CareDx, Inc. Q3 FY2023 Earnings Call

Good day, everyone, and welcome to today's CareDx Inc. Third Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, you will have the opportunity to ask questions during the question-and-answer session. Please note this call is being recorded. I’ll be standing by if you should need any assistance. It is now my pleasure to turn the call over to Greg Chodaczek, Managing Director. Please go ahead.

Good afternoon and thank you for joining us today. Earlier today, CareDx released financial results for the quarter ended September 30, 2023. The release is currently available on the Company's website at www.caredx.com. Joining the call today is Alex Johnson, President of CareDx's Patient and Testing Services; Abhishek Jain, Chief Financial Officer; and Robert Woodward, Chief Scientific Officer. Also joining on the call today is Michael Goldberg, Chairperson of the Board. 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 the federal securities laws which are made pursuant to 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, our examination of historical operating trends, expectations regarding coverage decisions, pricing and enrollment matters, and our 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 8, 2023. CareDx disclaims any intention or obligation, except required by law, to update or revise any information, financial projections 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 with the SEC. I will now turn the call over to Alex.

Thank you, Greg. Good afternoon, everyone, and thank you for joining today's call. I'm Alex Johnson, President of CareDx's Patient and Testing Services, a member of the newly formed office of the CEO, along with Michael Goldberg, Chairperson of the Board; and Abhishek Jain, CFO. I'd like to begin today's call by briefly covering the CEO transition we announced last week. Michael, Abhishek and I are aligned on the importance of executing against CareDx's strategic priorities and increasing shareholder returns, while the Board conducts its search for a new CEO. We have strong confidence in our leadership team and in the entire CareDx team to move the Company forward. For those of you whom I've not yet met, I have managed CareDx's largest business, the testing services business for the past two years. Prior to that, I had responsibility for our lab products business as well as for business development. I have been incredibly fortunate to have worked with Michael on CareDx's IPO nearly a decade ago and with Abhishek for the past two years. I've also been privileged to work with Peter Maag, who many of you know as our former longtime CEO and current Board member for the better part of 15 years, dating from our time together at Novartis. On behalf of CareDx, we thank Reg for his contributions to advanced transplant care during his tenure. We have a strong foundation for future growth, and we wish him the very best. Moving on to our third quarter performance. Today, I'm going to discuss our third quarter performance and results, discuss our decision to raise full year 2023 revenue guidance, and finally, I will provide additional context around the transplant market environment and our patient advocacy efforts. In Q3, CareDx reported revenue of $67.2 million, an increase of 7% as compared to normalized second quarter 2023 revenue. Normalized Q2 2023 revenue results exclude the previously discussed financial impact of $7.8 million related to Medicare claims billing that were held over from the first quarter of 2023 and recognized in Q2 revenue. Our Q3 revenue for testing services came in at $47.8 million, growth of 5% compared to the normalized second quarter of 2023. Our patient testing services result grew 2% quarter-over-quarter to 38,400. After the period of uncertainty in the last few quarters, we now see a baseline being set in the testing services business as patient testing services volumes appear to have stabilized. We continue to be well placed in the transplant market, which is growing and is expected to continue to grow. Next, our digital transplant solutions business grew 33% year-over-year to $9.9 million driven by organic growth from our recent acquisitions. Some of our earlier acquisitions are beginning to scale nicely, helping us to drive both operating leverage and strengthening our moat. Our lab products business realized revenue of $9.5 million with year-over-year growth of 33%, driven by the success of our NGS-based portfolio. We are pleased with our improved performance, which is a result of an enhanced focus on driving revenue and improved efficiency in lab products, which has been an ongoing effort. We are pleased with our continued progress to actively reduce our overall expense base, which has helped mitigate the billing article impact lower full year revenue on our results. We will continue to look for ways to be more effective and efficient. Our adjusted EBITDA loss was $10.9 million in the current quarter as compared with normalized adjusted EBITDA loss of $18.1 million in Q2. Our goal is to be operating cash flow and adjusted EBITDA positive, and we are pleased to show demonstrable progress on this metric. We have confidence in our outlook going forward. As announced last week, we are raising guidance and now expect CareDx's full year 2023 revenue to be in the range of $274 million to $278 million. Abhishek will provide additional details during his remarks. In light of our strong cash position and belief that our stock is currently undervalued, we will continue to opportunistically pursue stock repurchases as part of our previously announced stock repurchase program. Next, I'll discuss our reimbursement coverage. In Q3, two previously announced catalysts came to fruition. We received Medicare coverage for AlloSure Lung and for heart care. Since its launch in 2021, AlloSure Lung has become increasingly valuable for lung transplant patient care. Heart care multimodality coverage was approved for surveillance. This has established a path for multimodality reimbursement that can be generalizable for other testing modalities in our portfolio such as AlloSure Kidney and UroMap. We continue to focus on increasing commercial payer coverage. For example, one national plan and three regional plans expanded coverage for AlloSure Heart to start at six months as compared to one year. We also gained coverage for two new regional plans for AlloSure Kidney. Moving to catalyst. When we have talked about catalysts in the past, we have highlighted our robust pipeline of clinical testing solutions, which is exciting, and we will continue to cover in future calls. Today, I want to highlight progress on a slightly different catalyst, one, which can facilitate greater payer coverage for AlloSure Kidney, and that is KOAR. KOAR, our kidney allograft outcomes registry has now completed the last clinical visits in Q3, and we will next move to data analysis. We anticipate a publication in 2024. KOAR has the potential to provide additional insights to payers, including Medicare, with respect to the clinical utility of AlloSure Kidney, including surveillance use in a wide variety of kidney patients. Our priority is to be good stewards of capital in this new environment, to invest in our strongest businesses and pipeline products that help us to deliver on our mission to bring innovation to transplant patient care while also creating the most value for investors in the short to midterm. Our strategy has not changed. We have nearly a quarter-century commitment to improving transplant patient outcomes, extending long-term allograft survival, and this will continue. We are confident that patients and investors can both benefit from the innovation and commercialization expertise of the CareDx team. Next, I want to address the conversations around GLP-1 drugs and their potential impact on kidney transplant volumes. There are about 550,000 dialysis patients in the U.S. and only about 25,000 kidney transplants per year, with organ supply continuing to be the limiting factor. While GLP drugs have the potential to delay or may eliminate the need for dialysis in some patients, there's also the potential to help increase the number of dialysis patients eligible for a kidney transplant by improving their overall health or reducing their BMI. With respect to supply, it may be useful to note the potential impact of GLP drugs on the living donor pool, which is a major driver of kidney transplant volumes. Living donation volumes have the potential to increase beyond current trend lines as potential donors become healthier due to GLP-1s and feel more confident to donate their kidney. Before I turn the call over to Abhishek, I would like to touch on our advocacy efforts on behalf of transplant patients. We have been actively engaged in discussions with Medicare and HHS as well as helping to support legislative action and advocacy efforts to restore full patient access for Medicare beneficiaries. We have made good progress to date. On August 15, a bipartisan group of 14 members of Congress wrote to CMS Administrator, Chiquita Brooks-LaSure to challenge CMS to reconsider these new limits on access to critical molecular tests that benefit transplant patients. In September, the Wall Street Journal Editorial Board published three editorials decrying the rollback in coverage for Medicare patients. Then in mid-September, MolDX held open meetings for public comment on the proposed LCD. CareDx was proud to have presented at both the MolDX Palmetto and the Noridian open meetings on molecular testing for allograft rejection. We and the broad transplant community will continue to fight for access to transplant innovation. With that, I'd like to turn the call over to Abhishek to discuss additional details on our quarterly results and outlook, and we'll go from there to Q&A.

Thank you, Alex. In my remarks today, I will provide some additional detail on quarterly financial results, residual impact of the billing vertical revisions on our financials and close with an update on guidance. Unless otherwise noted, my remarks will focus on non-GAAP results. Also, my comparisons with Q2 '23 results will exclude the financial impact of $7.8 million related to Medicare tests that were held over from the first quarter of '23 and recognized in Q2 revenue and referred to as normalized second quarter. Please refer to GAAP to non-GAAP reconciliations for detailed information. Key highlights of Q3 results were: number one, reported revenue of $67.2 million, our testing services revenue at $47.8 million increased approximately 5% as compared to normalized second quarter revenue of $45.6 million. Patient testing services volume appears to be stabilizing as it increased 2% as compared to the last quarter. Number two, our products as well as patient and digital solution businesses delivered another strong performance with each business growing over 30% year-over-year. Number three, adjusted EBITDA losses were paid down to $10.9 million as compared to $18.1 million in the normalized second quarter. Number four, collections were 103% of our reported test and services revenue, making it the fourth consecutive quarter of net positive cash collection. Number five, we maintained a strong cash position of $268.2 million. And last but not the least, SEC concluded its inquiry and does not intend to demand an enforcement action against the Company. Given the strong results in the third quarter of '23, we are raising our revenue guidance for the full year '23 to $274 million to $278 million from our previously announced guidance of $240 million to $260 million. Moving to the details, reported testing services revenue for the third quarter was $47.8 million, up approximately 5% as compared to normalized revenue of $45.6 million in the second quarter. Reported testing services volume for the third quarter was approximately 38,400 tests, up 2% as compared to the last quarter. The volume increase was distributed across all organs. In the third quarter, MolDX covered heart care for use in heart transplant surveillance for the first 12 months post transplant. Heart care tests not meeting the coverage criteria were not recognized in revenues in Q3 post Noridian adoption of the billing article. Lastly, our revenues in Q3 were positively impacted by a one-time claim settlement with a large medical advantage payer for outstanding claims. Our non-GAAP testing services gross margin was 74% in the third quarter of '23 as compared to 73% last quarter. Our normalized second quarter testing services non-GAAP gross margin was 68%. Our current quarter gross margin included the onetime benefit of the claims settlement as discussed previously and the benefit of a Stanford royalty approval reversal, which will now be paid at a lower rate. Now turning to other businesses. Our patient and digital solutions business recorded revenue of $9.9 million, a growth of 33% in the third quarter of '23 as compared to a year ago. Non-GAAP gross margin improved 10 percentage points to 39% in the third quarter as compared to 29% in the same quarter last year. Gross margin expansion has been driven by the organic revenue growth, continued cost savings initiatives and higher gross margin profile of our new acquisitions. Our products business delivered $9.5 million in revenue in the third quarter of '23, an increase of 33% as compared to the same quarter last year. Non-GAAP gross margin improved to 58% in the third quarter of '23 as compared to 44% in the same quarter last year, an increase of 14 percentage points. Our goal is to continue to look for opportunities to further improve gross margin for this business. We are continuing to work on site consolidation that will streamline our manufacturing operations, increase efficiency throughout our supply chain, and importantly, improve patient care. Turning to operating expenses and adjusted EBITDA. Non-GAAP operating expenses for the third quarter were $57.7 million, down approximately $1.2 million sequentially from Q2 '23. The decrease in our R&D and sales and marketing spend of $4.4 million as compared to last quarter was driven by the full quarter impact of our actions related to workforce reduction, prioritization of our investments in R&D, and continued cost savings and discretionary spend. G&A expense increased $3.2 million as compared to last quarter and was driven by various litigation matters in our response to the billing article division. We are actively working to reduce these transient elevated expenses. For the third quarter of '23, we reported negative adjusted EBITDA of $10.9 million compared to normalized negative adjusted EBITDA of $18.1 million in the second quarter of '23, an improvement of $7.2 million as compared to last quarter. We are pleased with the progress we have made in reducing adjusted EBITDA losses. Turning to cash. We continue to maintain a strong balance sheet with cash, cash equivalents, and marketable securities of $268.2 million and no debt. For the fourth quarter in a row, our collections were greater than 100% of our testing services revenue. We have now collected over $22 million in incremental cash in the last four quarters. As a reminder, we have expanded our collection program to include overdue payments from commercial and Medicare Payers similar to Medicare Advantage. I would also like to note that we earned $3.2 million in interest income in the third quarter of '23. As Alex mentioned earlier, based on our cash position and belief that our stock is currently undervalued, we are continuing to opportunistically pursue stock repurchases. Turning to the impact of billing article revisions on our financials and mitigation plan. First, billing article revisions added complexity and uncertainty that were disruptive to our business. In the past two quarters, we focused our efforts on operational implementation of billing article requirements, both internally and with transplant centers. We made great progress, and the results speak for themselves in terms of new tier production and supplementation. We are pleased to report that tier production for our kidney and heart test services was over 90% at the end of September, ahead of our initial target. Second, in Q3 '23, we are seeing testing services volumes stabilize across organs and we have implemented necessary changes in our billing and revenue recognition processes. As you heard from Alex, we believe we are seeing a baseline being set. Our previously announced cost reduction program is largely complete, helping us partially offset the impact of the billing article on our financials. Our goal is to be operating cash flow and adjusted EBITDA positive based on this new level of revenue. And we have levers to bridge the gap: number one, profitable organic growth; number two, increased reimbursement of our unpaid tests; number three, reduced G&A expenses, specifically elevated legal spend, and finally, drive further efficiencies in our operating expenses. We are actively pursuing each one of these levers. Finally, turning to guidance. Based on the strong results in Q3 '23, we are raising our full year '23 revenue guidance to be in the range of $274 million to $278 million, an increase of $26 million at the midpoint. Our revised guidance number one assumes Medicare reimbursement remains as currently implemented; number two assumes approximately $4 million in revenue headwinds going into Q4 associated with the full quarter impact of heart care tests that are outside of the new coverage criteria post-Noridian adoption and the one-time settlement with a large medical advantage payer for outstanding claims; and number three, we also assume approximately 5% lower testing services volume due to Q4 seasonality around holidays and potential weather disruption. Based on our assumption of a new revenue baseline being set and with viable levers to bridge the gap to cash flow and adjusted EBITDA positive, we do not expect the need to raise cash in the foreseeable future. We continue to be proud of the operational excellence and the financial discipline demonstrated by the entire team during the quarter. With that, I'll hand over to the moderator to open the line for questions.

Our first question comes from Andrew Cooper, Raymond James.

Maybe first, just want to make sure I caught you right, probably check on the gross margin dynamics. So can you just give us maybe a dollar amount for the one-time MA settlement just so we can sort of adjust for that? And then, as we think about the trajectory from there does Q3 really feel like the stable place in terms of what the cost of goods on testing services can look like? Is there more room to improve on that front? Or is it purely sort of a reimbursement calculus to continue to see the gross margin rise?

Yes. Andrew, good to talk to you, and on the gross margin side for the testing services, the 74% is slightly higher because of the couple of one-time events that I called out. Those couple of events were about $4 million. So if you were to think about the gross margin going forward, I'll take you back to Q2 normalized gross margin, which was about 68%. Having said that, we have made more progress on our gross margin in Q3, so modeling at 70% may not be a bad idea, number one; and number two, of course, we continue to look for more operating leverage as revenue grows and as we move forward, but more to come on that as we go forward and probably in the next call.

Okay. Helpful. And then I appreciate you sizing the heart surveillance headwind in Q4. Just curious in terms of what may be on the docket to trying to fight for expansion of that beyond that 12-month window? Do you need incremental studies? Do you feel like there's a way to take what you already have and maybe repackage in a way that can move the needle there? Just how should we think about the trajectory there on heart care and potentially expanding beyond 12 months for surveillance?

Yes, this is Robert. Thanks for the question. We do see opportunities in various studies and publications that we anticipate coming up, both from CareDx and from some of our customers, key accounts that are using these tests and publishing independently. So, we'll be tracking those and looking for those to make a difference sometime in 2024.

Okay. Great. And maybe just one last one quickly with the closing of the SEC issue without any decision to move forward from the body. Anything else you can provide in terms of DOJ or the UPIC audit in terms of progress? Has there been ongoing conversations? Or just what's the time frame we should think about potentially hearing some amount of closure on the remaining outstanding inquiries.

Yes, Andrew. The SEC inquiry we mentioned in September concluded with them sending us a letter stating they would not take any enforcement action. We are very pleased with this result. We are also looking into issues similar to the civil investigative demand from the DOJ. Having the SEC's letter and conclusion is a positive outcome for us. Regarding the DOJ, it is difficult to speculate further, but I want to emphasize that we are cooperating. This matter has been ongoing for a couple of years. We will see how soon it gets resolved, but I don’t have more information about the DOJ at this time. Robert, would you like to discuss the UPIC side?

Yes. I could mention just the UPIC that there was some movement on that in the quarter and they haven't requested any additional claims or taken other actions. Like any of these audits, we intend to appeal them. There's always an ongoing appeal process and eventually get to an indefinite review at some point.

Our next question comes from Matt Sukes, Goldman Sachs.

This is Prashad on for Matt. Just wanted to get your thoughts on what you're looking for in the search for a new CEO and what the duration of your search looks like?

Sure. This is Michael. I'll take that one. We're looking for somebody who can continue to execute the strategic plan that we are currently on, improve performance and deliver long-term profitable growth to our investors. In my experience, it generally takes six to nine months to install, that is to identify, but to install a new CEO. The Board is entirely confident in the executive leadership team in place today to be able to put the plan together that they will be solely responsible for executing in 2024.

Our next question comes from Brandon Couillard, Jefferies.

This is Matt on for Brandon. I appreciate the color around kind of volumes stabilizing and then the number of initiatives underway to get to adjusted EBITDA and cash flow positive goals. Any more clarity you can provide in terms of timing on those now that you feel a bit more comfortable with both the cost actions and kind of stabilization of volumes? How should we think about when you could hit those targets?

Yes. I'll probably take a step back here that last year in Q3, we put a stake in the ground that they're going to be profitable in the first half of this year. Had we not been impacted by the billing article, we would have been profitable in Q1 itself of this year. Then we were hit by the billing article. And if you recall in the second quarter, our testing services dropped by almost like $25 million on an apple-to-apple basis that I called out in my last script. So if you look at the adjusted EBITDA now, which is at about $11 million for the current quarter, I think we are extremely proud and pleased with the progress that we have made on this particular goal of returning to operating cash flow positive and adjusted EBITDA positive. On specific timing, I will provide more color in our next call because we have multiple levers, as I was kind of alluding to that we have probably secular growth in the transplant volume market and in our testing services volume. And then, of course, how we are able to get paid on some of the tests that we are not getting paid because there is a renewed focus on the coverage and everything. And of course, if we need to be more thoughtful on operating structure and being more efficient and effective there, that is definitely on the table too. There are multiple levers, and we have made good progress. We feel comfortable where we are, but in terms of the specific timelines, we'll wait for the next quarter call that we have a little bit more information as to how things are stabilizing in Q4.

Our next question comes from Mark Massaro, BTIG.

This is Cindy on for Mark. So last quarter, you discussed clinic hesitation around ordering kidney surround testing. It appears like this dynamic might be behind us. So can you just discuss what factors or headwinds sort of rolled off for you to drive these volumes here in Q3? And can you just remind us of any one-time benefit or prior period collections that happened here in Q3? I know you spoke about the Medicare one-timer, but just any other one-timers that we should be backing out?

Thanks. And I think we're really pleased with some of the progress that we've seen over the last six months. One of the effects of having six months to do this is a lot of the transplant centers now have had time to update their systems, their procedures, the education. Where I think there was a lack of understanding of not just how to do things, but to do. Now clinicians have had enough time to absorb this and really institutionalize what they're thinking. So we're very much looking ahead and feel very good that these centers have a very good understanding of where their ordering is today and opportunities for the future.

Sure. Let me take the second part of your question around the one-timers in Q3. I called out a couple of those pieces. The first one is after the Noridian adopted the billing article on heart care, we are not recognizing that revenue post that adoption. That means going into Q4, the revenue that we recognize for those heart care tests prior to the Noridian adoption will not be available in Q4. The second event is this one-time claim settlement, and the number is about $4 million for these two events. So that's the piece that I would call out on the one-time. But other than that, there isn't a material that would need to be modeled from the numbers standpoint.

Okay. Perfect. Understood. And then I guess, any updates to provide on when we might see a readout on the Sure study? Can you just remind us what studies we've completed or underway that support these of heart care and just how you're thinking about additional evidence generation on that front?

We're currently analyzing the Sure data, which includes data monitoring. This study is ongoing, but we're working on an interim readout with the aim of publishing one or two papers in 2024. Just to note, AlloSure Heart and AlloMap Heart are both fully covered with no time restrictions. The earlier question about extending data beyond 12 months pertains only to the combined heart care results. In many situations, when doctors have specific needs for optimal patient management in heart care, we collaborate with them to submit payment requests to Medicare and to appeal any demands.

Our next question comes from Alex Nowak, Craig-Hallum Capital Group.

I want to go back around the CEO transition. Maybe just expand on the departure of Reg. There's obviously a lot of moving parts here with the story. I think the Company needs a leader out there to navigate through all of those moving parts. Why the departure now? And just how important is it to the Board to name this successor fairly quickly here to guide the Company during this challenging time?

Yes, Alex, this is Michael. These are complex situations and there are elements of it that are personal in nature. So I'm not going to provide much more on that other than to say it was mutual and the time was right. In part, the time was right because the Company and Board wanted to set themselves up for success in 2024, and we're into the planning process for establishing that budget and operating plan now. We wanted to make sure that the extraordinarily capable group of senior leaders that Reg had cultivated were in a position to be 100% responsible for constructing that plan because they'll be 100% responsible for its execution. Now we think that the executive team here is stable. We think they are extraordinarily capable and well-qualified and experienced in this business. By virtue of the structure that we've set up an office of the CEO with Abhishek, Alex, and myself, we meet on a daily basis. There are no missed beats or decisions deferred; we're operating the business as a functional CEO. So we're prepared to operate in that fashion until the Board is comfortable that we've got a CEO identified and installed. So I wouldn't worry. In fact, I would be cautiously excited.

Our next question comes from Mason Carrico, Stephens.

This is Jacob Krahenbuhl on for Mason. I appreciate the color around volumes funding like a more stabilized level this quarter, actually increased slightly sequentially. But just wondering, given you found a stabilized level, given the multiple iterations to the billing article and the LCD as well as the recent coverage room with heart care. Could you maybe give us some color whether qualitatively or quantitatively on growth across organ type, specifically heart and kidney?

Yes, I can provide some context on that, Jake. For the growth in test and service volumes this past quarter, we observed growth from all three organs. We feel confident that this baseline has established a stabilization that will support further growth.

Our final question comes from Dipesh Patel, H.C. Wainwright.

This is Dipesh on for Yi. Could you perhaps clarify if you expect to see any further updates from MolDX regarding the coverage of molecular transplant tests as part of routine monitoring care to detect organ rejection?

I think where we're at right now is that after a couple of iterations of a bill article and the perspective of the community, those are changes to coverage. They then propose a draft LCD that is now open for comment. The open comment period for two of the max has already passed; two more are in process. We would expect them to move forward and based on the draft and the comments they've received, produce a final coverage policy from that. That's what we would expect to happen. We've been surprised in the past, different from our expectations, but that's the normal process. The timing around that is something we're often asked, and that's sometimes before August of next year if there's a rule that has to be finished before the original draft was released.

Got it. That's very helpful. Lastly, how might you expect the testing volume to grow sequentially going forward?

Look, I think we're certainly in this quarter, certainly, there's nothing that would make us change from the guidance and the thinking that we've seen so far. Now that we've seen a baseline being set, I think there's growth ahead of us, and we'll have to see how the quarter plays out, certainly in terms of weather and winter storms and such. But we're feeling like we've certainly hit some stabilization in a baseline that we can grow from.

We have no further questions in the queue at this time. I would now like to turn the call back over to today's speakers.

Great. Thank you. We wish you the very best this afternoon. Thank you all.

This does conclude today's program. Thank you for your participation. You may disconnect at any time.