CareDx, Inc. Q3 FY2022 Earnings Call

Good day, ladies and gentlemen, and welcome to the CareDx, Incorporated Third Quarter 2022 Earnings Conference Call. Today’s conference is being recorded. At this time, I would like to turn the conference over to Ian Cooney. Please go ahead.

Good afternoon, and thank you for joining us today. Earlier today, CareDx released financial results for the quarter ended September 30th, 2022. The release is currently available on the company’s website at www.caredx.com. Reg Seeto, Chief Executive Officer; and Abhishek Jain, Chief Financial Officer, will host this afternoon’s call. Before we get started, I would like to remind everyone that management will be making statements during this call that include forward-looking statements within the meaning of federal securities laws, which are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Any statements contained in this call that are not statements of historical facts should be deemed to be forward-looking statements. All forward-looking statements, including, without limitation, examination of historical operating trends, expectations regarding coverage decisions, pricing and enrollment matters, and our future financial expectations and results are based upon current estimates and various assumptions. These statements involve material risks and uncertainties that could cause actual results to differ materially from those anticipated or implied by these forward-looking statements. Accordingly, you should not place undue reliance on these statements. For a list of descriptions of the risks and uncertainties associated with our business, please see our filings with the Securities and Exchange Commission. The information provided in this conference call speaks only to the live broadcast today, November 3rd, 2022. CareDx disclaims any intention or obligation, except as required by law, to update or revise any information, financial projections or otherwise, or other forward-looking statements, whether because of new information, future events, or otherwise. This call will also include a discussion of certain financial measures that are not calculated in accordance with generally accepted accounting principles. Reconciliation to the most directly comparable GAAP financial measure may be found in today’s earnings release filed with the SEC. I will now turn the call over to Reg.

Thanks, Ian. Good afternoon, everyone. And thank you for joining us for CareDx’s third quarter 2022 earnings conference call. Today, I'd like to focus my discussion on the following three topics. The first is our differentiated financial profile and Q3 results. The second is our growth platform over the next 18 months, which we call the three C's: catalysts in the pipeline, collections improvements, and coverage expansion. The third is building on our vision of leadership in the transplant ecosystem. Moving to the first topic, in the last earnings call, we made a commitment to achieve adjusted EBITDA profitability by the first half of 2023. Since then, we've made tremendous progress towards this committed goal. Notably, we meaningfully improved our adjusted EBITDA losses in Q3 versus Q2. This is a trend break we like, especially when combined with our strong balance sheet and debt-free position. As a management team and board, we believe maintaining this strong financial position is critical to building a sustainable business, especially in this current economic environment. We plan to deliver on our profitability goal, and this will enable us to operate as a self-funding business. This has been a constant source of feedback from our long-term shareholders and truly differentiates CareDx when compared to others in our space. As highlighted, our financial position: we, one, retain an excellent cash position with $291 million in cash and marketable securities on the balance sheet; two, we maintain higher gross margins, highlighted by 73% GAAP, and 74% non-GAAP in our testing services; three, we experienced strong volume growth with a 15% year-over-year and 3% sequential growth; and four, we improved our adjusted EBITDA position to enable our progress towards profitability. Regarding Q3 results, overall revenue for the quarter was up 5% year-over-year and down slightly sequentially to $79.4 million, primarily driven by testing services, with lower market growth than we projected. Five, anticipated shift in payer mix to more commercial payers, resulting in an increase in non-reimbursed tests; three, an incremental 1% sequestration reduction for Medicare tests; and one-off impacts from Hurricane Ian during the last week of patient testing. There was also significant growth in our products business affected by foreign currency fluctuations and ongoing staffing shortages in HLA laboratories that have slowed new installations. Despite these issues, we were able to improve our adjusted EBITDA versus Q2 2022 and we are on track to achieve adjusted EBITDA profitability in the first half of 2023. Non-transplant volumes, the year-over-year growth for Q3 2022 was in the mid-single digits. Based on the early signs of a stronger recovery we saw in Q2, we expected higher sequential growth versus what we obtained in Q3. Notably, it has taken 18 months for transplant volumes to finally reach the same baseline levels we saw last in Q2 of 2021. Staffing shortages and decreased living donor kidney transplants remain two of the biggest challenges to market growth. Our testing services remain the strength with leadership across kidney, heart, and lung. With kidney, we remain focused on executing our long-term strategy. With now more than 100 transplant centers and community nephrology practices following AlloSure kidney protocols. Today, we have more than 75% usage across kidney transplant centers, and we saw an increase in commercial market share in these transplant centers. The entry into community nephrology has been an outstanding success, and is now approaching 10% of our overall kidney volumes. We have more than 200 practices using AlloSure kidney in Q3 due to our community nephrology expansion. This represents significant potential as the majority of transplant patients are managed in community settings. Although community patients have a lower coverage level, we have an ongoing commitment to support all patients regardless of their coverage. With heart, our care for heart remains above 95%. This demand continues to reflect the value of multimodality. As a reminder, we are the only Medicare-covered gene expression and donor-derived testing heart and the only test with multimodal coverage through Medicare. Today, more than 90% of heart transplant centers in the United States use CareDx's offerings. Now for lung, AlloSure Lung addresses a significant unmet need by providing a non-invasive option for the highest-risk transplant patient population, where wanting lung transplant patients will fail within five years. The use of AlloSure Lung exceeded stronger benchmarks, and we are ready to reach greater than 6% penetration in transplant centers within 12 months of commercial launch. This uptake in lungs reflects the incredible demand in the lung transplant community with over 2,000 tests ordered in Q3. Now moving on to the second topic. As we're working towards a sustainable, profitable model, we're excited about the future opportunities to accelerate revenue growth. We are focusing our efforts over the next 18 months on three priorities for the three C's: catalysts in the pipeline, collections improvement, and coverage expansion. Now on to the first C, catalysts in the pipeline. I am pleased to announce the following. First, we can share that AlloMap Kidney is currently under MolDx review. Secondly, we are completing our clear implementation work on UroMap in preparation for future MolDx submission. We look forward to bringing these latest innovations to clinical use to improve patient care. Now on AlloMap Kidney. The story delivers on the market need for diagnostic guidance. AlloMap Kidney is built upon our leading FDA-cleared gene expression test AlloMap Heart. AlloMap Kidney has been built specifically for kidney transplant patients. UroMap has now completed analytical and clinical validation, and we are finalizing implementation in our clear lab. The quality of UroMap is the best-in-class defined in multiple New England Journal of Medicine publications. UroMap is a gene signature that can assess both the problem of rejection and the problem of BK virus and proxy. Now on to the second C, collections improvements. We continue to ramp up the infrastructure. We will share a new metric which looks at the ASP on reimbursed tests. Notably, our ASP for paid tests has not changed over the last seven quarters. Abhishek will cover this in more detail. During the last six months, we've ramped up internal infrastructure and third-party support to address the increased workload across the different pay stages with pre-submission, submission, and appeals. We're starting to see signs of improvements in our cash collection with improved collections in Q3 versus the prior quarter and year over year. However, the reality of long collection cycles for Medicare Advantage and commercial plans means that visual progress will show up with a lag. Now on the third C, coverage. The number of non-reimbursed tests continues to increase with our intentional strategy to launch new organs such as lung and to move into community nephrology where coverage is lower. However, this volume growth creates a long-term opportunity. In the meantime, we are working towards obtaining payer coverage to get these tests covered and reimbursed by private payers. Coverage represents our biggest P&L level issue. For example, using 2021 volume numbers, we would have collected over $100 million of incremental adjusted EBITDA if our current commercial tests enjoyed the same broad coverage as AlloMap Heart, the gold standard at about 70%. Now, as a reminder, AlloSure Kidney is at about 30%. AlloSure Heart is between 25% to 30% coverage, and AlloSure Lung is less than 5%. We are now targeting two specific milestones that are expected to expand our coverage in our AlloSure Heart and AlloSure Lung. In AlloSure Heart, we are encouraged by the inclusion of donor-derived cell-free DNA in the proposed guideline updates at the April International Society of Heart and Lung Transplant Meeting. As a reminder, AlloMap Heart is part of the ISHLT guidelines, which was pivotal in expanding pay coverage. On AlloSure Lung, we are working with MolDx to achieve a determination of coverage by Medicare. There is clear demand in the lung transplant community with over 2,000 patients that have used AlloSure since the launch. Notably, there are only 2,500 lung patients transplanted each year and 15,000 patients in the community. Now moving on to the third section, our vision and strategy. Our vision is to be a leader in the transplant ecosystem and one of the few companies 100% dedicated to transplant. CareDx has emerged as a market leader across the transplant patient journey and built an incredibly deep moat within the transplant centers. Today, we're number one in post-transplant biomarkers in kidney, heart, and lungs. We're number one in transplant medication coverage discharge; we've reached 100 transplant centers. We're number one in transplant quality monitoring; we've integrated 40 centers. We're number one in transplant-specific app with more than 55,000 downloads through our app allocated. And we're number one in next-generation sequencing-based HLA typing. As reflected milestone, Universal recently announced that there have been no more than a million patients transplanted in the U.S. with 500,000 or half of those for the last 15 years. We are proud that more than 100,000 transplant patients have used the CareDx offering over those last 15 years, representing 20% of transplant patients in the U.S. during this time. Moving to guidance. As you saw in our press release, we lowered our guidance and now expect full-year revenues to be in the range of $320 million to $325 million. This guidance is driven by the lower Q3 revenues and higher than anticipated shift to commercial payers. Abhishek will cover this in more detail in his section. In closing, we're committed to remaining on our path to profitability in the first half of 2023. To summarize, we demonstrated our ability to improve our adjusted EBITDA despite lower revenue in the second quarter. We've highlighted a rich set of potential revenue growth drivers to accelerate growth through the three C's: catalysts in the pipeline with anticipated commercial launches, AlloMap Kidney and UroMap; collections improvements through increased infrastructure and engagement with third parties; and coverage expansion through AlloSure Lung reimbursement and the potential inclusion of donor-derived cell-free DNA like AlloSure in the ISHLT guidelines. We look forward to the next 18 months as we continue to execute on our strategy. With that, I'll turn it over to Abhishek to discuss our third quarter financials.

Thank you, Reg. We are pleased to report that we're making progress on the commitments we made last quarter on returning to adjusted EBITDA profitability. I would also like to echo the comments about our confidence in being able to expand coverage and improve collections over time and leverage our business models. Reg alluded to our differentiated financial profile. Let me provide further details on the same and Q3 results. Number one, strong cash position of $291 million and self-funding business model. Number two, solid volume growth and impressive gross margin performance. Number three, progress on a path to adjusted EBITDA profitability. Number four, the strength and the consistency of our ASP on reimbursed tests. I want to start by highlighting our financial strength. We ended the quarter with $291 million in cash, cash equivalents, and marketable securities, and no debt. We continue to invest in our portfolio in line with our goals of preserving principal, diversification, and maximizing returns. In Q3 2022, we generated over $1.2 million in net interest income. We do not require raising capital and have the flexibility to deploy capital that increases value for our shareholders. This is a unique story in our space. We remain confident that the business is self-funding into the foreseeable future. Moving to the quarter. In Q3, we recorded total revenues of $79.4 million, up 5% compared to $75.6 million in the third quarter of 2021. Testing Services revenue was down 2.6% to $64.8 million. Product revenues increased 10% year-over-year to $7.2 million, and patient and digital solutions revenue increased 185% year-over-year to $7.4 million. Our revenues in Q3 2022 were impacted by slower than anticipated market volume growth. Our higher mix of non-covered tests, final and second part of sequestration cuts have been offset with Hurricane Ian and foreign exchange headwinds on our product business. Also, the market growth was lower in Q3 as compared to Q2; we were pleased to finally see total transplant volumes return to the same level as they were more than 18 months ago. It has taken longer than expected. For the quarter, our testing volumes grew by 15% year over year to almost 46,500 tests. We saw sequential volume growth in all organs. The non-GAAP gross margin for the quarter was 67%, compared to 70% in the third quarter of last year, and 69% in Q2. The change in gross margin versus the last quarter is primarily driven by our products business returning to its normal gross margin. We continue to maintain a healthy gross margin of 74% in our testing services business, despite the continued increase in the mix of unpaid debt. We are very pleased with the durability of our gross margin profile and proud of our labs and the supply chain team as they continue to drive efficiencies. Non-GAAP operating expenses for the third quarter were $57 million, down $5 million sequentially from Q2 2022. We are extremely pleased to see this trend change given our permitted goal of achieving positive adjusted EBITDA in the first half of 2023. This was achieved by focusing on three factors. Number one, financial discipline across the organization. Number two, operating efficiencies driven by process improvement. Number three, increasing effectiveness in strategic areas of driving growth, improving collections, and expanding coverage. Notably, despite the reduction in operating expenses, we continue to invest in clinical development with studies across solid organ and stem cell transplants. For the third quarter of 2022, we recorded negative adjusted EBITDA of $2.5 million compared to negative adjusted EBITDA of $5.7 million in the previous quarter. We made significant ground on our commitment and are pleased with the progress towards our goal of delivering positive adjusted EBITDA in the first half of 2023 and are confident in our ability to continue to drive profitable growth. Now let me turn to ASP. In order to provide further clarity on our ASP, this quarter we are beginning to disclose the ASP for tests where we receive reimbursement. Our ASP for reimbursed tests has been essentially flat and above $2,500 since Q1 of 2021. The overall ASP started to change in Q1 2021, which was the first full quarter impacted by AlloSure Heart. As a reminder, during 2020, our overall coverage and testing services was above 70%. But the addition of AlloSure Heart was only covered at 25%. Our focus is on expanding coverage versus the overall changes in ASP, as these include non-covered tests. To reflect this point, ASP on paid tests was slightly above $2,500 in Q1 2021, and has remained above $2,500 in this most recent quarter. This is in contrast to our overall ASP, which includes non-covered tests. We want to highlight this metric to emphasize that you're not seeing any price degradation for our tests. And the change in total ASP, which includes non-paid tests, is driven by our strategy to number one, grow market shares in community nephrology; number two, increase penetration in new areas, such as lung, where we have yet to receive broad reimbursement coverage; and number three, launching areas that drive innovation, such as multi-modality in heart. As with AlloMap Heart, coverage is an area that will expand over time. As a reminder, our non-GAAP gross margin of 74% has been achieved with greater than 70% coverage for AlloMap Heart and AlloSure Kidney but 25% to 30% coverage for AlloSure Heart and less than 5% coverage for AlloSure Lung. Our goal is to expand coverage to above 70% across our testing services portfolio, using AlloMap Heart as the gold standard for coverage and reimbursement. As discussed in our previous call, our strategy of gaining market share and helping patients improve long-term outcomes coupled with market dynamics has resulted in an increased percentage of non-reimbursed tests. The durability of our adjusted gross margin has allowed us to offset these incremental non-reimbursed tests, while providing us an opportunity through expanded coverage and improved collections over time that we are vigorously pursuing. Regarding the information requests from the government, we do not have any material updates to report. We continue to cooperate and are moving expeditiously in responding to the request. Turning to guidance, we are revising our full-year guidance to the range of $320 million to $325 million from $325 million to $335 million previously. This change in midpoint is driven by lower Q3 revenues and a higher than anticipated shift to commercial payers. Specifically for Q4, in setting the guidance, we have assumed that there are no further sequestration cuts. We do not plan for one-off impacts such as Hurricane Ian. We have built in lower market growth in our range. Lastly, we have assumed a higher commercial sales mix across the range. To close, we have an enviable financial position, healthy adjusted gross margin, strong cash positions, and solid volume growth. We have demonstrated our commitment to return to positive adjusted EBITDA in the first half of 2023 by staying prudent on operating expenses while ensuring that we continue to invest in areas that will drive future growth. With that, I'll open the call for questions.

Thank you. We'll take our first question from Brandon Couillard with Jefferies. Please go ahead.

Thanks. Good afternoon, guys. Maybe just starting with the guidance for the year and planning for the fourth quarter, you've been running around $80 million in revenue for the first two quarters of the year, which would imply a step up of $4 million or $5 million sequentially into the fourth quarter. Would you just elaborate on the level of confidence in that? And how we should be modeling the realized ASP trends sequentially? Is there another kind of 5%, 6%, 7% step down again, in Q4?

Hi, thanks, Brandon. It's Reg Seeto, and I'll hand over to Abhishek to take some more questions and comments. For us, we had the strong run rate going into the 320 million guidance you just described, where we think there's actually further opportunity in the marketplace that will come from the testing services. We do see growth in the products business and also with digital. So the guidance, as Abhishek mentioned, will go through step by step. Please go ahead.

Yes, that sounds good. Brandon, regarding the change in the guidance midpoint from 330 to 322.5, this adjustment primarily stems from two factors. Firstly, the carryover from the Q3 revenue, which came in at the lower end of our expectations. Secondly, we've made a slight modification to our market growth and payer mix assumptions based on the Q3 results. These are the two factors influencing our midpoint adjustment from 330 to 322.5. As for our confidence level, I believe it's a balanced guidance. We expect market growth to remain around the same number, slightly above it, and we anticipate that our testing services volume growth will align with or slightly exceed market growth. We also expect our payer mix to continue shifting towards commercial payers without any sequestration cuts. These are three of the four elements we are considering in our guidance, which gives us confidence.

Yes. Maybe you won't be in a position to talk too much about 2023. But how should we think about the ASP trend as we model out next year and the degree of further erosion? Any parameters you may give us would be helpful?

Yes, Brandon, I'll take the question, and then I'll hand it back to Abhishek. I think it wasn't that clear. But, when you talk about ASP rates, this really is about coverage, not ASP for us. And I think you saw that we've shown a slide now over the last seven quarters that when we get reimbursed tests, we achieve reimbursement rates of about $2,500. The key here is to focus on getting additional coverage and collections in these areas, which will then overall benefit that overall profile. So, we've delivered a series of catalysts, which go through launches, through coverage, and collections to improve ASPs overall. But we need to establish that coverage first, and then we can discuss the ASP trends as a step in that process. But I'll let Abhishek elaborate if required.

No, I think you have covered it well, Reg. The key point is our ASP for paid tests has not changed. The question now is how do we start to get paid on some of the unpaid or non-covered tests. That is where the focus on collection and coverage comes into play.

So the last one. What's the next step in terms of the timeline for kidney care, and how about the timing of potential commercial launch next year?

Yes, we're really excited about some of the catalysts coming up. We're thrilled to share what's happening with kidney care and AlloMap Kidney, and now it's been submitted to MolDx for review. We know there’s demand for this test, as we saw during the open enrollment, where this was the study that most people wanted to do. The market preparation is underway with our marketing materials. The organizational infrastructure is already in place. In terms of the offering itself, it has been defined. We look forward to updates from this process as we have ongoing discussions.

If you're maybe muted. Did you have any other follow-ups? Hearing no response, we’ll take our next question from Alex Nowak with Craig-Hallum Capital Group. Please go ahead.

Great. Good afternoon, everyone. This is Connor on for Alex. I guess first, MoIDX is holding a Contractor Advisory Committee Meeting in mid-November to discuss the coverage of transplant tests. What will be discussed at this meeting? Is CareDx invited to present? Any color would be helpful.

Yes. Thanks, Connor. What has been laid out is that it's an invitation event. People can attend, and we will be there as part of this. It will be run by subject matter experts, and we think it's a significant step forward for the transplant field. We'll continue through the current approval process, and while we may not know the full agenda, we do look forward to attending and participating as appropriate.

So, the invited participation means that while presentations won’t come from those attending, we are still able to engage the subject matter experts to discuss. We look forward to learn more about the discussions that develop.

Got it. Okay. That all makes sense. And I just have a couple of questions to dig a little deeper on pricing. I know you mentioned having some success in appeals through better infrastructure you are building. But when do you expect that to help ASP stop their decline? Is the ASP still roughly 25% Medicare, 75% commercial?

Yes. I'll make some comments and then let Abhishek address the detail. The essential consideration is coverage. When tests are reimbursed, they achieve reimbursement rates around $2,500 across the portfolio. Where we don’t get reimbursed is simply due to lack of coverage or collections. It’s about ensuring we achieve coverage first to allow improvements.

I would just add that while we’re building capacity on the collection side, we need to state that generally, results in collections are not immediate due to the long payment times from Medicare Advantage and commercial payers. But we are seeing improvements in our infrastructure leading to better outcomes over time.

Got it. That makes perfect sense. And then maybe just one more. The timing of the CAC meeting coincides with your pursuit of reimbursement for lungs. I guess it’s been sitting on their desk for a while. Any incremental feedback or insights from MoIDX?

Yes, there is an existing pathway we have submitted under the current process, and we’ve had good discussions with MoIDX. We’re looking forward to continue these discussions but currently, it is a matter of working through established guidelines.

Alright. Thank you for the questions.

We'll take our next question from Matthew Sykes with Goldman Sachs. Please go ahead.

Hey. This is Prashant on behalf of Matt. Congrats on the quarter. So just two questions for me. First one, according to recent data, it seems like transplant volumes have recovered post-COVID and are trending upward compared to the prior couple of years. Do you see that continuing? How do you account for that in your guidance?

Yes, I'll comment about the overall trends and volume. If we look at the transplant volumes, it has taken 18 months to return to what we consider the prior baseline. We are thrilled it is finally there, but nothing is a given, and we have seen some sequential growth which isn’t as strong as what we saw in Q2. But longer-term, it’s an exciting opportunity with multiple levers to increase organ transplants in the United States.

Regarding market growth, the Q3 transplant volume growth was lower than Q2. We’ve pruned down our market growth assumptions in light of what we have seen in the previous quarters.

Got it. Thanks. That's really helpful. Lastly, could you discuss the longer-term opportunity for cell transplants? Is the timeline to realize this further out, or do you see any factors that could accelerate this?

Yes, cell therapy is an exciting area. It’s predicated on those therapies making it to market, which currently hasn’t happened in solid organs. It’s likely more meaningful in the five-year timeline going forward, but we are seeing numerous partnerships that provide us opportunities beyond solid organs. With continuous effort on stem cell and ongoing development, it provides meaningful options advancing our mission.

Great. Thank you so much.

We'll take our next question from Mason Carrico with Stephens. Please go ahead.

Hey, guys, thanks for taking the question. This is Jacob on for Mason. Just following up on the AlloMap Kidney submission to MoIDX. I know it's largely out of your control, but just wondering what your internal timeline looks like to get Medicare coverage for that test? Is the fourth quarter of 2023 still a possibility?

Yes, we have submitted the application, and typically there's a six-day process during which we expect ongoing feedback. We’ll wait to see how it plays out, but we believe we have a robust submission with good publication support.

Once you do get positive coverage, is the initial launch focusing on transplant centers, or do you plan on driving adoption in both transplant centers and the community setting? Any insight on clinician behavior differences in both segments?

Yes, there are two different stages. We’re in more than 75% of transplant centers, and extensive protocols are established. Community settings are still in earlier stages, but we have over 200 centers using AlloSure last quarter, driving early adoption. Educating on donor-derived cell-free DNA utility is key in community settings moving forward as we emphasize the value of multi-modality.

Okay. Got it. Thanks. That's it for me.

Thanks for the question.

We'll take our next question from Yi Chen with H.C. Wainwright. Please go ahead.

Hey, this is Chad on behalf of Yi Chen. We just have a couple of quick questions. First, was there any color on the dip in revenue quarter over quarter?

Yes, I can address that. The drop in testing services revenue was about a couple of million dollars from the last quarter, impacted by various factors. One was the anticipated sequestration impact that we projected, along with slower market growth than expected, and finally, the mix of commercial payers shifted higher than anticipated.

And any color or timelines as it relates to both of your upcoming catalysts?

For AlloMap Kidney and UroMap, we submitted under the established processes and provided robust data. However, it wouldn't be appropriate to comment on exact timelines. We have good discussions and do feel confident in our assessments as we continue through the approval process.

As mentioned earlier, our revenues dropped given the Q3 incidents impacting overall performance. This has driven adjustments to our market assumptions moving forward.

Thanks to all for your engagement today. We have an incredible mission here at CareDx, which is how do we improve patient outcomes and organ outcomes for a very subset of special patients in the transplant community along that patient journey. Thank you for taking the time to listen to this call and for your support for CareDx. Have a great day.

Ladies and gentlemen, this concludes today's conference. We appreciate your participation. You may now disconnect.