Welcome to Natera's 2018 Fourth Quarter Financial Results Conference Call. At this time, all participants are in a listen-only mode. Following management's prepared remarks, we will hold a Q&A session. [Operator Instructions] As a reminder, this conference call is being recorded today, March 12, 2019. I would now like to turn the conference call over to Michael Brophy, Chief Financial Officer. Please go ahead.

Thanks, operator. Good afternoon. Thank you for joining our conference call to discuss the results of our fourth quarter and full year 2018. Also on the line is Steve Chapman our CEO; Bob Schueren, Chief Operating Officer; Solomon Moshkevich, General Manager of Oncology and Transplant and Matt Rabinowitz, Executive Chairman. 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 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 our 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 product 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 to revise any forward-looking statements. We will provide guidance on today's call, but we'll not provide any further guidance or updates on our performance during the quarter unless we do so in a public forum. We will quote a number of numerical growth changes as we discuss our financial performance and unless and otherwise noted each such reference represents a year-on-year comparison. And, now, I'd like to turn the call over to Steve.

Great. Thanks, Mike. Good afternoon, everyone, and thanks for joining us. I will cover our recent highlights and progress since we last spoke in November 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. Before we jump into recent highlights or revisit the three goals that we spoke about at the JP Morgan Conference in January, we think Natera can drive significant value for shareholders in the near term by executing on these three core objectives. First, we want to extend our leadership position in reproductive health and get a cash flow break even. Continued volume growth combined with a roughly $200 gross profit per unit would get us there, which we think is achievable. Second, we need to deliver rapid revenue growth in our oncology business. We generated a lot of compelling data so far and this year we expect that to translate into meaningful revenue from pharmaceutical companies. Finally, we need to pass key inflection points in our organ transplant business by commercializing our tests and getting Medicare coverage. Continuing our success from 2018, where we completed all of our stated milestones. We will spend more time on these goals throughout the call. Let me now move on to a summary of a recent highlights on the next slide. On volumes and revenues, we processed roughly 6,669 tests in 2018, which represents a company record of 30% year-on-year growth versus 2017. We processed over 174,000 tests in the fourth quarter, including processing over 119,000 Panorama tests and assessing more than 46,000 Horizon tests. We're very pleased with this rapid volume growth. Revenue growth also roughly tracked our volumes. We generated total revenues of $67 million in the quarter, up 29% versus Q4…

Thanks, Steve. 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. As a reminder, the results from Q4 of 2017 have been restated under ASC 606, in which revenues are recognized on an accrued basis, so the face of the financials are apples to apples in the filing that crossed the wire today. Our fourth quarter total revenues were $67 million compared to $52 million for the fourth quarter of 2017. This growth was driven by volumes, as Steve described. Gross margins were 36% in the quarter compared to 29% in the same period of the prior year. Panorama revenues for the quarter were $36 million compared to $30.9 million in the fourth quarter of 2017, an increase of approximately $5.1 million. Horizon revenues for the quarter were $23.9 million compared to $16.1 million for the fourth quarter of 2017, an increase of approximately $7.8 million, driven by both volume growth and sales and product mix. Total operating expenses for the fourth quarter were roughly $54 million compared to $62 million in Q4 of 2017. At the close of the quarter, the company held approximately $158.5 million in cash and equivalents compared to $170 million as of September 30, 2018. As of December 31, 2018, we held a net carrying amount of $73.4 million under our seven-year term $125 million debt facility with OrbiMed Advisors and had drawn down $50.2 million, including a quick accrued interest under the $50 million line of credit in place with UBS. Turning to our future outlook. We expect 2019 total revenues of $275 million to $302 million. Gross margins to be 35% to…

[Operator Instructions] And our first question will come from the line of Bill Quirk with Piper Jaffray. Your line is now open.

Good. So, I guess, the first question and Mike you've kind of alluded to it a little bit in some of your comments regarding timing of taking those oncology orders and turning this into revenue, but can you give us a little extra color on your breakdown expectations for the big categories, things like Panorama, Horizon, and I think I heard you right on oncology, it's probably going to be something like $3 million to $4 million '19 expectation? A - Mike Brophy Yeah. So, I wanted to just keep the guide to the total revenue, Bill, like we've always done. I feel like when we give more detail, it actually introduces more complexity and makes life harder for everyone. So I think it's simpler to kind of stick to that in a total revenue guide. It's fair to say that, like, if you look at past years, the vast majority of that revenue has come from Horizon and Panorama. So I don't think that what percentage of revenue is going to be dramatically different than what you've seen in past years. We will have material amount of revenue coming from oncology and it's going to come kind of on that waterfall that you start with contracted revenue as the beginning of that kind of revenue recognition waterfall and then as we said on the call, kind of, cascades 12 to 36 months from there to actual revenue recognition. And then finally on transplant, there's nothing in the guide for transplant revenues just given our launch -- expect to launch timing.

Understood. And then just, I guess, a clarifying question. With respect to the cash burn forecast, is that inclusive of the net $30 million that you expect to have.

No, that does include the cash. That contemplates the cash we're getting from BGI.

Understood. Okay. Got it. And then, I guess, just on transplant, presumably -- given that you've got your draft LCD in here before the end of the year, presumably we should have some sort of update, I would think, by the end of March. Is that the right way to think about it guys? Then obviously there's an open comment period and then we'll get some sort of final documentation from Palmetto, call it late summer, early fall. Is that the timeline you're looking at as well?

Yeah, roughly. I mean, I think we're engaged with Palmetto and in discussions -- when the local coverage decisions are released, there's an opportunity for us to participate there and then from there will follow the standard psycho as you outlined.

Okay. Got it. Thanks, guys.

Thanks, Bill.

Thank you. And our next question will come from the line of Catherine Schulte with Baird. Your line is now open.

Hey, guys. Thanks for the question. With the One Lambda partnership, how are you going to divide the commercialization responsibilities between your team and One Lambda? And how should we think about this in terms of incremental feet on the street for you?

Yeah. So, obviously, we're really excited about that partnership. I mean with One Lambda's presence in all the major transplant centers, they have a very strong reputation, they're plugged in with the top doctors and top labs. As we've said, we're going to be building out our direct sales force in parallel, I think similar to what we've done in the past, when we brought NIPT to market, we had a direct strategy and we also had partners that came to market with us, we saw that as a way to expand our distribution. I think there's natural accounts where they have stronger relationships and there will be accounts where we have strong relationships in the field team just works together in a very positive way to collaborate. Again, we're excited about the opportunity with them and it makes sense. Matt, do you want to add anything here?

Yeah. I think it's a great question just how one collaborates with big partners. There's a very technical sell that we can make in transplant, because the doctors are so compelling. As you saw from that slide, we've got about a 1.85% standard deviation on repeatability of our test versus the competition at about 9.2% in the main publications. So we've seen that incredible analytical performance translate into much better clinical performance. And so, it's going to be very important when you've got that kind of a technical advantage to have our sales team collaborating with the sales team of Thermo Fisher and helping to make a very differentiated technical sell. And we saw the same thing in NIPT. We had a very different technology, very differentiated. We took market share very quickly with the help of our partners, but we really did depend on having our own experts sort of co-travelling with them and educating those larger sales forces. So it's going to be a pretty similar approach in transplant.

Okay. That's helpful. And then what are your latest thoughts on ACOG? And can you just quantify what your assumptions are in the back half for that improved average risk reimbursement?

I'll take the general comments and then I think Mike if you want to talk more broadly about what's in the forecast. So obviously we're engaged with ACOG. We've established a good relationship with them. We're also a participant of the NIPT consortium where many members; Illumina, Roche, etcetera, are engaged various ways with ACOG. And I think generally everyone is sort of hearing positive noises, but nobody has the exact playbook for what ACOG is going to do. So we obviously expect some positive guidance as we've reflected in our forecast, but we don't know the exact timing and we don't know exactly what the guideline is going to say. Mike?

Yeah. Just in terms of quantifying it, I mean, we've talked about previously how -- within the commercial business, in average risk NIPT, we're getting paid circa 35%, 40% of the time there and the guide just contemplates kind of a steady appreciation of that, that the time we get paid in a linear way through the course of the second half of '19.

Okay. And then last one for me. For Signatera, when should we expect to get some data from your pharma relationships and get more clarity on the reimbursement pathway for indications other than the ones you are pursuing yourself?

Solomon, do you want to take them?

Yeah. Thanks, Steve. In terms of data publication, we are looking forward to presenting some new data at ASCO in the middle of the year in Chicago. And in terms of additional collaborations with pharma, I think the roadmap looks very bright here. We don't always control release or publication of data that comes from a pharma collaboration. But where the data is compelling and there's an agreement that it should be out in the field, we work together with our partners to publish that. So, I can't give you a specific timeline around data like that right now. I would say that there continues to be a data pipeline coming from academic collaborations as well and we look forward to presenting more data this year. In fact, I think there's going to be some publications that come out in some major journals in the coming months. In addition to that, from a reimbursement perspective, we would say that we don't expect to have Medicare reimbursement in the immediate term. We are working with Medicare in the same way that Steve described on the transplant side to set up a road map there and I think that's going to depend on bringing the test to market and also demonstrating the utility of the tests and the key unmet need applications where we've described before. I think the initial indications would be in the areas where our data is strongest and the unmet need is clearest, including early stage and late stage diseases. I think we've...

Yeah. I'll just add, a lot of the data that we presented throughout the year of 2018 is now going to be published in the very near future in very high impact journals. So, we've been very pleased with publications that have been accepted, that are going to be published in the very near future. In addition, we're feeling very good about our pharma pipeline. So, companies that have looked at the data and thought about the different ways that they can use or test within their development programs or for future clinical trials and we said we expect to have $40 million to $50 million in total contracted value cumulatively by the end of 2019 and that is significant, significant progress from where we were at the beginning of '18 and even at the end of '18. So we're seeing a lot of momentum that's based on the strength of the data and the strength of the technology.

Great. Thank you.

Thank you. Our next question will come from the line of Mark Massaro with Canaccord Genuity. Your line is now open.

Hey, guys. Thanks for taking the questions. I guess just my first one for clarification. Does the $40 million to $50 million include the BGI payment or the $30 million net inflow in 2019?

No, those are totally separate streams. So, the BGI is the $30 million that we referenced. That's what we expect as a net cash inflow from this BGI partnership that we just signed. The $40 million to $50 million in contracted revenues from pharmaceutical companies is the value and the cumulative set of deals we've signed with pharma companies to using Natera. Does that make sense, Mark?

It does. And just for clarification, so that contracted value will convert to revenue over 12 to 36 months?

Yeah. And so we've already signed some deals as we talked about on prior calls and yeah, I mean, 12 to 36 months is roughly the waterfall.

Okay, great. And then certainly 2019 marks a year of greater investment. Certainly, I appreciate the increase especially on the oncology side. You have to build up a little bit on the kidney side, but I think you also talked about increasing your leadership position in NIPT. So I guess, if you could, could you give us a sense on how many people you'll be adding in the OB/GYN sales call point and just help us with some of the numbers across the areas?

Yeah. So, I think, when you look at the investments that we're making in 2019, I mean, as you said, it makes a lot of sense for us to be making investments in OpEx at this point. When you look at our trajectory in pharma, $40 million to $50 million in total contracted value and that is the leading indicator for revenue and that puts us on a trajectory at the top oncology diagnostic companies in the space. On transplant, we're at a major inflection point now where we've done all the work, we've done all the R&D, we have to commercialize the test and we have to get Medicare coverage and we're going to be in a position to go out and compete very, very fiercely for market share. So we feel like it makes a lot of sense to continue to invest there. And then in women's health, we have an opportunity to continue to grow business, because our technology is differentiated. And, as we said, our COGS are coming down rapidly. We have a path to get down to $200 and with average risk coming in and we have an opportunity to unlock, like, $60 million roughly from our existing accounts. So, we're really sitting in a very good position right now and it makes a lot of sense to be making investments to put ourselves in a leadership position. Our commercial team has been fairly stable over the past and other select areas where we're making investments going forward, because we think it makes sense.

Great. And then, if I can, maybe a question for Matt. You're building bespoke assays, I believe we're the only company doing this in oncology. And so, I'd be curious to hear your take on how you think the fact that you're building customized panels for a particular cancer patient is resonating with some of your -- in your early conversations both with pharma partners and potentially with other institutions relative to some of the other larger panel opportunities, relative to other companies.

Sure. Well, I'm glad people have questions for me. That's good. I'll take a crack at that and then I'll hand it over to Solomon. So, just to go through the fundamentals, when you build these customized panels per patient, there are two big advantages. The one big advantage is, you can go down to the very low levels of cell-free DNA, pretty much single molecule levels of detection with a limited amount of sequencing. So we're going down to levels of below 0.01% in catching these tumors and we're able to do that with incredible sensitivity and specificity. When we saw our clinical data, that shows that we catch the recurrence of lung, bladder, breast, colon cancer and several other cancers coming down the pike with positive predictive values in certain cohorts that are 100%, I mean it will never stay 100% but, geez, performance is phenomenal. It's largely because we've got that bespoke approach where we can go down to roughly single molecule detection levels with unmatched sensitivity and specificity to our knowledge. Okay. So that's the one component, but with a limited amount of sequencing you can go very low. But the other component is that you can capture a large number of variance per patient. If you use a standardized panel, even if you're looking at several hundred genes, the number of variants that you see on that one size fits all panel can be very low, even for the 300 to 500 gene panels, you can see zero to five variance for a particular patient. And that makes an enormous difference, because the frequency at which these variants appear in the plasma can range over two orders of magnitude, the little fractions. So the fact that we can track many variants means that we can…

That was an excellent answer. So to add to that, I think the data is demonstrating also the strength of the method that Matt described. So we've now tested approximately 3,000 plasma samples from around 700 patients across 18 different cancer types and we've published some of the bigger studies in the cancers that you've seen before in lung, colon, bladder and breast cancer, but we have tested now in many different cancer types and what we're seeing is pretty consistent performance and also a validation of our method, because we're seeing that the first MRD positive time point that we detect is very frequently and majority of the time is below 0.1% variable allele frequency. So what Matt described that the technology is designed to be able to confidently detect below that 0.1%, where larger panels start to suffer because they're just not looking for enough variance to constantly detect at that level. So detecting below 0.1% also means you're going to have a longer lead time of molecular relapse versus clinical relapse. And that lead time makes a clinical difference, because in theory if you're going to treat somebody, you have a better chance of cure lower disease burden. So I think between the scientific rationale that Matt described and that being demonstrated now in the clinical data that we have shown across many cancer types, you're starting to see the market embracing the opportunity and the differentiation of this method.

Great. Thank you for all the color.

Thank you. And our next question will come from the line of Tycho Peterson with JPMorgan. Your line is now open.

Hi. Thank you. This is Aleny on for Tycho. Maybe just to start off with just wondering on a go-forward basis how are you thinking about revenue protests? It looks like it has leveled out in the $400 price range over the last four quarters? And then what are the dynamics you expect once the ACOG bulletin for average risk comes out?

Thanks, Aleny. As we said starting in the prepared remarks, so over the medium term and longer term, Steve covered a number of drivers that we think can be very constructive to the average selling price. As to the guide in '19, we're taking a conservative approach on the assumptions, including. like, the fraction of time that we get paid, particularly in the first half of the year and then we do have an assumption in the second half the year that we do start to get some benefit from average getting paid a higher fraction of the time, kind of gradually improving for the course of second half of the year.

Great. That's helpful. And then in terms of the pacing of pharma contracted value, you mentioned around $40 million to $50 million expected by year-end, was wondering how the timing of the CLIA assay launch affects that? Are we looking at a sort of back half loaded year in terms of the contracted business?

Yeah. So I think the CLIA launch is one of many factors that will help us improve our ability to sell faster with pharmaceutical companies. As we mentioned, we have these marquee publications that have now been accepted in very high impact journals. We think that data coming out along with the CLIA launch, along with our announcement of the partnership with BGI, that gives us special access in China that is going to be very hard to compete with, because for pharma trials you need to have Chinese patients enrolled if you want to launch the drug in China. So there is many different factors of this sort of flywheel effect that we're now on that are going to start to increase the pace at which we're able to sign partnerships with pharmaceutical companies. As we said, this trajectory of $40 million to $50 million now that we're on toward the end of 2019 is really in line with the top diagnostic companies in the oncology space and that is a leading indicator of future revenue.

Great. Thanks. And then on the kidney transplant test, while analytical and clinical data looks good and revenue sensitivity is definitely encouraging, was wondering what else you believe is necessary to increase the penetration rate above the 5% level? And what steps you are taking? You do expect Medicare reimbursement by the end of the year, but how do you think -- what effect do you think that will have in increasing adoption?

Yeah. So I think the market so far appears to be doing very well. I mean, we've been very encouraged with other DNA tested around the market and their ability to grow rapidly up to roughly this sort of 3% to 5% market share. From our standpoint, it's the same playbook as when other test launch. I mean, there's a lot of medical education, peer-reviewed publications, there's detailing with medical science liaisons in the field, et cetera, and physicians begin to use the test as Medicare coverage and data become available. So, we plan on commercializing in 2019 with both the direct sales effort and in our partnership with One Lambda, who we really think is a premier partner because they have relationships in all of the top transplant centers. Now, there's a lot of other things that go beyond just the technical and clinical performance or assay that we think will help us scale very quickly. There's a lot of user experience capabilities that we've built and a lot of operational efficiencies that we've built in running a very high scale and high throughput cell-free DNA laboratories, so we've now performed over 1.5 million cell-free DNA tests in our lab and what you learned through that process is really important and we've made a lot of significant improvements that we can now leverage as we move into the transplant space. The same on the user experience side, we're doing hundreds of thousands of tests per year with physicians that have very high expectations for how we work with them and how we work with their patients and we're able to piggyback on a lot of the stuff that we've built in the women's health space and bring that immediately and directly to transplant physicians, and a lot of the things like interfaces and so forth we've done before and we know how to execute.

Great. Thank you.

Thank you. And our next question will come from the line of Alex Nowak with Craig-Hallum Capital. Your line is now open.

Great. Good afternoon, everyone. Steve and Matt, congrats on the deal with BGI. When do you expect to see your Signatera test launched into the Chinese market and generating royalties there? And then just you mentioned it in the prepared remarks, but just any update on QIAGEN, when they're going to launch your test on GeneReader?

Yeah. So we think the BGI could launch the Signatera assay in China in 2020. They're -- they have the ability to move very quickly and efficiently as they've done in many other cell-free DNA tests. We don't need Chinese FDA approval to launch the test. There's many hospital systems that are exempt from that provision. When you look at the Chinese market itself, there's about 4.3 million patients that are diagnosed with cancer on an annual basis and that's like 3x the US. So if you just compare the trajectory of other cell-free DNA tests in the US that are sort of $50 million to $75 million range, and you would imagine in China BGI can generate $50 million to $75 million. We think we're in a position to make tens of millions of dollars in the future from ongoing royalties in the BGI partnership and at some point recognize revenue on the upfront payments and milestones that we've gotten in the partnership. Shifting gears to QIAGEN, they are a very strong partner and we are feeling very positive about the relationship with them. Things are going in line with our expectations and the expectations that we outlined on the call roughly last year when we announced our partnership with them. And Matt, do you want to add anything additional?

Yeah. Well, thanks, Steve. I don't know if I'm going to speak again on this call, so I'll just take this opportunity to say that Steve has done an amazing job leading this company and the management team has coalesced around Steve's leadership really beautifully. So we're feeling great about that decision to go with an internal ace rather to bring somebody from the outside. So, congrats and thanks, Steve. On the BGI and QIAGEN deals, you know, we've spoken for a long time about this vision to piggyback on the emergence of sequencing all over the world and to offer our proprietary technology in a way that is really accessible to patients all over the world and so the deal with BGI was just part of that vision. BGI, as Steve said, has a lot of resources in China. They can move very quickly. I think they're going to be a major competitor in the sequencing space. So it was crucial for our vision to be partnered with them. And I think this deal has taken a long time to come together, but it's a great deal for both companies on QIAGEN, QIAGEN has got a lot of inroads into the lab business worldwide. They've got their DNA extraction and their oncology pipeline and a whole series of technologies that synergize beautifully with woman's health. And they've got this packaging of sample to in-flight approach where they really streamline [indiscernible]. So I think QIAGEN is going to have a very compelling value proposition as well. And the timelines for QIAGEN are really up to them. You know, we're supporting them in every way that we can and we are expected to. And we're hoping that they're going to come out with a very compelling proposition. And, you know, they're driving the timelines. You're just going to have to ask them what their launch dates will be. But all of that is looking very good. And then as we said in the prepared remarks, the announcement with BGI doesn't change our plans with aluminum QIAGEN. We want to be supporting all of these different sequencing providers. And in terms of what we do here in the United States, we think that the additional sequencing competition is going to be good for the market and it's certainly going to be very good for patients and health care in general. And we will offer those technologies that are most accurate and cost effective and in our lab and that have the best service associated with them. So all of that is looking very good.

Okay. Understood. Thank you. And then I believe there's a new CPT code here in 2019. So I know Panorama has some challenges years ago when switching over to a new code. So just do you foresee any challenges, first couple of months here of the year? Is there anything baked into the guidance regarding that?

Yeah. I think others have talked about this generally very favorably particularly around the pricing upside. I think Medicare price the code in the sort of high 2,000s range, if I recall directly. And we think that's a very positive, I think, for the long term, I think the medium term question is really what happens with coverage and we're monitoring that. It's certainly a portion of our business, although we do offer a very broad range of offerings in carrier screening and we have a mix of how physicians tend to order with many choosing smaller panels. But with respect to how this makes an impact and so forth, I think we've been fairly conservative with the guidance for this and other factors that Mike outlined on the call.

Okay, got it. And then just last question from me for Mike. I just understand the need to invest in the business here and you also talked about some of the potential upsides around COGS and average risk pricing, but just based on your current trajectory what you currently see out there, when do you anticipate achieving cash flow breakeven for the business? Thanks.

Yeah. So we went into some detail in the prepared remarks around cash flow break even for the women's health business and that's where we've oriented the goal. So Steve laid out an illustrative example of getting there with a unit based volume of 900,000 units. And at that base volume, you'd be covering your women's health operating expenses with about a $200 spread. Now, obviously, there is a number of variables there. There's the gross margin spread, which is affected by pricing and it's affected by COGS. And there's also the volume base. So it's possible, as we alluded to in the prepared remarks, that we could get to that breakeven point at a lower volume rate base, if we get the reimbursement comes more quickly. So -- but I think that's sort of a middle case for you to contemplate, Alex, as just kind of steady volume growth to that level with that gross margin spread would get you a cash flow breakeven in the women's health business.

Okay, got it. Thank you.

Thank you. Ladies and gentlemen, this concludes our question-and-answer session for today. We thank you for your participation in today's conference, and you may now disconnect. Everybody, have a wonderful day.