north of $5,000, a number which only incorporates the cost of adjuvant treatment in adverse events, but it excludes all the physical and emotional workplace benefits of avoiding chemotherapy.

The value of repeat testing with Signatera to monitor for treatment response and recurrence would be additional to that $5,000.

We expect the results of our colon study with preliminary data being presented next month at AACR will form the basis for utility studies to launch when the CLIA test becomes available and will enable our reimbursement strategy, which is to apply for a unique CPT code with an ADLT distinction and to obtain coverage with data development at the time of launch.

We plan to execute this strategy across multiple clinical indications and to deliver compelling evidence to drive changes in the NCC and practice guidelines. We are also considering filing for joint FDA/CMS approval using new streamlined regulatory pathways. We believe our test will have uses broadly across many cancer types.

Ultimately, our vision is for Signatera to be adopted into the RECIST criteria and recognized by the FDA as a standard measurement of treatment response across nearly all cancer types and stages, just as ubiquitous as scans are today. With that, let me hand it over to Mike to review our financial performance.

Mike?.

Thanks Steve. We presented the slide previously and predicted stable pricing for the year with several long-term pricing tailwinds.

This is because rather than experiencing steady erosion of average selling prices because of competition or other factors, we traded pricing for stability in the form of long-term contract repairs and experienced one-time changes in CPT codes in previous years, all of which is now fully reflected in our financials.

Matt references the delay in cash collections in Q4 was worth what we estimate to be about $4 million. Most of this impact affected NIPT given the scale of our NIPT volumes compared to our other products. We did not experience material impacts to our underlying pricing in the quarter.

Total revenues divided by units on which we recognize revenues in the quarter was approximately $715 compared to $720 in Q3 and $710 in Q2. The drivers for longer term price appreciation are on the right hand side of the slide.

We continue to see steady improvement in patient collections and Medicaid reimbursement, while our mix of Medicaid volumes remains around 30% of total volumes.

So, the context for 2018 is a return to strong revenue growth, as Matt described, driven by improvements to our core business driving NIPT volume growth, new products contributing to revenue after making the investments in 2017, monetizing our core technology to piggyback on the emergence of new next-generation sequencing providers, and stable pricing as I described previously.

You see the revenue guide for 2018 is $250 million to $275 million and I will spend more time on the guidance in a few slides. As a reminder, our revenue guidance for 2018 is based on the adoption of new revenue recognition standards, ASC 606.

One key implication of this return to growth is that we can describe the path to cash flow breakeven without relying on an improvement in low-risk NIPT or microdeletions reimbursement.

We previously described this path, but we included substantial improvement in our pricing driven by a broader reimbursement of our tests, which we still believe is likely, but here is a more conservative outlook that still gets you there.

If we can maintain mid-single-digit sequential quarterly growth in our test accessioned over roughly the next two years, we think that a blended ASP or average selling price of roughly $450 and blended cost of goods sold of roughly $190 achieved over the same timeframe, would allow us to reach a breakeven cash quarter, while slowly growing operating expenses in line with our history.

Blended average selling prices in the mid-400s are in line with our recent history.

While we continue to expect average selling prices to bounce around, we think modest contributions from our new products, improved collections from patients, or moderate expansion in coverage, such as new contracts within the Medicaid market, would be sufficient to support that pricing level in the future.

I'll describe our COGS progression in a moment, but we believe a target below $200 in the next two years is readily achievable. Next slide shows our COGS in the quarter came down slightly in Q4, and we are still on track to launch our automated carrier screening project in Q2 this year.

Beyond that, we have generated concept data on the next substantial reduction in COGS based on technology developments in NIPT that we think will allow us drive blended COGS much lower again over the next 18 months.

We've made some significant investments in R&D since the beginning of 2015, but as you can see on the right hand side of the page, the returns have been very strong even if you only count COGS reductions we've achieved and leave aside key product improvements that have driven revenues.

This map also excludes the value that we have received from the QIAGEN deal, for example, though, of course, we are able to sign deals like that because of the substantial differentiation and performance of our core technology and the capabilities of our cloud platform.

This allows us to enable a broad base of sequencing partners, which is an incredibly valuable capability. Of course, we have a tremendous amount of earnings power embedded in our existing average risk NIPT and microdeletions volume that are not currently reimbursed by insurance, which we've broken out here between low-risk NIPT and microdeletions.

We estimate conservatively that there's about $30 million in revenues that drop straight to cash flow as we described previously.

We continue to see incremental growth in the number of covered lives that reimburse NIPT in the average risk setting, and we do think there is substantial upside in our business as average risk reimbursement continues to evolve in our favor. With that in mind, the next slide shows the estimated breakdown of our projected R&D spend for 2018.

As you can see, a significant proportion remains focused on COGS reduction and the core prenatal business, where we've shown we can generate very strong returns. Oncology comprises slightly more of our spend this year as we pursued some of the small clinical trials Matt described earlier in the call. Now to summarize our results from the quarter.

The results for the quarter and the full year crossed the wire this afternoon. For brevity on the call today, I'm going to focus on the key points of the Q4 results. Our fourth quarter total revenues were $53.8 million compared to $49.3 million for the fourth quarter of 2016.

As Matt mentioned, we estimate about $4 million in cash collections were delayed from Q4 into 2018 due to a longer payment cycle as we navigated new prior authorization policies.

We did this to limit the number of claims that are denied outright solely for not obtaining the prior authorization from the physician and we've now cleared that billing backlog and have begun collecting that cash. In Q4, roughly 50% of the revenue recognized test in the quarter were also accessioned in the quarter. For Q3, this figure was 47%.

Given that we are recognizing revenues on cash for this final quarter in 2017, this delay, of course, directly impacted gross margins. Gross profit for the quarter -- for the fourth quarter 2017 was $17 million, representing a 32% gross margin compared to $11.3 million, a 23% gross margin in the same period of the prior year.

Adding back, the roughly $4 million in delayed claims would have generated gross margins of roughly 36% in the quarter.

Panorama revenues for the quarter were $32 million compared to $34 million in the fourth quarter of 2016, a decrease of $2.4 million, which again, is driven primarily by the shift in network contract and the cash collections timing related to prior authorization process that I just described which primarily affected Panorama.

We recognized revenue on approximately 53,560 Panorama tests in the quarter compared to approximately 55,600 Panorama tests in Q4 of last year. Horizon revenues for the quarter were $17 million compared to $11.4 million in the fourth quarter of 2016, an increase of $5.6 million, driven by volume growth.

We recognized revenues on roughly 19,900 carrier screening tests in the quarter compared to roughly 9,700 tests in the quarter last year. Total operating expenses for the fourth quarter were $62 million compared to $49 million in Q4 of 2016.

The vast majority of this increase was driven by a legal settlement pertaining to past government reimbursements. The company has agreed to an $11.4 million settlement with the government with no admission of wrongdoing. We disclosed this matter in our previous public filings after receiving a civil investigative demand.

As a result, we accrued a legal expense for the full amount of the settlement in Q4 and we plan to pay out most of the cash in increments in 2018. There are frequently legitimate differences of opinion with government reimbursement of cutting-edge novel services such as Natera's.

We feel strongly that we complied with the applicable laws and regulations, and throughout we provided our valuable services in good faith and with transparency. When we launched our test, due to the unique nature of our test, there was no precedent for billing.

It took until 2015 for the American Medical Association to develop an assay-specific code for NIPT. When we launched Panorama, Natera engaged a nationally recognized coding expert and relied on his opinion.

The government was made well aware of the nature of our testing, including through appeals, which included extensive information about what was ordered by the physician and the test that we were performing. We've vigorously disputed all the government's allegations.

Nonetheless, given the expense, time, and effort required to litigate these types of cases, all the way to a jury trial and link these subsequent appeals processes, we felt it was clearly in Natera's best interests to settle the case now. There will be no corporate integrity agreement associated with the settlement.

An important indication that the government did not have concerns about these matters going forward that there was not any intentional wrongdoing on Natera's behalf. And that this is primarily a routine coverage dispute. Natera will continue working with all government payers.

At the close of the quarter, the company held $119.3 million in cash, cash equivalents, short-term investments and restricted cash compared to $146.6 million as of September 30th, 2017.

As of December 31st, 2017, we held a net carrying amount of $73.1 million under our seven-year term $100 million debt facility with Orbimed Advisors and had drawn down $50 million, including accrued interest under the $50 million line of credit in place with UBS. These cash figures do not include the impact of legal settlement or the QIAGEN deal.

Turning to our future outlook, we expect 2018 total revenues of $250 million to $275 million, cost of product revenues to be approximately 50% to 55% of revenues, selling, general and administrative cost to be approximately $140 million to $150 million, research and development cost to be $50 million to $55 million, and our cash burn to be $40 million to $60 million.

The key assumptions in this guidance are revenues driven by volume growth with stable underlying pricing, contributions from new products, margins driven by COGS improvement as we described, and roughly stable operating expenses as I've talked about on this call.

This guidance incorporates only moderate impact from the prior authorization programs I've talked about. We expect our recent success in growing volumes to continue through the year. And as Steve mentioned, the guide incorporates roughly $15 million in revenue contribution from cord blood and other new products launched in 2017.

A note on the accounting, beginning in Q1 of 2018, we will be transitioning from recognizing the majority of our revenues on a cash received basis and will instead book revenues on an accrual basis as required by the new accounting standard, ASC 606.

Of course, the goal of an accrual is to accurately estimate our actual cash collections from tests reported out in a period. So, over time, we expect the impact to our financials to be neutral. However, we estimate that our transition to accrued revenues will result in a one-time impact to revenue in 2018.

Under our prior cash received revenue recognition policy, for example, units reported out in Q4 and paid in Q1 will be recognized as revenue in Q1. Under ASC 606, this cash received for units reported out prior to January 1, 2018, will not hit revenue anymore, but instead will flow through prior periods as we adopt the full retrospective methodology.

Of course, we will also be able to recognize revenues late in fiscal year 2018 for units reported out by the end of the year, but uncollected until afterwards. Those units would ordinarily drop into 2019 as part of the cash-basis approach.

In addition, under ASC 606, we must estimate items like revenue reserves from overpayments and initially, of course, we intend to remain on the conservative side in taking these reserves.

We estimate the net impact of these rule changes to be a reduction of $5 million to $10 million in 2018 revenue and this impact is reflected in the guidance to revenues and margins we are giving today. Now, I'd like to open the line up for questions.

Operator?.

Thank you. [Operator Instructions] Our first question comes from the line of Doug Schenkel of Cowen & Company. Your line is open..

Hey, good afternoon guys and thank you for taking our questions. Just to kick-off with a clarifying question on revenue guidance.

What is included, if anything, for the QIAGEN payments? Is this -- just to be a little bit more clear about this, does your revenue guidance include revenue contributions from QIAGEN?.

It includes -- hey Doug, it's Mike. It includes a small amount of revenue recognition from QIAGEN. Obviously, we just signed a deal and so we're working through the revenue recognition topics with our accountants. But it's a few million dollars. It's not a -- wouldn't materially change the range.

And on the Q1 call, we'll give you the full details of where we landed there..

Okay. That's helpful. Because, obviously, if they were a significant amount of QIAGEN contribution in that, that would be a lot different from what we're expecting. So, I mean, initially it looks like especially adjusted for ASC 606. Your guidance for 2018 is not -- not far off from where consensus expectations were coming into the year.

Then maybe just a couple of more questions, if I may, on the QIAGEN relationship.

I guess, first is, how does this impact your plans for using a little bit of sequencing internally, if at all?.

I'll take that. Thanks for the question, Doug.

So, let me just mention that the revenue guidance, I think, is actually above consensus expectations for the year, including the -- if you take out these -- the small amount of revenue that was expected from QIAGEN for the year, the revenue guidance would actually be above what the consensus estimates were.

So, that's hopefully a little bit clarifying. In terms of the relationship with Illumina and QIAGEN. Look, QIAGEN is a magnificent partner. They have got broad distribution around the world. They are by far the leader in DNA extraction. They've got really good penetration to labs and hospitals in territories globally.

So, we're very happy with that relationship. QIAGEN has also made lot of inroads with their V1.1 sequencer. That system seems to be working very well for a set of applications where they are enabling smaller hospital labs and laboratories in territories all over the world.

So, they are a very strong distribution partner for us, and we're really happy with that relationship. We think that we can actually help them sell a lot more of their systems. We've always said that we wanted to piggyback on the emergence of sequencing all over the world.

And we want to enable labs and hospitals to make the decision on what sequencer they want to use. So, they're going to make the decision based on the sequencers' costs and performance and the services they get.

And we want to be providing these very high-volume services in prenatal testing and oncology that piggyback on that revolution of sequencing around the world. We see this very similarly to the computer industry in the 1980s. It was initially the IBMs of the world that dominated the space, because they controlled the hardware.

But as the hardware became more democratized, it was the application layer that really started to control the day, like the Microsoft and the Googles of the world. So we want to provide these applications on top of sequencing systems and I think the QIAGEN deal is a great way of doing that.

Now that said, for our lab we don't have immediate plans to change. We have a good relationship with Illumina. We will use whatever sequencing system provides the best technology, the best price, and the best service. And we've got a great relationship with Illumina.

There's a lot of topics that are being discussed between our self and Illumina to add additional content onto their sequences as well. And so we think that, that relationship will continue. So, long as we have good relationships with our suppliers, we'll be very happy to keep them in our lab. But we'll make that decision based on technology and cost..

Okay, that's helpful. Is the arrangement with QIAGEN an exclusive? I ask this in part because, while there is potentially a lot of promises associated with that platform by our account, there's probably not more than 150 GeneReaders out there in terms of total placements globally. So, they're a pretty small player today.

I'm just wondering how -- if this is an exclusive because if it is, it's definitely banking on them doing a lot better from a placement standpoint in terms of actually being in a position to generate real revenue for you. .

That's a very thoughtful question, Doug. Thank you for these. So look, there's a lot coming down the pipe from QIAGEN. Their V1.1 sequencer is doing well. And they've made a lot of inroads with the Sample to Insight philosophy where they go all the way from the DNA extraction all the way to the results. And that's really yielded fruit.

So, I have a sense that their sequencing platform is doing very well. And I'll let QIAGEN talk about their numbers, but we've spoken to people who used their systems extensively, and it looks really good. That said, no, this would not limit our ability to offer Constellation broadly.

There are certain aspects of exclusivity with QIAGEN and we think that they are a very valuable partner and we want to make sure that, that partnership goes well. But as we've said, we want to be able to offer Constellation broadly and let the labs choose whatever sequencing systems they want to choose.

And this deal does not limit our ability to do that. That said, I do think that QIAGEN is going to do very well out there. And we certainly want to help them, and that partnership is going to occupy a lot of our attention, because, I think their distribution reach is important for us..

Okay.

Last one, recognizing Illumina has been pretty successful in defending its IPS data and NIPT, who is responsible for potential legal costs, you or QIAGEN?.

We're not going to go into those details of the relationship. But I will say this. Before you enter into a relationship of this scale, there are two things you do. You do a lot of analysis of your legal position and we've got a very strong technology, which is a very unique technology on NIPT.

And we've analyzed this position with many different groups, both partners as well as investors. And we went through a very thorough analysis of this with QIAGEN. And -- so obviously, we feel we are in a very good position given the unique nature of our technology. And the second thing is, you generate a lot of data.

We've got a lot of data on various platforms. And we feel that the technology that differentiates Natera is going to be usable on many platforms. And as I said before, we think it's important that the labs and the hospitals around the world get to make their decision based on whatever sequencing system they want to use.

And I think the best sequencing system is going to win..

Okay. Thanks Matt..

Thank you. Our next question comes from the line of Bill Quirk of Piper Jaffray. Your line is open..

Great. Thanks. And good afternoon everyone..

Hey Bill, how are you doing?.

Very well, very well. Matt or maybe Steve, just I guess, first question on the 2018 guidance concerning the contribution from new products, the $15 million in 2018.

Can you help us think a little bit about, I guess, how you came up with that number or maybe kind of risk assess that for us? Is this largely tied into clinical trial revenue or cash pay revenue? I guess, I'm -- what I'm really trying to ask here is, how much, I guess, reimbursement risk is there to that $15 million contribution? Thank you..

Maybe I'll take that as a first step and I'll let these guys chime in and fix it. The driver of the new products revenue is really coming from cord blood, Bill.

I mean, that's the biggest of the products and then followed by contributions from other areas like tools revenue from pharma as we get some of these pilot studies done and also some contributions from Vistara as well.

So, if you think about that cord blood product as a cash pay product, there is -- compared to our standard book of business, there's less reimbursement risk than normal..

Yes, I'll come over the top on that, Mike, thanks. This is Steve. So, as Mike said, vast majority is from cord blood. There is still a significant amount of data from Vistara and then the beginning of a ramp in the pharma business.

And at this point, we have good visibility based on having launched the products in 2017 on what the growth rate is and what our performance is, and what the ASPs are. So, we feel pretty confident in our ability to make projections there.

But I think the pharma business as well is really just getting started and I think the numbers we put together there are pretty conservative because the deal amplify off one another.

So, once one of the initial studies that we signed with the pharma company is successful, that really opens the doors very quickly to additional and much larger scale studies with the same partner. So, we look forward to some upside there on the pharma business..

Okay, very good. Thanks for the color on that. And then secondly, Steve, just going back to your comments that you made regarding the twins testing effort, and the fact that this is opening up a lot of new doors for you.

Recognizing that it's early, but can you just talk a little bit about the trends within some of those accounts that have signed on to use Natera, specifically citing the ability for the test to help with twins.

I guess I'm trying to get at is, are you seeing volumes that are kind of consistent with average accounts? Or are you seeing these physicians kind of pick and choose between tests offering yours, for example, when they have an expectant parent with multiples..

Yes, thanks, Bill. So, I think, largely -- most offices want to use one provider. And I think, while there are some that split samples for various reasons, we see largely people trend towards using one provider because it's just easier for their office.

And so for a long time, we didn't have a twins assay and that enabled competitors to really keep a presence in our accounts and it also limited some of the accounts that we could break into, particularly the maternal-fetal medicine specialist.

So, there is growth coming from our existing customers, where they are now able to sort of treating and caring [ph] as a one-stop shop, where they weren't able to previously. We are keeping competitors out as a result. There's growth coming from us opening up new doors as we announced on the call.

We're breaking into some new accounts that previously we didn't have access to. And usually, when we get a foothold in these customers, because of the full suite of services that we're offering and because of the U.S. platform that we built, we tend to see our accounts start with us and then move on to the full suite of services..

Got it. Appreciate it. Thanks guys..

Thanks Bill..

Thank you. Our next question comes from the line of Steve Beuchaw of Morgan Stanley. Your line is open..

Hi, thanks for all the time here tonight guys. I'll ask one for Mike and one for Matt. I'll ask them both and then I'll jump back in queue. Mike, there are a few moving parts in the model here with the absence of the buyer reference drag, which created a little bit of pressure in the first half of 2017.

QIAGEN layering in with small new products layering in which are immaterial? And it's a little hard to know the timing on the revrec for some of these items in the way they contribute.

So, it'd be really helpful if you could just give even a high-level thinking on the pacing of revenue over the course of the year, how it might compare to last year? Or if you want to think about in growth rates, that certainly works as well.

And then, where you think you could exit the year on gross margin? And then for Matt, you've given us a lot of color on the QIAGEN relationship, but as you can tell, we're all very interested in and strategically it's pretty fascinating. So, I wanted to approach it from a couple of different angles with you.

One is, how much of the GeneReader installed base out there do you think can get run for both cancer applications and prenatal applications, because it does seem like the commercial push for QIAGEN after this point has barely been cancer intensive? And then if you think about the decision that a lab has to make, if they were to compare straight up on economics, the assay between the GeneReader QIAGEN -- I'm sorry, the QIAGEN-Natera combination versus some of the alternatives out there, are they getting clearly better economics on what you're offering? Or was it really more, hey, look our platform is clearly the superior assay and we're going to win that way? I apologize for the long-winded questions and thanks for all the color..

Okay, so I'll go first and then we'll turn to Mike. Again, guys, thanks a lot for these questions on the QIAGEN relationship. I agree with you, it's a strategically very important relationship, and it's consistent with our vision of being core technology provider. Our lab is the first customer for all this great technology that's coming out of our R&D.

And once the technology is well understood and a lot of data is generated within our centralized lab, we want to put it out in the cloud. And I would say that this is really a precedent-setting deal. This is, to some extent you could say, a first big deal between a lab that has got specialty cutting-edge technology and a platform provider.

And so I think that it's very important for us and QIAGEN. I think, it's very important for the industry overall. So, I'm very happy to talk about it. In terms of the decisions of the lab, you talked about the economics. Look, labs are going to make the decision like they should in a free market system.

Labs are going to decide based on service and cost and quality. And I think there are certain labs that are going to go with Illumina and certain labs and hospital systems that are going to go with QIAGEN. QIAGEN has banked on this very strong position they have in terms of Sample through Insights.

And I think, when you can streamline things for the lab, you can make life a lot easier for them. The fact that you can go all the way from DNA extraction, all the way to a result that's meaningful and interpreted, is a big deal for a lot of labs, because they want to be able to offer this cutting-edge test with a minimum of complexity.

And QIAGEN has got the QCI bioinformatics service, which is great. And Natera has the Constellation cloud offering, which, I think, is a superb product. This takes care of all of the difficult issues for labs and hospital systems to get up and running with these cutting-edge tests.

And I mentioned that on our prepared remarks, the elastic cloud computing resources, the storage, the provisioning, the compliance, the data security, all sorts of issues that make it real easy to come up and running.

So, I think the cost model that QIAGEN will create is going to be very compelling, given the fact that it's a rarely streamlined service for these labs. And a lot of labs are choosing QIAGEN. I think, so far they are choosing QIAGEN for small volume applications based on the V1.1 sequencer, but there's a lot of stuff coming down the pipe from QIAGEN.

There is going to be a lot of stuff coming down the pipe from lots of different sequencing companies, and QIAGEN is going to be right in there. So, in theory, yes, you can run the NIPT and the oncology applications on the V1.1.

But I think that the volumes will come on -- it's going to play out over several years and there is going to be new things coming from QIAGEN over these next few years as well. Okay.

That said, Mike, you want to talk about revenue?.

Yes, so you made reference to last year we guided a fairly lumpy year, because of some of the issues you mentioned. 2018 is more sane in terms of the pacing. So, that's why didn't give you kind of very specific explicit guidance on that in the model.

The revenues in Q4 are heavier than like a straight line growth rate would imply, simply because there is some of that new product revenue that we've included in the guide that will land later in the year. And I think on Q1 is a bit lighter than the other quarters, simply because of this ASC 606 transition.

And if there's follow-ups there, I'm happy to get into that. The summary is, under the old cash received revenue recognition model, Q1 of 2018, we'll be recognizing revenue on units that we reported out in Q4, but where we received the cash in Q1.

And obviously, under this new system, we're just going to go straight to just accruing the units that we report out in Q1. So, there's some puts and takes there. That's the penalty in Q1. And then it's -- as I mentioned on the call, it's a penalty overall for the year, but over time it's going to be neutral..

Thank you. Our next question comes from the line of Catherine Schulte of Baird. Your line is open..

Hey guys, thanks for the questions. Mike, just a quick one for you to start off.

Given the number of winter storms we've been seeing, are you expecting to see weather impact in Q1?.

That's a good question. I'm tempted to take you up on that Catherine just because I think it's a little bit early to say. I'm looking at Steve to see -- we're in Boston right now, we're in a blizzard. So, we -- I'm tempting to say, yes. But I don't know.

Steve, what do you think -- I mean, have you seen something in the recent volumes there?.

I mean, we haven't yet. We had a lot of momentum coming out in Q4. And we haven't seen any disruptions yet. I mean last year we had hurricanes and other natural disasters as well. So, I think every year there is something and we just sort of work through it. .

Yes, I think it will be fine. But everyone on the call still minimize your carbon footprint, please. We like polar bears..

All right, great. And then just on Signatera.

Can you give any anecdotal feedback from the initial pharma pilot study customers? Have you seen any of those initial users expanding their projects or is it still too early?.

Well, I think it's too early to say, but yes, we have had initial feedback and it's been very positive. I mean I can't talk about expanded projects as these are processes that take a while. But the feedback has been very positive. The performance of the assay is very good.

I think when people look at the data; they are impressed that we can go down to roughly single-molecule sensitivity. And they are impressed that we can track so many mutations per patient and that the assay works right out-of-the-box as a customized assay per patient.

And you're able to get such good sensitivity and specificity because you're able to target all of these variants on a per patient basis. When you compare it to the broad panel, the broad panel will typically catch zero to five variants, even on these panels of 500 genes.

So, the pharma partners that have seen results and the clinical trial partners that have seen results, I think you've been very impressed with our approach in all of those respects.

We are still working through the clinical indications that are area of focus and we are talking to pharma partners now about some much bigger trials, which we will be talking about much more this year. I would say at this stage that their technology just works for current monitoring really well.

We consistently seen where you have cancer detected, and then you want to catch the recurrence of cancer in -- typically in a metastatic setting, but also in other settings. The recurrence just seems to be very well detected by this technology.

And when we talk about that roughly $15 billion market, that's largely driven by the fact that there's around 17 million, 18 million people in United States alone that are living in remission from cancer. And so being able to do regular blood draws, we can catch recurrence early, is a really big deal.

It's very relevant for the management of cancer patients, and it's very important for pharmaceutical companies as well. So, that's an indication that seems to be bearing out really well. And then for each of these pharma trials, they've got a particular set of indications that are unique to their biological interest and unique to their drugs.

And so those are discussions that take a while to sort of pan out to the next step, but it's looking good. .

Great, that's very helpful. And then you talked a bit in the prepared remarks about potential CLIA products for oncology. And clearly, this is a moving target as partners get more data.

But how many of those commercial tests do you envision potentially having by the end of the year?.

Well, we haven't really broken that out.

But Mike, do you want to say more on that?.

Just give me the question again, Catherine..

The question was the CLIA oncology tests, have we got in the model this year?.

There's no material amount of CLIA revenue in the model this year, Catherine. So, we're just going kind of taking that -- I'm not saying it's not happening. But just in terms of the guide that we gave you, there's not a material amount of dollars in the guide for CLIA revenue -- pharma tools revenue..

Steve, you want to comment?.

Yes, I was just going to just talk briefly about sort of the launch plans for the CLIA products.

So, I think, as we've discussed, we've really been able to condense this period of clinical validation from what previously would have taken three to five years to sign up these partnerships and collect perspective samples and then validate in each particular tumor types that we want to look at, because we collected these prospectively collected bank samples.

We've been able to condense that clinical validation period, and this year we will be reading out multiple clinical validations across various cancer types, several of which we've already talked about.

So, the idea is, once these clinical validations are available and we are ready to launch, we want to pursue a coverage with data development through the local coverage decision pathway. And we also believe that we can get a unique PLA code and apply for advanced diagnostic test category status, which we think will give us very favorable pricing.

So, you should expect to see some very targeted indications reading out initially and then over time, that broaden into multiple indications more to pan cancer assay as the initial data are available..

Thanks Steve. I'm going to make another comment on the guide. To refer back to the prepared remarks, the way you should think about this guide is growth of the core business predominantly. We've got a little bit of -- very small amounts in there from QIAGEN, and then there is a certain amount there from these new products that are taking off.

But fundamentally, we've been saying for a while that when the ASPs in the core business stabilize, you're going to start to see revenues tracking on that volume growth. And volume growth look really good in Q4. As I said, it's looking really good into Q1. And that volume growth is going to return to really strong revenue growth as we said it would.

So, I think there's a lot of upside here. We are being conservative on the CLIA oncology stuff, there's going to be mostly pharmaceutical revenue assumed in oncology. There's other areas of upside, but the guide is above the expectations, and that is fundamentally driven by the growth of the core business..

Great. Thank you..

Thank you. Our next question comes from the line of Mark Massaro of Canaccord Genuity. Your line is open..

Hey guys. Thanks for taking the questions. The first one for me is on QIAGEN. Congrats on the deal and the terms of the deal.

I guess, can you speak to when you expect your content to be available on the GeneReader? And then related to that, can you speak to, whether or not or -- walk us through roughly what the cost will be to develop the content from your perspective? And is that included in the 2018 guidance?.

I'll talk to that, and then Broph, you can add anything if you want to. So, in terms of the timing, look, as I said earlier, you generate a lot of data before you go into a partnership like this. So, the timing is something that is going to be determined by QIAGEN now. We -- you should just ask the question to them.

We're going to be very supportive of them. And I think that there's going to be some great announcements. But I don't want to steal their thunder. They are the ones who are driving the timing now. In terms of the other question, Broph, do you want to talk--.

Yes, and so Mark just to clarify, you're asking if there's a royalty revenue in the guide.

Is that fair?.

No.

Actually just the cost that you might be incurring to help QIAGEN develop the content on the GeneReader?.

Sure. Yes, absolutely. Yes, that's fully loaded in the R&D spend guide. .

Okay, great. And then a question on average-risk NIPT. I know, obviously, many of us are waiting on ACOG to support average-risk NIPT in a more clear manner.

Matt or Steve, do you have any comments on whether or not you think you might see something before the annual meeting this year? Can you just speak to any chatter you're hearing?.

Do you want to take that or should I?.

Yes, sure. I mean, look, obviously, we're disappointed things haven't moved much faster with Aetna and UnitedHealthcare. Although, we are in very close contact with ACOG, we had a meeting just recently. So, there's lot of very positive discussion there.

I think we got [Indiscernible] in the past some of our additional strategies, whether it's working with employer groups or targeting the sort of long tail of additional smaller plans that we're still working through. But there is a lot of activity there.

But I think the key is that as Mike said, we're not reliant on changes to successfully run the business. And there is a significant amount of built-in upside in both average-risk and microdeletions if those changes do come through..

Got it. Great. If I can sneak one last one, and this one is for Matt. Your technology seems to be, or I should say, your strategy in oncology seems to be with residual disease and patient monitoring.

Can you speak to why you think your technology is uniquely positioned to address these needs as opposed to, say, therapy selection or even early-stage cancer detection?.

Thanks. I'm going to make a comment on the earlier remarks. Actually, wait, let me just take this question first and then if we have time, I'll go back to the earlier remark. So, the technology is not just about recurrence monitoring. The technology is about building a customized assay for any particular patient mutation profile.

So, that's relevant for therapy response monitoring for residual disease detection after you've had chemotherapy or after you've had surgery. If you have residual DNA, you know that you haven't got all the cancer out. And the data across many different cancers is very strong there.

Your chance of relapse when you see residual DNA is about 10 times higher over the next three years than if you don't see residual DNA and then, obviously, recurrence monitoring. And then it's very important for a lot of the cancer vaccines and immunotherapy stuff.

I think that a lot of the key treatments to cancer over the next five years are going to be these immunotherapy approaches.

And because you're building a customized training of the patient's immune system to go after particular new antigens, you want to be able to monitor those new antigens as well as the new antigens that you're not going after in that patient. So, it's very well-suited to that customized therapeutic approach to have a customized diagnostic approach.

So, there's a whole range of applications. We don't focus right now on early cancer detection. As I said before, we do have a bunch of trials that are going on related to early cancer detection. But to make headway in that market from a reimbursement perspective is really hard.

You've got to not only catch the cancer, but know what organ that cancer is coming from, and know exactly what the follow-up needs to be. And there are other companies that are going after this.

I think it's going to be a very tough problem, both technically to figure out exactly where the cancer is so that you don't freak people out and have them go through really expensive CT scans and MRIs and full body scans, because they don't know where the cancer is coming from.

You can do a lot of damage to the healthcare system and to an individual by giving them that kind of information unless you can be very specific. So technically, it's a very hard problem. And then from a reimbursement perspective, it's hard to get reimbursement when you're doing pan population asymptomatic screening.

So, there are certain trials that we have going on in that area, which are very consistent with our penetration of the women's health market. And so we're not blind to those opportunities. We're looking at some targeted opportunities, where we'll productize if we see that it really works well.

But I think that our strategy from a reimbursement perspective makes sense to go after the high-risk population first, where you are actually giving clear value to the doctors and the patients, and clear value to the health economic system.

And the patients who have been diagnosed with cancer and are either going through treatment or are in remission are the high-risk patients. And that's a really big market. So, hopefully, that answers your question..

It does. Thanks very much..

Thank you. And our final question comes from the line of Raymond Myers of Benchmark. Your line is open..

Thank you. I'd like to ask a few clarifying questions. Matt, first for you. You talked about a few million of revenue this year recognized from QIAGEN.

Can you help us understand more precisely what do you mean by a few million? And describe how is revenue recognized on this $40 million from QIAGEN?.

Hey, I'll take that, Ray. So, the revenue recognition just comes down to the components of the deal. And certain components of the deal, the cash upfront is broken down into pieces. And then each piece kind of has its own revrec logic that we are working through with the auditors now.

So, when I clarify -- I mean to clarify a few million, it's circa $5 million, maybe a little less is what we have in the guide. And then again, we'll update you in Q1 for what the revenue recognition is for the upfronts..

Thanks. It helps --.

Go ahead..

Sorry, I didn't mean to interrupt. It helps with understanding your guidance, so I appreciate that.

If you're done with that answer, I next wanted to ask you about, how many Panoramas were accessioned in the quarter?.

I've got 90,578 Panoramas accessioned in the quarter..

Okay, couldn't be more precise. Thank you.

What was average-risk covered lives in the quarter?.

So, the average risk covered lives in the quarter was above 110 million. It's grown kind of a few million per quarter over the last two or three quarters..

Okay, great. And last question was about the SMART trial.

Are we still expecting interim results this summer of the SMART trial?.

So, just to clarify what the expectations are there, we expected to -- we completed enrollment of the SMART trial in August. And then we'll be completing the work around the trial, the readouts, just from actually getting the -- the children born through Q2 of this year.

So, just to clarify what the previous discussion was, and so Matt, you want to talk about that?.

Yes, sure. Thanks Mike. So, before I talk about SMART, I want to go back to this low risk coverage issue, and there was an earlier question about ACOG, where I said I'd come over the top after Steve answered. So, I'll just take this opportunity to make some comments there.

We have had a couple of additional positive coverage decisions on low risk in the quarter. We would like it to be happening faster, but it is happening. And it's very clear that we've made the right bet there. In terms of our engagement with ACOG, it's an ongoing discussion that we have with ACOG. And we're getting, I think, good support from them.

We're getting very strong support from other professional societies who are writing strong letters to the insurance companies that aren't covering this. So, it's possible that ACOG will do something more pushy with the insurance companies, but I can't speak for them. They're just going to do what they see as fit in their own time.

But while that's going on, there is a lot of other activity going on for low risk coverage. What we're seeing is big employers who are contracted with certain insurance providers are making the decision to cover low risk and other of our tests themselves.

And as the big employers make those decisions, it puts more and more pressure on insurance companies. And there's a lot of other activity that's going on besides ACOG.

So, I think, you are going to see an ongoing trend here, although, obviously, if ACOG was more pushy with insurance companies, that would be the fastest way of making this happen in a matter of months. Okay, so now on the SMART trial, we've got the data going to be collected from the born children at the end of Q2.

But then there's got to be a process of data analysis and the PIs have got to be working through all of the clinical issues and get the package out. So, we do expect that we're going to be reporting out on SMART this year, but we don't know that the publication is going to be out this year. And the SMART trial enrollment is going very well.

As I said before, we expanded to 20,000, because we wanted to use that infrastructure to validate many of our technologies, which do very broad coverage of pregnancies, not just the standard aneuploidy stuff. And so there's going to be a lot to report out on that SMART data and on subsets of the SMART data over time.

But I think the fundamental first readout of the SMART data is on track to happen this year. We just can't say exactly when the publication is going to come out..

Sounds great. Look forward to it. Thank you..

Thank you. At this time, I'd like to turn the call back over to management for any closing remarks..

Thanks very much for these thoughtful questions guys. And I really appreciate that you guys are spending time thinking about this QIAGEN deal. We think that it's a really precedent setting deal. It's a great partnership.

And it's consistent with the mission of Natera to be providing this technology to change lives around the world and this is a really way of doing it. I also am really looking forward to return to growth as the ASPs stabilize. I think you've seen phenomenal volume growth as Natera has taken on and grown our leadership position.

And with the ASPs roughly stabilizing, having the revenues track that growth is going to be great. So, thank you very much, and thanks to Mike and Steve..

Thanks guys..

Ladies and gentlemen, this concludes today's conference. Thank you for your participation and have a wonderful day..