Veracyte, Inc. Q3 FY2023 Earnings Call

Good day, and thank you for standing by. Welcome to the Veracyte Third Quarter 2023 Financial Results Webcast. At this time, all participants are in a listen-only mode. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your first speaker today, Tristan Ribar. Please go ahead.

Good afternoon, everyone, and thanks for joining us today for a discussion of our third quarter 2023 financial results. With me today are Marc Stapley, Veracyte's Chief Executive Officer; and Rebecca Chambers, our Chief Financial Officer. Veracyte issued a press release earlier this afternoon detailing our third quarter 2023 financial results. This release, along with the business and financial presentation is available in the Investor Relations section of our website at veracyte.com. Before we begin, I'd like to remind you that various statements that we may make during this call will include forward-looking statements as defined under applicable securities laws. Forward-looking statements are subject to risks and uncertainties, and the company can give no assurance they will prove to be correct. Further, we are not under any obligation to provide further updates on our business trends or our performance during the quarter. To better understand the risks and uncertainties that could cause actual results to differ, we refer you to the documents that Veracyte files with the Securities and Exchange Commission, including Veracyte's most recent forms 10-Q and 10-K. In addition, this call will include certain non-GAAP financial measures. Reconciliation of these measures to the most directly comparable GAAP financial measures are included in today's earnings release accessible from the IR section of Veracyte's website. I will now turn the call over to Marc Stapley, Veracyte's CEO.

Thanks, Tristan, and thanks everyone for joining us today. I am pleased to share our third quarter results as well as an update on progress across our growth drivers. Our Q3 revenue was approximately $90 million, an increase of 19% compared to the prior year period. Yet again, our core testing business drove this strong outcome with impressive revenue growth of 27% versus the prior year period. We also continued to further enhance our already differentiated financial profile, generating $14 million of cash flow from operations and marking the fourth out of the last five quarters with positive cash flow. Our proven framework of driving test adoption through robust clinical evidence, reimbursement and guideline inclusion has provided indisputable differentiation for our leading on-market tests, enabling us to serve more patients and grow revenue at an accelerated rate. During the quarter, we reported approximately 15,500 Decipher Prostate tests, slightly up sequentially, as summer seasonality was more than offset by a reduction in backlog. Given Decipher's growth, we have invested in our San Diego lab operations over the course of this year, focusing on both lab capacity and efficiency. I'm incredibly proud of our lab operations team that has executed these improvements. One of the impressive outcomes of their efforts is that the Decipher turnaround time is now lower than we've ever seen, enabling us to get answers to physicians and their patients even faster. Consequently, Decipher backlog was lower at the end of the quarter than we forecasted by more than 500 tests, which were processed and recognized as revenue. With the faster turnaround time now being the new normal, our backlog should remain approximately at this lower level going forward. We again saw a record number of unique ordering physicians for the Decipher Prostate test in the quarter, as our highly productive urology salesforce continued to broaden awareness of the test level one evidence status in the NCCN guidelines. There are hundreds of publications and presentations contributing to evidence for the Decipher platform, and we continue to engage with key opinion leaders through our Decipher GRID research offering. During the quarter, Decipher GRID was ordered by physicians close to 50% of the time. As a reminder, Decipher GRID information is added to the patient report upon physician request to provide further gene expression and signature data for research use only, which may offer additional insights into prostate cancer molecular biology. Furthering clinical evidence for our products is a key focus in our proven framework. This quarter was no exception as we presented six abstracts at the recent American Society for Radiation Oncology or ASTRO Conference. This included three oral presentations focusing on a large randomized Phase 3 trial, demonstrating the Decipher Prostate genomic classifier's ability to predict risk of metastasis among patients with clinically high-risk disease. This is our 12th validation study of Decipher in a Phase 3 randomized trial demonstrating the test performance and clinical utility for enabling physicians to apply precision medicine for patients with prostate cancer. As far as we know, no other molecular test for prostate cancer comes close to this level of clinical evidence. We remain committed to providing access for patients across the care continuum, especially as high-risk prostate cancer trends upward. As part of this, we have developed and validated our Decipher offering for patients with advanced, metastatic, and castrate-resistant prostate cancer. We are currently engaging with Medicare's MolDX program on their draft coverage policy to enable Decipher testing of this patient population. We expect the draft LCD to be finalized over the coming year. Once completed, we will submit for technical assessment to grant Medicare coverage and will concurrently engage commercial payers. We view these steps as critical to ensure our ability to serve the approximately 300,000 prostate cancer patients diagnosed each year in the United States. Moving to Afirma. We had another record quarter with approximately 13,500 tests reported. Our dedicated commercial team added more than 65 new accounts in the quarter, including some large health systems and competitive wins. We believe this growth is driven by increasing usage with existing customers as well as market share gains. Our current estimate is that more than 550,000 patients receive a thyroid fine-needle aspiration procedure in the United States annually to assess their thyroid nodules for cancer. Of those, approximately 119,000 are in the indeterminate or Bethesda III-IV categories, which have historically accounted for the vast majority of Afirma’s patient population. This year, the Bethesda system for reporting thyroid cytopathology broadened their recommendations for which patients may benefit from molecular testing to include those with a Bethesda V cytology diagnosis who likely have thyroid cancer. We strongly believe that Afirma can provide critical information for the approximately 15,000 additional Bethesda V patients annually who are now included in the recommendation for molecular testing. Given Afirma's strong performance and positive outlook, we are once again updating our revenue growth expectations to be approximately 18% for fiscal year 2023. Afirma’s success is due in part to continued enhancements we've made to the test over the last 12 months, including the addition of TERT promoter mutation testing and ongoing customer experience improvements such as our customer portal. We continue to work with leading key opinion leaders to advance the science around thyroid nodules and cancer, and as a result, we will be launching our new Afirma GRID Report this quarter. This research tool, similar in concept to Decipher GRID, leverages Afirma's whole transcriptome-derived sequencing platform and database and was developed through our novel discovery work and based on published literature. It is designed to serve as a comprehensive resource for research into molecular characteristics that may ultimately help improve the understanding of how to manage patients with thyroid nodules and cancer. Going forward, our focus is to utilize this new tool to partner with academic researchers and key opinion leaders to advance findings that may one day help to further personalize treatment for patients. For both prostate and thyroid cancer, there is still a lot to learn to better support patients in their diagnosis and treatment, and we are proud to facilitate new research with our GRID offerings. Our goal for both tests, which are still significantly underpenetrated in the market, is that every patient that can benefit from our molecular diagnostics has access to Decipher Afirma, and we strongly believe that continued research will help drive benefits for patients everywhere. Turning now to our long-term growth drivers, we continue to make significant progress on both Percepta Nasal Swab and our global IVD strategy. Our NIGHTINGALE study for the Percepta Nasal Swab test has grown to approximately 90 sites, and we remain on track to finalize trial enrollment no later than the second quarter of 2024. We continue to view the Percepta Nasal Swab test as serving a critical clinical unmet need by improving the assessment of identified nodules for risk of malignancy in current or former smokers who undergo recommended screening for lung cancer, as well as providing a risk classification. This patient population continues to grow as the American Cancer Society expanded the lung cancer screening guidelines for former smokers, now including individuals aged 50 to 80 instead of 55 to 74. We advanced our IVD strategy this quarter as well. We had another solid quarter for our Prosigna breast cancer test, with product revenue increasing 21% versus the prior year period, driven by demand from the Nordic region. Earlier this year, Prosigna was adopted as the definitive breast cancer test by the Government of Norway, following a nationwide prospective study involving more than 2,000 patients. Looking ahead, we're excited about a report published this month by the Scottish Health Technologies Group, which recommended a favorable position for Prosigna reimbursement, expected to foster further demand in the region. Our transition of Prosigna assay manufacturing from Nanostring to our Marseille, France location is progressing. This transition is becoming increasingly critical as we face supply challenges. Consequently, we intend to expedite our own manufacturing line to ensure we meet patient needs. Beyond improving our long-term economics for our IVD strategy, our global supply chain and manufacturing teams, working collaboratively with the commercial team, have done an excellent job meeting this accelerated goal. Despite our mitigation efforts, we do expect this to be a headwind to volume and revenue in the fourth quarter, though this impact has been offset by strong testing outlook reflected in our updated revenue guidance. Recall that product revenue represents less than 5% of our total revenue. As a reminder, our decentralized IVD strategy is designed to make our clinically impactful tests accessible to patients worldwide. Fundamentally, we believe that the quality of our diagnostics and the evidence supporting them distinguishes us, as evidenced in the U.S. market. Based on our experience, customer feedback, and the growing installed base of NGS and qPCR platforms, we have decided to adopt a multiplatform strategy for our tests. We believe this will help us reach more patients with our tests more quickly and thus accelerate long-term growth. Building on our nCounter development work, our team has begun bridging Decipher Prostate to qPCR and will soon commence a project to bridge our nasal swab to NGS. To enable the launch of products on NGS, we have signed an agreement with Illumina to develop and offer our tests on their NextSeq 550Dx instrument. We are on track to launch these new products consistent with previous expectations, and we expect Decipher Prostate to commercially launch in mid to late 2025 and nasal swab in 2026. At that point, we anticipate leveraging our existing IVD commercial team who are currently selling Prosigna to drive reimbursement and adoption gradually for these new tests across various countries. I'm excited about this multiplatform approach, emphasizing our belief that exceptional cancer care begins with broad access to exceptional diagnostics. To help us further advance our global vision, we were pleased to announce the addition of two highly respected industry veterans to our senior leadership team during the quarter. Dr. Phil Febbo has joined Veracyte as Chief Scientific Officer and Chief Medical Officer, and Dr. Marie-Claire Taine is now General Manager of our IVD Business based in Marseille, France. Additionally, we recently launched a new corporate website, showcasing our vision and how we differentiate from other companies in the space. In closing, Q3 was an exceptional quarter with strong execution in our core testing business and progress across our long-term growth drivers. We are now focused on executing our remaining goals for the year while also setting the stage for global leadership in cancer diagnostics. With that, I will now turn to Rebecca to review our financial results for the quarter and our updated guidance for 2023.

Thanks, Marc. As Marc mentioned, we achieved excellent results in the third quarter with $90.1 million of revenue, an increase of 19% over the prior year period. We grew total volume to approximately 32,500 tests, a 23% increase over the same period of 2022. Quarterly testing revenue was $82 million, an increase of 27% year-over-year, driven by strong adoption of our Decipher Prostate test, following its level one evidence designation by the NCCN and continued penetration of the Afirma market, as well as strong prior period cash collections. Total testing volume was approximately 29,500 tests, which includes the impact of our improved lab efficiency and backlog reduction that Marc mentioned. Testing ASP was approximately $2,750 per test, benefiting from approximately $1.5 million of out-of-period collections. Adjusting for this impact, testing ASP would have been approximately $2,700. Third quarter product volume was approximately 2,850 tests and product revenue was $4 million, up 21% year-over-year. Biopharmaceutical and other revenues totaled $4.1 million, down 47% year-over-year. Reductions in customer projects, extended sales cycles, and overall spending constraints across the industry led to this decline. Moving to gross margin and operating expenses, I will highlight non-GAAP results, which exclude the amortization of acquired intangible assets, restructuring costs, and the impairment of long-lived assets but include routine stock-based compensation. Non-GAAP gross margin was 69%, up approximately 350 basis points compared to the prior year period. Testing gross margin was 73%, up 400 basis points compared to the prior year period, benefiting from efficiency gains, fixed cost leverage, test mix, and higher ASP. Product gross margin was 39%, roughly flat versus the prior year period. Biopharmaceutical and other gross margin was 18%, down year-over-year due to lower fixed cost absorption. Non-GAAP operating expenses, excluding cost of revenue, were up 13% year-over-year at $58 million, driven by higher personnel costs, clinical trial expenses, as well as investments in facilities and infrastructure. Research and development expenses increased by $2.8 million to $13.3 million. Sales and marketing expenses decreased by $0.5 million to $23.8 million, and G&A expenses were up $4.3 million to $20.6 million. We recorded a GAAP net loss of $29.6 million, which included $7.3 million of stock-based compensation expense, $7.3 million of depreciation and amortization, and a $34.9 million impairment charge tied to our decision to adopt a multiplatform IVD strategy. We ended the quarter with $202 million of cash and cash equivalents, well ahead of our expectations. Turning now to our updated 2023 guidance. We have raised our revenue projections yet again to $352 million to $354 million compared to our prior guidance of $342 million to $350 million. This increase is based on our strong third quarter results and an improved outlook on testing revenue, accounting for the Q3 backlog impact and out-of-period collections, which we do not anticipate repeating. This guidance also anticipates Q4 product revenue of $2 million to $3 million given the supplier challenges previously mentioned. Our forecast now estimates ending 2023 with more than $200 million of cash on hand, taking into account the impact of upcoming milestones, contingent consideration payments, capital expenditures related to our lab expansion, and other working capital trends. Importantly, this updated guidance represents an increase of approximately $30 million compared to our expectations at the beginning of this year, driven by the strength of our testing portfolio and the fabulous execution of our managed care and billing teams. To date, this year has been incredible for the Veracyte team, and I'm excited to continue to deliver on the financial goals we've set for 2023 and beyond. We'll now go to the Q&A portion of the call. Operator, please open the lines.

Thank you. Our first question is from Tejas Savant with MS. Your line is now open.

Hello, this is Yuko on for Tejas. Thank you for taking our questions. Maybe starting with the Illumina collaboration that you announced today; how does this collaboration fit into a more centralized testing model in the U.S.? Or is the focus here mainly OUS adoption? If that's the case, have there been any changes in the strategy to build the test on nCounter?

Yes, great question. Thanks for that. So the collaboration with Illumina is very much focused on the OUS market, and it's regarding our distributable IVDs as kits on the NextSeq 550Dx platform. Now, remember we're a customer of Illumina's today, and this doesn't change or impact that in any way, shape, or form other than we've expanded our relationship with Illumina to include collaboration outside the U.S. as well. So we're excited about that. In relation to the nCounter, the multiplatform strategy we discussed will involve leveraging the best instrument for each test. We will launch Decipher Prostate on qPCR and the Nasal Swab on NGS, ensuring we take the best platform for each application. The nCounter will still be supported for Prosigna and other tests. There are no changes to that strategy. Prosigna will also be launched on NGS, providing more options for our customers. Hopefully that answers your question.

Yes, that was great. Thank you. Then as a separate follow-up question. You touched on this during the prepared remarks, but it sounds like some of the timelines have changed for submission of Prostate and Nasal Swab for the IVDR process. I was wondering if you could elaborate on some of the discussions that you had with the notified body, and whether anything from those discussions may have changed the timelines.

Yes. So actually the timelines for when we now expect to launch these tests commercially have not changed. I’m talking about Decipher Prostate and Nasal Swab. However, we’ve transitioned from providing a submission timeline to a commercialization timeline, which we think is more predictable and clearer. We’re now comfortable saying when we’ll be able to commercialize these tests based on our roadmap and project plan. In earlier assumptions, Decipher Prostate would be expected to commercialize mid to late 2025 and Nasal Swab in 2026. We're now confirming those timelines. It's also important to note that while we’ll be ready to commercially launch, it doesn’t guarantee reimbursement and adoption in every country. We still need to work on driving reimbursement and support at the country level.

And just to add, the decision to broaden our strategy to include other platforms stems from the growing installed bases of those other platforms. We believe this will solidify the timelines Marc discussed and provide opportunities for quicker revenue growth given the larger number of instruments already in the field.

Great. Thank you very much.

Thank you. One moment for our next question. Our next question comes from Matt Sykes with Goldman Sachs. Your line is now open.

Hey, guys, this is Prashant Kedia on for Matt Sykes. Congrats on the quarter; really great to hear the results. So how does an MSEd Test fit into the paradigm of screening for lung cancer with Percepta Nasal Swab and low-dose CT?

Yes. That's a really great question. We think about multi-cancer early detection and screening differently compared to how we perceive Nasal Swab. Nasal Swab targets patients with lung nodules identified, helping determine whether to expedite treatment or to avoid unnecessary procedures. Currently, very few out of the 15 million people who could benefit from screening actually receive it; only about a million. More lung nodules are detected incidentally than through direct screening. While we care about increasing screening, we believe multi-cancer early detection tests could help escalate that process. If a patient is flagged as potentially having lung cancer through a multi-cancer early detection test, they would have a low-dose CT follow-up, and if a lung nodule is detected, then that patient enters the Nasal Swab workflow. Nonetheless, in the near term, the incidental population will likely remain larger until under-screening is resolved.

Got it. Thank you. That's helpful. And how are you planning on increasing market penetration with Afirma? Is it more sales reps, additional coverage, expansion, product updates, or can you give us more color?

More of what we've been doing quite honestly. We've exceeded our original expectations for Afirma this year, and we've increased our guidance to 18% growth, significantly higher than we anticipated. Our efforts are clearly paying off in terms of market penetration and onboarding new accounts. What are we doing? We’ve enhanced the product, added mutation testing, launched a customer portal, just announced our GRID offering for research, and we have a dedicated and effective sales team. Adding numerous sales reps isn’t the key driver; we’re achieving this with a stable yet strong team. Continuing these initiatives will drive further growth. The market is about 50% penetrated today, and we believe it can reach 70% or more.

Additionally, there was a recent draft LCD. While it may take time to be implemented, we are focused on penetrating the market as it stands today and ensuring every appropriate patient receives the necessary test. To that end, our managed care team is actively working with MolDX on the latest draft LCDs.

That’s a great point, Rebecca. Approval would pave the way for reimbursement for Bethesda V patients, where we believe our test has substantial clinical utility. If that gets passed in the next year or so, we would be very pleased about that for patients.

Got it. Thanks. It sounds like you're tackling it from all angles. Congrats again.

Thank you.

Thank you.

Thank you. One moment for our next question. Our next question comes from Andrew Brackman with William Blair. Your line is now open.

Hi, Andrew. We're not able to hear you.

All right, we will move to our next question. Please stand by. Our next question comes from Puneet Souda with Leerink. Your line is open.

Hey, guys, hopefully you can hear me.

Yes.

I’m wondering if you can talk a little bit about the supply chain issues, and what that means for the fourth quarter, if you can quantify that? And then it’s good to see that you're addressing this with multiple platforms, but can you talk about the economic agreement with Illumina? I assume that being a multiplex platform means you’ll see more growth compared to the qPCR and nCounter approach?

Let me come back to that one in a moment, but on your first question regarding supply chain. This isn't our first experience with supply chain challenges. We talked about that with Afirma in the past as well. Occasionally, we face shortages of key components or kits. The good news is we are standing up our own manufacturing for Prosigna kits in Marseille as part of our IVD strategy anyway. We accelerated plans, and we're making great progress launching our own kits to mitigate supply challenges, increasing our available inventory. We have implemented a customer allocation process to ensure all patients have access. We’re getting through it, and we projected lower product revenue for Q4 of $2 million to $3 million, lower than we’d anticipated previously.

To your question on economics for Illumina, we follow a standard open offer clinical agreement that outlines the structure, including technology access fees and milestone payments as we launch new IVDs. The economic structure includes royalties based on sales. We've factored the technology access fee into our cash guidance.

Got it. That's helpful. Rebecca, I’m wondering about the Biopharma impact. It's evident that Decipher is doing well. Afirma continues to gain traction at these penetration levels. Can you provide any insights on the 2024 outlook, considering the moving parts, including supply chain?

Yes, regarding our other platforms, those will have longer-term impacts as they are set to launch in 2025 and 2026. Our goal is that the issues with supply will not affect 2024 given our proactive strategy for our own manufacturing, which we are expediting. On Biopharma, we cannot offer numbers for 2024 at this point as we continue to evaluate where we see growth. However, both Afirma and Decipher are performing well, and we expect to see continued traction.

To add on that, as Decipher and Afirma grow, we will keep pursuing guidance and support to ensure we succeed. None of our practices will change. Our working formula that has served us well continues to be our focus, and we aim to address any challenges as needed.

Got it. If I can squeeze in one more—great to see Phil join the team. The prostate and thyroid areas continue to be major focuses. Now that you have multiple platforms, are there other areas or indication types you can potentially explore?

Yes, it's excellent to have Phil on board. We will continue our expansion within current indications, especially urology and pulmonary, with Nasal Swab as a critical part. Regarding future indications, we’re consistently exploring opportunities, but no specifics to share at this moment. We’re satisfied with our current indications and how they fuel growth, but we will pursue additional opportunities as they arise.

Okay. Helpful. Thanks, guys.

Thanks.

Thank you. One moment for our next question. Our next question comes from Sung Ji Nam with Scotiabank. Your line is now open.

Hi. Thanks for taking the questions and congrats on the quarter. Can you comment on why you’re opting to put Decipher Prostate on qPCR instead of next-gen sequencing on the NextSeq? Just confirming, isn't Decipher whole transcriptome analysis?

Yes, great question and thank you for that. Decipher is indeed a whole transcriptome test, as is Afirma in the U.S. in our CLIA lab. However, as we plan to launch IVDs on various platforms, we are structuring more targeted tests. Decipher focuses on a specific 22 gene set making it a good fit for qPCR given the extensive existing installed base. This approach will significantly optimize efficiency across our tests. We could later launch on NGS as well, but right now, it makes sense to leverage the strengths of qPCR.

Got it. That's super helpful. Also, regarding Afirma, great to hear you’re taking market share. Can you clarify if you’re taking share from competitors? What are the key drivers you see behind that? Additionally, what’s your current estimate of market share?

It’s a great question. The overall market share is difficult to measure, but we see our efforts driving significant market penetration. More patients getting tested and physicians utilizing our products are key factors. Within our existing customers, usage is increasing. We also see anecdotal evidence of share gains from other tests. Key differentiators include our extensive evidence base, including NCCN level one support for Decipher and significant data backing Afirma, coupled with a skilled salesforce promoting that evidence effectively.

Great. Thank you so much.

You're welcome.

Thank you. Please stand by for our next question. Our next question comes from Mason Carrico with Stephens Inc. Your line is now open.

Hey, guys, thanks for the questions. Congrats on another strong quarter. Regarding the $14 million cash from operations, that’s impressive and unique in the space. How do you balance investments and driving top-line growth versus operating leverage to support free cash flow moving forward?

I’ll start. Our philosophy has not changed. We’re focused on top-line growth without compromising quality. We are continuously optimizing our operations for improved performance. We've recorded sustained efficiency gains in our Decipher lab operations and other areas like IT systems to scale effectively, maintaining profitability and cash flow. We don’t need to raise cash and do not anticipate that will change.

We aim to continue the successes of 2023. With four of the last five quarters generating cash flow from ops, we have every intention of sustaining that alongside revenue growth. This approach has become a key differentiator for Veracyte, and we intend to continue that balance.

That’s helpful. Moving to Decipher and the metastatic draft LCD, can you discuss your interpretation of the LCD and any thoughts on the criteria that could open up testing to multiple tests per patient? If this were to happen, how do you perceive incremental testing opportunities?

The draft LCD is favorable for patients, and we believe we have evidence supporting testing for this cohort. We're pleased with it. However, one area to address is the rules on multiple tests per patient, as there are valid situations warranting that. We've shared feedback openly with MolDX, hoping this will be addressed for patient care. If patients receive early Decipher tests, it may lead to better management and reduced progression.

Right, that’s clear. Thank you, guys. I appreciate it.

Thank you. This concludes our Q&A portion. I would now like to turn it back to Marc Stapley for closing remarks.

Thanks. I appreciate it. I’m extremely pleased with the performance of our core testing business, and I’m encouraged by the untapped opportunity to help more patients in both the prostate and thyroid cancer markets. We’re clearly growing in both indications at a rate that is outpacing the market, and with our extensive product enhancements, evidence development, and opportunities to broaden reimbursement, I see that continuing for many years. Additionally, I’m excited to see our global expansion come to fruition with our augmented IVD strategy. I applaud our team for their diligence and commitment to continuously evaluate our opportunities and strategies. I’m proud of our Veracyte employees who have shown they can execute quarter after quarter, driven by their passion to transform cancer care for patients worldwide. Thank you.

Thank you for your participation in today’s conference. This concludes the program. You may now disconnect.