NanoString Technologies, Inc.
Q1 2018 Earnings Call Transcript

Published: 9 May 2018

[Operator:]

Good day, ladies and gentlemen, and welcome to NanoString 2018 First Quarter Financial Results Conference. [Operator Instructions] As a reminder, this call is being recorded. Now, I would like to turn the conference over to Vice President of Investor Relations, Doug Farrell. Sir, you may go ahead.

[Doug Farrell:]

Thank you, operator. Joining me on the call today is Brad Gray, our President and CEO; and Tom Bailey, our CFO. Earlier today, NanoString released financial results for the first quarter of 2018. A copy of the press release that can be found on our website at nanostring.com. During this call, we may make statements that are forward-looking, including statements about financial projections, existing and future collaborations, future business growth trends and related factors, prospects for expanding and penetrating addressable markets, our strategic focus and objectives, and the development status and anticipated success of recent and planned product offerings. Forward-looking statements are subject to risks and uncertainties, many of which are beyond our control, including risks and uncertainties described from time to time in our SEC filings. Our results may differ materially from those projected on today's call and we undertake no obligation to update this publicly. With that, let me turn the call over to Brad.

[Brad Gray:]

Good afternoon and thank you for joining us today. I'm going to provide an overview of our performance for the first quarter and an update on our strategic objectives for the year. And then, I'll turn the call over to Tom to review the details of our Q1 operating results. Our year is off to a good start as we made solid progress against both our commercial and strategic objectives. I'm pleased with our recent commercial execution as we establish momentum that puts us on track to meet our financial goals for the year. Our top priority is accelerating the growth of our core nCounter business. We achieved this goal during the first quarter as our product and service revenue increased by 14% to $18 million. Growth was strong across multiple segments of our business, particularly biopharmaceutical customers, clinical laboratories and in distributor territories. We are particularly pleased with the growth - of the strong growth at our consumable business, which inclusive of both life sciences and Prosigna, generated 15% growth during the first quarter. We believe that this is the result of actions taken over the last 12 months to strengthen our commercial channel. In 2017, we grew our installed base by about 25%, creating a natural tailwind for consumable revenue. To help leverage this expanded install base, we added dedicated consumable sales reps, increasing our sales team by about 20%. These specialized consumable reps are having a tangible impact on our commercial productivity as territories with field based consumable reps are generating stronger growth than territories without these reps. Our instrument sales grew by 5% in Q1, better than implied by our guidance and with nice linearity throughout the quarter. We had strong placements of our high throughput dual use flex systems as many customers paid a premium for the option to run diagnostic products. This was particularly true in Europe where platforms that offer diagnostic utility are more likely to win tenders over dedicated research systems. Spread systems represented just under 40% of unit sales in the quarter. Overall, our Q1 performance increases my conviction that the enhancements to our commercial infrastructure have created durable improvements that are increasing the visibility and the predictability of the business. Congratulations to new commercial leadership team on a great start to the year. Now, let me shift to our strategic objectives. Our first strategic objective is extending our leadership in oncology, research and diagnostics. I'm pleased to report that we're making substantial progress on this objective. During the first quarter, oncology accounted for about 75% of our new instrument placements within direct markets. Oncology panel revenue grew 50% year-on-year, driven primarily by immune-oncology. As the PanCancer immune profiling panel remains our top selling research panel, our strategy for maintaining leadership on oncology research is to continue expanding our menu of panels. The latest addition to our offering is our 360 series of cancer panels which incorporate our diagnostic content and are designed for use in drug development. The IO 360 panel launched late last year remains our fastest growing panel launch ever and is designed to characterize the tumor microenvironment and immune interactions to elucidate a tumor's mechanism of immunovation. For example, at the AACR conference last month, researchers from [indiscernible] and Paris presented research using the IO 360 panel to study PD1 blockade in solid tumors. Their research demonstrated the predictive value of the tumor inflammation signature, which is included in IO 360 for the second line treatment of non-small cell lung cancer with OPDIVO in a real world clinical setting. In addition, we have introduced a mouse version of the IO 360 panel, so we now provide a suite of tools that span from animal models to clinical trials. We recently launched the breast cancer 360 panel, which combines the power of the tumor inflammation signature and the PAM50 signature, that is the basis for Prosigna. And so far, customer interest is high. This panel was created to support translational researchers in their quest to understand how heterogeneity and breast cancer impacts drug development and patient management. We plan to introduce additional 360 panels later this year, with offerings in lymphoma and lung cancer. This year, the AACR conference was a tremendous success for the company and a positive leading indicator of our continued strength in oncology. Our technologies were showcased in a record number of abstracts and our commercial presence generated about 600 customer leads. Our spotlight theater presentation grew more than 100 attendees who came to learn about our 360 series of panels and our digital spatial profiling platform. In addition, we hosted key opinion leader dinners for digital spatial profiling and the breast cancer 360 panel that were attended by about 60 customers from Academia and Biopharma. We also had a great quarter on the diagnostic side of our business. We achieved a major commercial milestone for Prosigna, breaking through $2 million in quarterly sales for the first time. We are seeing growth across all geographies, catalyzed by reimbursement wins and successful tenders. Prosigna continues to gain adoption in Canada, following positive coverage decisions in several provinces. In France, our success in a tender for the unit Cancer Network has provided ongoing access to several existing accounts as well as the opportunity to win new accounts. In the UK, the National Institute for Health and Care Excellence, more commonly known as NICE recently updated its recommendation of gene profiling test to include Prosigna. If this recommendation comes into effect as expected in September, we expect to begin establish testing hubs and driving UK Prosigna sales, beginning in 2019. Finally, we are continuing our efforts to expand our diagnostic menu. We are preparing to submit a PMA for our LymphMark DLBCL assay, pending results from the ongoing Phase 3 robust study. In parallel, we've expanded our engagement with biopharma companies, increasing the number of pilot studies by about 15% over the last quarter to approximately 80 studies at the end of Q1. Our second strategic objective for 2018 is to drive nCounter into new therapeutic areas and applications. As we described earlier this year, we're targeting well-funded research markets outside of oncology where the experimental questions are well matched to our nCounter platform. We have prioritized three areas today

[Tom Bailey:]

Thank you, Brad. I'm pleased to have the opportunity to discuss our results for the first quarter of 2018. Our teams delivered a strong first step toward achieving the financial goals we outlined in March and we've established good momentum heading into the second quarter. For the first quarter of 2018, our total revenue was 23.1 million. That includes product and service revenue of $18 million, representing year-over-year growth of 14%. Product and service revenue includes 4.7 million from instrument sales, representing 5% growth as compared to the first quarter of 2017 and 11.5 million in total consumable revenue for the first quarter, representing 15% year-over-year growth. Overall, consumable pull through was approximately $76,000 per system on an annualized basis. Life science consumables revenue, excluding Prosigna was 9.4 million, reflecting 9% year-over-year growth. Life science consumables benefited from the growth of more than 30% in panel revenue, which more than offset the anticipated decline in our custom CodeSets. Panels now account for more than 70% of life science consumable revenue, a good indicator of our successful transition to panel driven consumables. Consumable revenue includes 2.2 million of Prosigna sales, a record quarterly result and an increase of 51% year-over-year. As in previous periods, Prosigna revenue was split about one-third recorded in North America and two-thirds in the rest of the world. Service revenue was 1.8 million in the first quarter with the growth driven by our technology access program for DSP. We reported 5 million in collaboration revenue for the first quarter with the majority derived from our partnership with Lam Research. We expect collaboration revenue to ramp over the course of the year. Gross margin on product and service revenue for the quarter was 57% as compared to 55% for the first quarter of 2017, with the improvement primarily driven by product mix shift toward consumables. R&D expense was 13.8 million, an increase of 28% over the prior year. Investment in our Hyb & Seq program accounted for the bulk of the increase and was offset by approximately 3.5 million in program support payments that we received from Lam Research during the quarter. Excluding Hyb & Seq development expenses funded by Lam Research, our R&D expense would have been modestly lower in the first quarter of 2018 as compared to the prior year. In addition, a significant portion of our remaining R&D expenses relate to our investment in DSP, a new platform that is approximately a year away from a full commercial launch. Our SG&A expense was 19.4 million for the quarter, an increase of 11% as compared to the first quarter of 2017. This increase is primarily the result of investments made to expand and specialize our commercial channel in 2017. Stock-based compensation expense for the quarter was 2.9 million and we ended the quarter with 60.5 million of cash and short term investments. Now, turning to our financial outlook. We exceeded our product and service revenue guidance in the first quarter and we feel confident about the trajectory of the business. We are reiterating the full year 2018 guidance for revenue and operating expenses that we provided during our March call. This is consistent with our philosophy on guidance that we shared back in March of providing guidance we feel confident that we can meet and sometimes exceed. So in summary, for the second quarter of 2018, we expect product and service revenue of 18.5 million to 19.5 million, collaboration revenue of approximately 6 million and therefore total revenue of approximately $24.5 million to $25.5 million. Turning to our balance sheet, we continue to believe that our current resources and the additional business development and financial opportunities available to us will enable us to support our current business and product development initiatives. In addition to the financial support we expect to receive through our collaboration with Lam Research, we've established and maintained a $40 million at the market facility that would enable us to consider raising additional equity capital should conditions in terms be favorable to do so. We are also actively evaluating potential alternative financing vehicles and various business development options that could provide capital for the company and that may be available to us based on our improving core business performance in our robust product pipeline. Thank you for your time today and your interest in NanoString and I'll now turn it back to Brad to conclude the discussion.

[Brad Gray:]

Thanks, Tom. We're increasingly confident that enhancements to our commercial team made over the past year have increased our effectiveness and sets the stage for a stronger growth profile during 2018. Our recent product launches and the scientific successes of our customers are extending our leadership in the field oncology, while our entry into new therapeutic areas is expanding our serviceable markets. Meanwhile, customer excitement about digital spatial profiling provides conviction that the growth will further accelerate upon DSP launch during 2019. Overall, we are positive on the company's outlook for the balance of 2018 and beyond. We'd now like to open the call for your question.

[Operator:]

[Operator Instructions] Our first question comes from Doug Schenkel with Cowen.

[Doug Schenkel:]

Brad, product and service revenue of $18 million was I believe $1 million ahead of the high end of first quarter guidance. You talked about a lot of things that seem to be moving in the right direction. With that in mind, I'm just curious if there were maybe one or two things you might want to call out that are key drivers to the beat relative to your internal expectations for products and services.

[Brad Gray:]

I think the beat - the primary drivers of the beat that I would point to are one, consumable revenue on the life sciences side and two, Prosigna revenue. On the life sciences side, our pullthrough came in probably a little ahead of where we had visibility to at the time of our guide. I would point to the great effectiveness of our new commercial team, especially our new consumables leader and field based consumables reps and continuing to drive panel sales, which increased substantially over the course of the quarter. On the Prosigna side, we guided to about $8 million to $9 million for the year. Q1 came in nice and strong at 2.2 million with a lot of momentum there. So I think between those two things is really where the source of the upside relative to our initial Q1 guide came from.

[Doug Schenkel:]

So I think you've placed around 35 instruments in the quarter, recognizing you gave us an installed base that was approximately 640, so there's, some arrow bars around that 35 placement number. That being said, if we use that, that also is stronger than at least what we expected. That said, I would have expected instrument revenue to be stronger than what you reported on that type of placement number, that is unless SPRINT placements accounted for a greater proportion of placements, which I believe was not the case based on what you described in your prepared remarks. Can you just provide any additional color on why ASPs weren't a bit higher, if my math is right in the quarter and what are you expecting from here?

[Brad Gray:]

Yeah. Hey, Doug. I think, your math - your estimate of 35 units is a little high. I know that you're working to infer unit volume from some of our installed base commentary, which we always round. So I think your 35 number is a little high and therefore the ASPs on instruments, your estimates are a little low. I think our ASPs are in line with historical during the first quarter. As I mentioned in my prepared remarks, SPRINT accounted for about 40% of unit placements, which was right at the lower end of what we had previously guided the target of I think 40 to 45. So I think the mix was about in-line. The ASPs were about in line and instrument revenue was 5% up against the guide for flat for the year. So, we feel pretty good overall about instrument revenue for Q1. And in terms of the outlook, I think we're maintaining the flat guidance for the year, but we're obviously happy with the momentum during the first quarter.

[Tom Bailey:]

That I would add to Brad is that, at times, the inferred ASP in any particular quarter might reflect exactly where the system has gone, whether it's into a distributor or through a direct channel. So there might be some modest flux as a result of that that could impact that when you're trying to do the math relative to looking at the installed base that we reported in addition to the other factors that Brad mentioned, but overall, everything is very much in line with what we've experienced in previous quarters. On an ASP basis, we're looking at the various conduits of instrument placements.

[Doug Schenkel:]

Okay. That's really helpful. And sorry for making some mathematical leaps there and those answers are helpful. Maybe one last one, on DSP, where you clearly making tremendous progress. What's the average revenue opportunity associated with each of the 40 TAPs you have in place and ultimately, is the hope that many of these will lead the placements when you move into launch mode of the instrument and I guess finally, is there any notable change in interest in DSPs that you announced that you could use DSP with nextgen sequencing on the back end? Thank you.

[Brad Gray:]

Yes. So I think to answer your first question, of the 40 TAPs we've done, I think the average is value of the order so to speak is somewhere between $50,000 and $100,000. The typical scale for a biopharma company under the program is 20 samples at about $5000 each or $100,000 and the price for an academic is half that at about 20 samples at $2500. So it's somewhere between those two is the average. Now, it will take time to realize that revenue and in fact, our revenue recognition is in time lagging bookings for our technology access program, because we're capacity limited to the small number of prototypes that we have available and we're in a sense oversubscribed. To answer your second question, Doug, yes, we do hope that many of these participants will like what they see under the technology access program and will convert into instrument customers over time and that's really why the reason that we're both continuing our existing efforts on the TAP program and in lifting to help five leading CROs to go out and market the TAP service even more broadly to biopharmaceutical companies that we think could represent great early adopters for the platform. Finally, on your third question, we have seen a meaningful increase in the interest level in digital spatial profiling from having - based on having opened up the platform for NGS read out. If you think about the market opportunity in a closed system, if we had moved forward with the closed system that only read out an nCounter, we would be able to market into the 600 plus nCounter customers that we have out there today or we would have had to convince the customer to acquire both a digital spatial profiling system that something like 295000 plus $250000 for another nCounter system. That would have been a much higher hurdle for adoption. But today having opened it up, we can market into the 15000 next generation sequencing platforms out there and the barrier to entry is much lower for a customer to begin doing spatial genomics. In addition, we're finding that a lot of the same researchers who have enjoyed single cell science in a non-spatial format using droplet based approaches to single cell gene expression from other vendors are thinking about DSP as a secondary step to take interesting samples and interesting situations and see how the single cell science is actually interacting in space. And that is a more basic science research customer than we have traditionally addressed, but one who is very well funded and very enthusiastic about early technology adoption. So I would say that the decision to open up DSP to NGS so far looks like it's going to pay off nicely.

[Operator:]

Our next question comes from Catherine Schulte with Baird.

[Catherine Schulte:]

Thanks for the questions and congrats on the nice quarter. First, I was just wondering how much incremental TAP revenue do you expect these new CRO partnerships will generate in 2018 and was that already contemplated in your prior guidance.

[Tom Bailey:]

We won't be actually recognizing any revenue into the income statement out of the TAP programs. So that is not contemplated as part of the guidance that we've given. It's all based on our traditional product and service revenue. And there are reasons why there are differences between cash that we receive for these programs under DSP and revenue that we book that we won't need - we can get into offline, Catherine if you'd like, but it's - there's some complexities associated with that - with what we can book to revenue and what we have to wait to book for revenue until we either provide the service under the TAP or into next year when we deliver an instrument under the launch of the -

[Brad Gray:]

Yeah. Let me build on what Tom said, I think there's really two things that - let me parse your question to two ways as appropriate. One is, for signing the five CRO collaboration agreements, that was a non-revenue event for us. The signing of those collaborations themselves. That being said, it may deliver TAP services and they drive TAP services under the agreement, we would have an opportunity to recognize revenue for those services over time over the balance of the year. This was contemplated in our guidance we've been working on some of these agreements for quite some time, Catherine, knowing that we were going to make this announcement around the AACR timeframe. So it's based in to guidance.

[Catherine Schulte:]

And then on DSP, any update on commercialization plans in terms of your interest and potentially using a partner there? And if you were to use a partner, is that something you would set up prior to launch or with a plan B to launch it on your own and then add a partner if needed?

[Brad Gray:]

So DSP is a very exciting program and it has captured the interest and imagination of channel partners. We are receiving inbound interest from groups who are interested in servicing the traditional pathology market, servicing kind of the next generation sequencing and single cell markets and groups who are interested in building companion diagnostics on the platform. That being and we're entertaining those discussions and looking to see if there are win-win types of arrangements that we could put in place. That being said, I don't think we need a channel partnership to have a successful product launch. The core market of translational researchers and genomic researchers that we believe will be the early adopters is one that we feel our sales force is well positioned to launch the product into with the opportunity to expand later, expand the channel later post launch. So we're going to continue to evaluate these opportunities, but I don't think we can be specific about whether we will or won't enter one of these channel collaborations or the timing of it at this time, Catherine.

[Catherine Schulte:]

Okay. And then last one for me, appreciate your commentary on neurology and other applications drawing interest. I saw yesterday CBC posted a pre-solicitation for [indiscernible] to do some HPV genotyping, so just curious to get your thoughts on how much non-oncology applications will drive instrument demand going forward.

[Brad Gray:]

So, last year, you may recall oncology drove about 85% of our instrument placements in 2017. So for me, that's a great testament to our leadership in that field, but it shows that we have yet it's happened in a much broader area of science that we could be contributing too. For, me if we were able to increase the percentage of non-oncology instrument sale from 15% to 30% this year, that would be about in line with my expectations and that would be a nice boost to grow. Entering new therapeutic areas like neurology and immunology takes some time. We have to go, build our reputation in those fields as we did in oncology. We think we armed our sales team with great panel products that are well designed and useful, but we have to get the word out and get written in the grant cycles, et cetera. So in this first quarter, with non-oncology applications driving 25% of instrument placements, I feel that's a good start to the year. I'd like to see that increase over the balance of the year if we can. And if it reached 30%, I'd be quite pleased.

[Operator:]

[Operator Instructions] Our next question comes from Tycho Peterson with JPMorgan.

[Tejas Savant:]

This is Tejas on for Tycho. Just wanted to get a sense of the guidance in light of the relatively strong start to the year and what you're assuming here in terms of a budget flush in 2018 in light of the upside in the NIH budget? And then I've a couple of follow-ups.

[Brad Gray:]

Thanks, Tejas. I'll start and then maybe hand it over to Tom to add on top. We're very pleased with the start we had to the year. That being said, Tom really came on board outlined a guidance philosophy that was perhaps more disciplined than we've had in the past. One, that's focused on providing guidance that we're confident we can meet and from time to time beat. And so just one quarter into the year, it's a little early in our view to increase guidance. To your second question about the degree to which we have assumed a budget flush at the end of the year, you'll recall that when we provided guidance, both in 2017 and in 2018, we described that we were not assuming a substantial Q4 budget flush. That is a pattern that sometimes materializes, but can't be counted on to help mid guidance. So we don't have implicit any kind of extraordinary Q4 budget flush. That being said, even in years where there's not a budget flush, it tends to be our strongest quarter of the year, but I don't think we're assuming anything extraordinary.

[Tejas Savant:]

And then in terms of your biopharma collaborations, has there been any change in the manner of your conversations after the mark PDL agnostic data at AACR at all. Every once in a while, we hear about this sort of commercial this incentive to have narrow labels from big pharma. So have those conversations changed at all or are people still very enthusiastic about much more information, signature and other biomarkers.

[Brad Gray:]

We're remaining very strongly engaged with potential containing diagnostic partners on the tumor inflammation signature. And in addition, the IO 360 panel, which contains the tumor inflammation signature has become our fastest growing panel launch in the history of the company and I think that shows that there's still a lot of interest in understanding the mechanisms of immune resistance and what predicts response to these therapies. I will say the success of some of the drug developers in getting broad labels for anti-PD1 therapies has been noticed by everyone in the field and maybe providing less of a focus on that particular indication, but that's been offset by the emergence of second generation IO therapies that are focused on other mechanisms of action or targets besides PD1 and PD-L1. Increasingly, our customers are thinking about what combinations of immunooncology therapies to use. And we think that that is a critical question that can only be addressed with the kind of multiplex assay that can look at distinct areas of biology, much like the nCounter platform enables and the IO 360 panel enables. And so that's where a lot of the discussion is for us today.

[Tejas Savant:]

Got it. And then one final one here from me, Brad, in terms of DSP commercialization, how are you thinking about avoiding this risk of disruption to the core franchise, given that on the last call, you said, you're only going to invest in a few application specialists. So it's largely going to be the same sort of sales reps, because they now have the option to sell a more expensive box with a potentially higher pull through versus your existing lineup and there's an incentive there for them to over prioritize that perhaps.

[Brad Gray:]

I think it's a good question, Tejas. It's one we haven't really grappled with just yet, as the launch is still approximately a year away and I think those types of incentives can be compensated through sales force commission planning and the way that commissions are adjusted to address those. So I think we'll look at the tools we have available to make sure that our sales reps are spending the right balance of energy across the instrument portfolio at the time of launch, but we handle that today, right. We have a spread system that lifts for 149000 we have, a flex system that lists for 265,000. And so to add another instrument to my list of 295, I don't think substantially upsets the apple cart or stretches our sales force. They already deal with instruments at substantially different price points.

[Operator:]

Thank you. I show on further questions in queue. So I'd like to turn the conference back over to Mr. Farrell for closing remarks.

[Doug Farrell:]

Thanks to everybody for joining us today. The transcript should be up in about 90 minutes or so. If you did miss any portion of the call, domestic callers please use the number 888-793-9492. International callers please dial 734-385-2643. The conference ID for the same is both, that is 6188428. With that, thank you again for joining us and have a great day.

[Operator:]

Thank you. Ladies and gentlemen, that does conclude today's conference. Thank you very much for your participation. You may all disconnect. Have a wonderful day.