NanoString Technologies, Inc.
Q1 2016 Earnings Call Transcript

Published: 6 May 2016

[Operator:]

Good day, ladies and gentlemen, and welcome to the NanoString 2016 First Quarter Financial Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Mark Klausner. You may begin.

[Mark Klausner:]

Thank you. On the call with me today is Brad Gray, President and CEO; and Jim Johnson, CFO. Earlier today, NanoString released financial results for the first quarter ended March 31, 2016, and a copy of the press release can be found on the company’s website at NanoString.com. During this call, we will make a number 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, interactions with third-party payers, and the timing and outcome of any related reimbursement decisions, our strategic focus and objectives, and the development, status, and anticipated success of recent and other planned product offerings. Forward-looking statements are subject to numerous risks and uncertainties, many of which are beyond our control, including the risks and uncertainties described from time to time in our SEC filings. Our results may differ materially from those projected on today’s call. We undertake no obligation to update publicly any forward-looking statement. With that, I’d like to turn the call over to Brad.

[Brad Gray:]

Thanks, Mark. Good afternoon and thank you for joining us today. Over the past several months, we have continued to strengthen our leadership in precision oncology, with significant progress towards our strategic goals and have achieved a string of critical milestones across many dimensions of our business. Let me start with a few highlights. Our customers recently published their 1,000 peer-reviewed paper using nCounter technology. On the life science side of our business, we unveiled an expanded portfolio of 3D Biology assays that allow researchers to simultaneously analyze DNA, RNA and proteins. In parallel, we presented proof-of-concept data for our Hyb & Seq and digital IHC programs, demonstrating the untapped potential of our platform. On the diagnostics side of our business, we recently achieved Medicare coverage for Prosigna in all 50 states. Finally, we executed two major biopharma collaborations, which provided substantial cash infusion, making Q1 the first quarter of positive operating cash flow in the company’s history. We are proud of these achievements and optimistic about our continued growth. Total revenue for the first quarter was $14.7 million, an increase of 27% from the prior year. Our total revenue was above the midpoint of our guidance range of $14 million to $15.2 million in revenue for the quarter, though the mix was different from what we had anticipated as strong collaboration revenue offset lower than expected product and service revenue. Product and service revenue was $12.1 million for the quarter, below our guidance of $13 million to $14 million. The shortfall in product and service revenue was driven by lower than expected instrument revenue. While the mix of MAX, FLEX and SPRINT instruments was in line with our expectations, the total number of units sold was down year on year. Although we ended the quarter with a strong sales funnel, a number of Q1 instrument opportunities required more time than anticipated to close and the orders slipped beyond the end of the quarter. Our commercial team has been working tirelessly to close instrument opportunities that slipped past the end of Q1 to validate the quality and status of the Q2 sales funnel and to improve our funnel management prophecies for the future. Total demand for our instruments remains strong and we have seen significant improvement in the pace of instrument orders in April, making it the strongest first month of any quarter in company history. We expect instrument revenue growth to normalize over the balance of the year and we reiterate our guidance for total revenue of $86 million to $90 million and product and service revenue of $70 million to $75 million in 2016. During the quarter, we expanded the installed base to over 370 nCounter systems worldwide, while achieving annualized total consumable pull through of just under $100,000 per system. The life sciences consumable revenue grew 31% year on year and was strong across all regions and customer segments. Demand for panel products remained high, accounting for 45% of our consumable revenue. Biopharma customers and their CROs contributed approximately 40% of consumable revenue, growing about 80% year on year. Meanwhile, Prosigna revenue doubled year on year, while our new diagnostic partnerships with Merck and Medivation/Astellas drove our collaboration revenue to more than triple. Before I provide an update on our strategic objectives, I’d like to share some details from what was a very exciting AACR meeting held in New Orleans during early April. Because of our focus on cancer, this is an important meeting for the company and each year its significance grows. This year, our customers presented at least 35 different studies powered by nCounter technology, up 35% from a year ago. Our focus on immunooncology combined with our unique 3D Biology platform drove customer interest into the nCounter technology to record. The amount of huge traffic was unprecedented, with a number of customer leads captured increasing over 50% compared to 2015. In addition, we held dozens of private meetings with biopharmaceutical companies interested in accessing our 3D Biology, digital IHC and companion diagnostic capabilities. Overall, this was the most successful scientific meeting in company history and was a strong indicator about our future growth potential and the impact in the field on oncology. Now, I’d like to spend some time covering the progress we made on the four strategic objectives we identified for 2016. Our first strategic objective is to penetrate our expanded market opportunity by building an install base of nCounter SPRINT profilers. This SPRINT system delivers high-performance with a footprint and price point suited to the needs of individual researchers. In the quarter, we sold eight SPRINT units, accounting for just under half of our instrument placements. SPRINT is successfully expanding our reach with over 70% of SPRINT buyers to date representing new customers. In line with our product positioning and launch strategy, the majority of SPRINT customers today are individual academic researchers who focus on oncology. SPRINT is also appealing to smaller, newly public and privately funded biopharma companies who find it an affordable way to access nCounter for biomarker research. In addition, the price point for SPRINT is opening new markets, evidenced by a disproportionate number of SPRINT going to Asia, where SPRINT sales helped drive our year on year revenue growth in that region to about 50% during Q1. Finally, despite the compelling [super form of] SPRINT, we have not seen a major pattern of customer scaling down nCounter MAX orders in favor of SPRINT. As expected, the fraction of instrument revenue driven by SPRINT continued to increase during Q1 and SPRINT now represents over 40% of the units in our instrument sales funnel. We are aggressively building a funnel of SPRINT opportunities, focusing on individual researchers through awareness campaigns and seminars. As a result, we continue to expect that SPRINT sales will account for approximately half of the systems sold this year. Our second strategic objective for 2016 is to expand our suite of 3D Biology products. Our 3D Biology technology is a unique application that allows measurement of DNA, RNA and proteins simultaneously on any nCounter system from a single sample. We believe the 3D Biology products will enable researchers to make novel observations about cancer biology while maximizing the data generated from the valuable samples. In September of last year, we launched our first product in the 3D Biology family, the RNA protein PanCancer immune profiling panel. This panel is now being used by over 20 different customers, 70% of whom are researchers at biopharma companies. And even with this limited product offering, 3D Biology has helped expand our customer base, motivating a meaningful number of instrument purchases. At AACR in April, we introduced nCounter Vantage, a broader portfolio of 3D Biology assays that can be mixed and matched, creating many new ways for cancer researchers to apply our 3D Biology technology to gain a deeper view of cancer and immune biology. As part of the introduction, we launched two new assays that enable highly multiplexed analysis of RNA transcripts from key disease-driving gene fusions. The nCounter Vantage lung gene fusion panel and leukemia gene fusion panel are both designed to be combined with other Vantage protein and DNA panels. [indiscernible] analysis, we showcased two new panels which are initially being made available under product evaluation programs. The first panel is focused on immunooncology research, targeting 30 proteins involved in immune cell signaling and it’s designed to be combined with our 770 gene PanCancer immune profiling panel. The second panel focuses on proteins that drive solid tumor growth. It includes the capabilities of detecting protein phosphorylation that indicates pathway activation and it’s designed to be combined with our 770 gene PanCancer pathway panel. Finally, for the first time ever, nCounter technology can be used for the analysis of single nucleotide variations in DNA. We recently introduced the first of three new nCounter Vantage DNA panels, which are being developed to profile up to 192 single nucleotide variations, from as little as 5 nanograms of DNA. The first panel focuses on mutations that are important in a variety of solid tumors and will be made available under a product evaluation program beginning in Q3. We believe that these powerful new Vantage assays and our affordable nCounter SPRINT profilers together from a potent combination which appeals to many new customers expanding our reach and impact. Our third strategic objective for 2016 is to extend our leadership in the development and commercialization of molecular diagnostics. We expect to deliver this objective both by continuing to grow the market for our Prosigna breast cancer assay and by building a pipeline of companion diagnostic assays in collaboration with biopharma companies. We’ve had a number of wins for Prosigna during the last several months. In February, the ASCO clinical practice guidelines were updated to recommend use of Prosigna for guiding treatment decisions in early-stage breast cancer patients. Importantly, Prosigna and Oncotype DX were the only two tests to receive a strong recommendation together with a high rating of evidence quality. We believe that this will help drive further reimbursement wins with US insurers. In March, Prosigna received a favorable final local coverage determination by Noridian, providing Medicare coverage in 13 states, effective as of May 3. In April, Prosigna received a favorable final local coverage decision from Novitas, which covers Medicare patients in Texas and 10 other states. As a result, Prosigna now have Medicare coverage in all 50 states across the country, representing a great success for our reimbursement team and an exciting milestone for the company. We’re also making progress on reimbursement outside the US. In April, we learned that Prosigna will be covered by the French national health care system. This government reimbursement is incremental to the previously announced win of a tender by a major French hospital system. Shifting gears to our pipeline of companion diagnostic assays, the two major collaborations we announced earlier this year are off to a great start. In our collaboration with Medivation and Astellas, we’re working to translate a novel gene expression algorithm into a potential Prosigna-based companion diagnostic to identify patients with triple negative breast cancer, who will respond to the drug enzalutamide. The new algorithm which was initially developed by Medivation using RNA-Seq has now been successfully transferred to the nCounter platform. In addition, the FDA has determined that this modified Prosigna test can be useful in rolling the phase 3 study, meeting a major milestone earlier than we had anticipated and qualifying us to receive a $5 million milestone payment during the second quarter. Under our expanded collaboration with Merck, we’re working to develop, seek regulatory approval for and subsequently commercialize a diagnostic assay to identify patients with multiple types of solid tumors, who respond to the drug Keytruda. In recent months, we have successfully locked down the algorithm for the test and have been shipping the assay kits to clinical labs in preparation for processing tissue samples collected during clinical trials. Separately, we have accessed more immunooncology content through our recently announced collaboration with HalioDx, under which we will jointly develop gene expression assays for assessing response to immunotherapies. These assays originate from the pioneering work of Dr. Jérôme Galon, a leading researcher in cancer immunology, and expand our leadership position in immunooncology. In the future, we plan to make the researchers-only version to these assays available to biopharma companies for use on pilot studies, which we believe could open doors for new companion diagnostic collaborations. Meanwhile, we had continued to leverage our lymphoma and breast cancer assays into additional pilot studies with potential biopharma partners and the total to date has grown to 26 studies with 13 companies. As a result of all these successes and progress, we believe that our credibility as a companion diagnostic partner continues to grow, setting the stage for additional biopharma collaborations in the future. Our fourth strategic objective for the year is to expand our market, with new applications, using our optical barcoding technology, specifically through single molecule sequencing and multiplex digital immunohistochemistry, or digital IHC. We recently presented proof-of-concept data from digital IHC at AACR. Using a prototype slide processing instrument together with our existing nCounter system, we were able to demonstrate simultaneous profiling of 30 different protein targets in spatial context across a single slide of FFPE tissue. The technology demonstrated a dynamic range exceeding five logs and neared single-cell resolution. Customers’ interest in digital IHC have been even stronger than expected. During the AACR meeting, dozens of interested research customers visited our poster and we had approximately 130 attendees on our standing-room-only seminar. In addition, we held numerous private meetings with biopharma companies eager to expand a number of proteins that can be profiled in precious tissue samples. We believe that there is a substantial latent demand for technology that can profile multiple proteins on a single FFPE. We intend to commercialize digital IHC as an instrument and assay kit that could be used for slide preparation ahead of processing by one of our existing nCounter systems. While the commercial digital IHC instrument is still several years away, look for more proof-of-concept at a scientific meeting later this year. During the first quarter, we also presented the first proof-of-concept data for Hyb & Seq at the February AGBC meeting. Hyb & Seq is a novel, massively parallel, single-molecule sequencing chemistry with a potential to enable a workflow much simpler and faster than currently available sequencing methods. We see the greatest opportunity in clinical applications where we believe it may have critical advantages for running targeted cancer panels. Over the last several months, our Hyb & Seq program has continued to advance. This effort is focused on increasing the number of sequencing cycles performed and achieving uniform hybridization across the targets. We look forward to presenting our progress publicly at a scientific meeting later in the year. Overall, we have grown incrementally positive about the commercial opportunities for both digital IHC and Hyb & Seq and believe that they have the potential to fuel growth in our business for many years to come. Now, I’d like to turn the call over to Jim to review our first quarter financial results and guidance.

[James Johnson:]

Thanks, Brad. Total revenue for the quarter was $14.7 million, up 27% versus the first quarter of 2015. Total product and service revenue was $12.1 million, 12% higher year over year. Foreign exchange rate fluctuations reduced the growth in total product and service revenue by less than 1 percentage point. Instrument revenue for the quarter was $3.4 million, 22% lower than in the first quarter of 2015. The decline was driven by both volume and mix, as we sold fewer systems in total and the addition of nCounter SPRINT lowered overall average selling price. SPRINT represented just under half of systems sold during the quarter. Total consumable pull through for the quarter was $8 million, up 35% year over year. The pull through was slightly below $100,000 per system on an annualized basis, which reflects seasonality similar to the first quarter of last year and it’s consistent with our quarterly guidance for the current year. Life sciences consumable revenue, excluding Prosigna, was $7.2 million, up 31% year over year and was driven by particularly strong demand from our biopharma customers. Prosigna IVD kit revenue was $754,000 for the quarter, 98% higher year over year, with ex-US markets continuing to generate majority of sales. We recorded $2.6 million of collaboration revenue for the quarter, compared to $761,000 in the first quarter of 2015. The increase in revenue resulted from our new collaborations with Merck and with Medivation and Astellas. The first quarter collaboration revenue was above our expectations due to a higher than anticipated percentage of completion for these new collaborations. Gross margin on product and service revenue for the quarter was 52%, up from 51% reported for the first quarter of last year, largely due to product mix. R&D expense was $7.2 million for the quarter, up 22% over the first quarter of the prior year. The increase was largely driven by increased investment in new product development, including 3D Biology applications, our Hyb & Seq sequencing chemistry and digital IHC, as well as work performed under our new companion diagnostic collaborations. SG&A expense was up 6% year over year to $14.9 million for the quarter, and this increase reflects costs associated with added staffing and professional fees. Stock based compensation expense was $1.9 million, compared to $1.2 million for the first quarter of 2015. Our GAAP net loss decreased to $14.6 million or $0.74 per share from $14.9 million or $0.81 per share for the first quarter of last year. We strengthened our balance sheet during the quarter exiting Q1 with approximately $57 million in cash and investments, up from $49 million at the end of 2015. This positive operating cash flow was driven by the receipt of $18 million in technology access fees from our new collaborations, offset by other operating cash usage. So now I’ll turn to our 2016 financial guidance. We reiterate our guidance for total revenue of $86 million to $90 million for the year, assuming constant currency which is an increase of 37% to 44% over 2015. This includes expected collaboration revenue of $15 million. We continue to expect total product and service revenue of $71 million to $75 million, including Prosigna revenues of approximately $5 million. For the second quarter of 2016, we expect total revenue of $18.5 million to $20.5 million, including product and service revenue of $15.5 million to $17 million and collaboration revenue in the range of $3 million to $3.5 million. Collaboration revenue is higher than our previous expectations due to the accelerated achievement of a $5 million milestone payment in April under our collaboration with Medivation and Astellas. For gross margin on product and service revenue for the full year, we expect to be in the range of 54% to 55%, with collaboration revenue excluded from the calculation. For operating expenses, we continue to expect a total of $94 million to $99 million for the year, including approximately $8 million to $9 million of stock-based compensation expense. Our GAAP operating loss for the year is expected to be in the range of $40 million to $43 million and we continue to expect interest and other expense to be between $5 million and $5.5 million for the year. Our expected GAAP net loss for the year is unchanged at $45 million to $48 million or $2.30 to $2.45 per share. We expect total capital expenditures of between $4 million and $5 million for the year, net of lease-hold improvement funding from our landlord. And from a balance sheet perspective, we continue to expect the collaboration through Medivation and Astellas and Merck together will bring in $40 million to $45 million of cash for the full year 2016, which should put us very close to net cash flow breakeven for the year. So with that, I’ll turn it back over to Brad to wrap up.

[Brad Gray:]

Thanks, Jim. In summary, we’re building a diversified business with multiple growth drivers and an attractive mix of near and long term opportunities. In Q1, we delivered strong revenue growth, despite the shortfall in instrument sales. We are confident that we can quickly return to our high standards of sales execution and deliver expected growth along all dimensions of our business over the balance of the year. We’re well positioned to capture near term growth opportunities created by SPRINT, 3D Biology and our leadership in immunooncology, as well as longer term opportunities such as growing our diagnostics business through additional biopharma collaborations and expanding our powerful barcoding chemistry in new markets. With so many growth drivers and catalysts, we are extremely optimistic about the future. I would now like to open the line for your questions.

[Operator:]

[Operator Instructions] Our first question comes from the line of Doug Schenkel, Cowen and Company.

[Doug Schenkel:]

Brad, I appreciate all the detail on the strength of instrument demand in April. With that said, by our math, it seems like you came up light of instrument revenue expectations by something in the ballpark of $1.5 million. Was that all timing? And if so, could you at least help us a little bit more than you already have by telling us something like the majority of that miss has already been recaptured in Q2, we just want to make sure we can isolate this purely to a timing issue versus something else.

[Brad Gray:]

We obviously are extremely disappointed in the instrument performance in Q1. We’ve spent a lot over the last five weeks studying it and looking to rectify it. [At the risk of] going into too much detail, let me share with you kind of what our understanding of the root cause for that, that instrument trend and shortfall was. Our confidence is high both because we’ve had a good April and because we think we understand the issue. We’ve isolated two root causes to what happened in Q1. First, during Q4, our sales reps did a poor job of balancing their allocation of time between closing business and cultivating new opportunities that were only in the sales cycle. And then second, at the same time, they were overly optimistic about how quickly Q1 opportunities would close, or said differently, they underestimated the hurdles in the purchasing process that it still need to get through. And so what happened over the course of the quarter is that while we were constantly monitoring the sales funnel on our CRM system, things looked good all the way through mid-March, at which point in time instrument opportunity started to be reclassified as Q2 instrument opportunities. And that’s not the whole variety of reasons why that happened, but generally speaking, these were things like decision makers being unreachable due to vacation or reschedule of final approval meetings or other curve balls in the purchasing process. And so if we had a more mature instruments funnel, we would had more time to rectify those situations, but instead they slipped. And we have worked really hard over the last five weeks to close a number of those and we’ve been successful in closing a number of those. That being said, we don’t expect the entire shortfall to be made up in Q2. We expect that it will take several quarters before the full shortfall experienced in Q1 is made up in our instrument numbers.

[Doug Schenkel:]

Maybe to push a little further on that, you know recognizing – there’s really no question that NanoString has been making a ton of progress, if you look at the new publications, expanded reimbursement coverage in certain instances, new product launches, new features, clearly the company is doing a good job in innovating and moving your product offerings forward. I think again, not to pile on, but that’s why it’s so surprising that you could have an instrument miss even if it is timing related. Our model suggests you shipped about 17 instruments in the quarter. There’s some [error bars] around that, but we think we’re in the right neighborhood based on the data that’s out there in your prepared remarks. When you think about that number of placements and really the ratio of placements to the size of your sales, infrastructure really just abiding placements into sales people, it just doesn’t seem on the surface like an awe inspiring level of productivity for a sales force that has grown. It is getting more mature and seemingly should have more arrows in the quiver to use in selling nCounters. Recognizing what you talked about in terms of your disappointment about Q1, in general, are you happy with how the efficiency of the sales force is evolving? And if not, what steps are you taking more specifically to improve the productivity, not just to address this timing issue, but to really improve upon that ratio I’m referring to over the coming quarters?

[Brad Gray:]

In general, with the exception of the first quarter, I have been very pleased with the performance of our sales organization. They’ve delivered, since we became a public company, I think, 10 consecutive quarters of meeting expectation. That being said, there were some hard lessons that we learned in the first quarter and nobody here is pleased with the productivity that we saw during that quarter. I’d say as an organization we have become extremely skilled at closing instrument sales that are late in the sales process. But we have not yet mastered the art of balancing that closing effort with the lead generation and in the early stage cultivation effort. And that was really I think the key lesson of the first quarter. In addition, and I think obviously at a leadership level here, our diligence on the funnel needs to be stronger and we’ve spent a lot of time in the last few weeks more carefully diligencing the status of instruments in the funnel so that they are not overly optimistically classified. So those are the near term things that we’re doing to improve productivity. But there’s also some long term things that we’re doing and we’re getting help from the outside on some of these. First, we need to be better at defining the process of how we pull today for early stage instrument opportunities. We have so many more of them now with nCounter SPRINT that the old processes we used when we were a smaller company focused on the niche aren’t going to scale. And so to kick start this, we’ve created a tax force that includes people from sales and marketing to focus on moving these early stage opportunities, many of them SPRINT, and people who were just beginning to know and making sure that they are being managed all the way through the sales cycle even from the beginning to the close. And then second, we’re making some changes to the way we use our CRM system and our own forecasting procedures to make sure that we are very carefully categorizing even the early stage opportunities in the funnel. So I’m with you, Doug, and I’m disappointed in the productivity that we saw in the first quarter. We are going to have to focus on getting ourselves better, but I feel confident that we can.

[Doug Schenkel:]

And one last one, Brad and Jim, and a more positive one, the collaboration revenue in the quarter was clearly a big positive and better than we expected. I apologize if I missed this in the prepared remarks, but is that really more timing related or is there a chance that there actually could be an upward bias absent other announcements to your guidance for collaboration for the year, collaboration revenue for the year?

[James Johnson:]

At this point, we believe that it’s mainly just timing and that more of the revenue is being front end loaded than we’d originally anticipated. We still believe that $15 million is right number for the year based on what we can see today, but obviously things can change. But we believe that that’s the right place to be based on what we know right now. So it’s really just a case of recognizing revenue more quickly than we anticipated.

[Operator:]

Our next question comes from Steve Beuchaw with Morgan Stanley.

[UnidentifiedAnalyst:]

This is [Liza] on for Steve. Congrats on the Prosigna coverage. I was hoping maybe you could walk us through some of the puts and takes built into the 2016 guidance, and maybe provide an update on conversation with payers going forward.

[Brad Gray:]

I’ll take the conversations with payers going forward. Prosigna has really gained tremendous momentum from the perspective of guidelines and reimbursement. The addition of ASCO guidelines earlier this year, really it’s a fifth global guideline in a row I believe that had included Prosigna at very high levels of evidence, really has helped those last Medicare carriers who are holding out get across the line. In addition, it’s resonating, we think, with the private payers though those conversations take longer and they are a lot harder to predict exactly when they’re going to convert to positive medical policies on Prosigna. But overall, we’re really feeling good about our ability to continue to drive private payer coverage. I guess on your second question on guidance, I didn’t – I don’t know that I’ve quite understood the question, maybe you can restate that for us.

[Unidentified Analyst:]

Sure. Just kind of wondering if there are puts and takes to the $5 million and what could drive it above or below as we think about this.

[Brad Gray:]

I think our $5 million in Prosigna guidance has assumed that we would be – continue to be successful in getting coverage. So I do not think that, although we’re tremendously excited about getting to the milestone of a full coverage geographically in Medicare and it’s a huge win for our team, it’s no wonder that we have seen coming and planned for. So I do not think – and that’s why we’re not increasing Prosigna guidance. I’d be reluctant as I have said many times in the past to have people think about Prosigna growth is being driven by an inflection. It’s going to be steady growth here in the United States and that’s what’s implicit in the guidance.

[Unidentified Analyst:]

And just thinking through if you could provide some additional color on the HalioDx joint development, anything on potential timelines and how we should think about this collaboration relative to the other collaborations that you have with the biopharma companies?

[Brad Gray:]

HalioDx collaboration is fundamentally different than the ones we have with biopharma companies like Merck and Medivation and Astellas. In those instances, the development of a drug is paying us to jointly develop a diagnostic with their drug. In this instance, a small company that has identified content with the help of really a leading immunooncology researcher has been looking for a platform on which to put that content. And nCounter has emerged as a leading platform not just for gene expression signatures, but especially in the field of immunooncology. So it’s a really natural fit. And so what we’re doing there is we’re going to take that the gene signatures that they have discovered in which some biopharmaceutical companies have already expressed some interest in learning more about and we’re going to develop kits. And our hope obviously is that this biology is powerful that we find that it is useful in making decisions about who gets what drugs. And coming out this, with this content, we’ll be in a position, an even stronger position than we have been in the past to win new companion diagnostic collaborations. But that’s going to take time and the process is going to look a lot like it does today with our lymphoma assay and our breast cancer assay, where we put those tests in the hands of pharma companies to where we call a pilot study program, we wait for them to get positive results and then based on the conviction that we all have that that’s a predictive test we move forward. So it’ll take some time to play out, but we’re optimistic about it and we think it’s just another way that NanoString is becoming – positioned as the leading platform in immunooncology.

[Operator:]

Our next question comes from Jeff Elliott with Baird.

[Jeffrey Elliott:]

Brad, first question on these collaborations and I think the answer is no, but I guess the question is are you seeing any change in demand either from the rumors that Medivation can be acquired or that when you look there’s been several press reports about Merck perhaps trailing Bayer, given that Bayer in mass market whereas Merck has gone more on the precision medicine round and doesn’t seem to be working quite as well. I mean, are you seeing any change in demand from these partners or more broadly in your conversations in terms of precision medicine?

[Brad Gray:]

I would say no, we’re not seeing a reduction in demand by any stretch from either of our partners. In fact, I think these collaborations are off to such a rapid and positive start that those relationships have never been stronger. With respect to Medivation, our collaboration agreement, of course, contemplates changes in control for Medivation and regardless of who ends up owning Medivation, we’ll still have a partner. We would expect that expanding enzalutamide, really the core asset of Medivation in that regardless of who acquires that company, if anyone does, that they would continue the development programs. And so we don’t feel at risk at all related to a change of control at Medivation. And by the way, most of the companies who are rumored to be potential acquirers are already customers who know our technology well and we have often relationships. So that’s on the Medivation front. With respect to Merck and I know there has been kind of press coverage and commentary about the differentiated approach that Merck has taken differently than what Bristol-Myers Squibb has. I think increasingly people in the field believe that we’re going to have to select which patients get these powerful new therapies. And that’s going to be important both from an efficacy standpoint because we want to, of course, see if people are going to respond, but it’s also going to be absolutely necessary from a health economic standpoint where because [indiscernible] combination, the cost can skyrocket out of control very quickly if we are not thoughtful about to get to them. And so I believe that’s the vision that Merck shares and I think that our collaboration with Merck around Keytruda is a great start to what’s happening in the immunooncology field. But I think there’s going to be more demand over time, not less.

[Jeffrey Elliott:]

And then two on Prosigna, I think just in light of all the progress you’ve had it with the MAX and I guess is getting tracked what the guidelines, I guess, could you revisit how we should think about ASP, is it still kind of the $1,500 to $2,000 range? And then in light of getting 50 state coverage and the guidelines, it really seems like you got some momentum. But then when you look at the mix of revenue in the first quarter, it’s still largely international, I guess, is easer, anything that you’re waiting for specifically, is it more like you said before just kind of a gradual build and getting awareness in just adoption built overtime, I guess is there something specifically we should be thinking about for you to get some milestone to hit before that revenue would start to ramp?

[James Johnson:]

So look, first on the question of ASPs, our ASPs for Prosigna kits have maintained nicely in that $1,500 to $2,000 a kit range. And I don’t have any reason to believe that it’s going to move outside that range at this stage. As a reminder, the clinical lab fee schedule for Medicare and I believe this is the case for all of the different carriers now, we’re listed really at parity with Oncotype DX at $3,420 per test and that’s between $1,500 and $2,000 kit price. That leaves plenty of margin for the lab to cover their cost. And so we don’t feel pricing pressure here in the US. When you look at the global blended average, we’re still in that range. So from a geographic mix perspective, things have been growing in both our markets, 60% or so of Prosigna kit sales have come from the international, that’s true before, it’s also true in the first quarter. We think that will start to shift and that the US is going to start to grow even faster with some of these Medicare coverage decisions. But as a reminder, as you look at the first quarter, those decisions will not affect us during the first quarter, right. So Noridian did not become effective until May 3. The [indiscernible] decision came in the April timeframe. So remember demand is going to lag reimbursement decisions by one if not more quarters. And so continue to look for a steady ramp of Prosigna, not something that’s a huge inflection point.

[Operator:]

Our next question comes from the line of Tycho Peterson with J.P. Morgan.

[Tycho Peterson:]

A lot of my questions have been answered. But I want to go back to the instrument softness, Brad, I guess for starters, any geographic color, just given that Europe is in a pressure point for some of your competitors? And secondly, I guess in terms of leading indicators, can you maybe just talk a little bit about – do you have a sense of to what degree SPRINT is being [indiscernible] just trying to understand with the budget being up a little bit if you’re going to see a bit of a tailwind here on the academic side?

[James Johnson:]

There was a geographic difference with respect to the shortfall. As I mentioned in my prepared remarks, a highlight for us during the quarter was on growth overall of Asia Pacific. We really saw SPRINT at – well, it’s coming at the right price and performance for that market and that helped us drive a good bit of growth. So instruments were strong in Asia Pacific. I’d say they were moderate in the US where we had mixed performance. The slippage was – and some slipping in the US. The slippage was most in Europe and I don’t attribute that necessarily to sort of a market demand phenomenon. But I would attribute it to what I’ll call the differences of the sales process in Europe. In Europe, if the bureaucracy that also often exists in the academic customers and often the requirements for government tenders for things to really have to go out to tender, so multiple parties can bid on them. That’s part of the process. I would say the sales processes have a larger tendency to drag on in Europe than they would in North America. It’s a slower sales cycle with more potential for kind of late-breaking curveball. And so as a result we did see more slippage in EMEA, in Europe than we had in North America. I’m sorry, Tycho, remind me of your second.

[Tycho Peterson:]

On just NIH dynamics and are you being – is there a good leading indicator?

[Brad Gray:]

So that’s right. So SPRINT became – the research world came to know about SPRINT really for the first time in mid-July of last year. And so if you look at the NIH front, NIH granting cycles, really the first wave of NIH grants into which SPRINT could have been written will be coming out in the July timeframe. So we do think that that will be helpful for continuing to grow SPRINT as that product is geared towards the academic market.

[Tycho Peterson:]

And then I guess just lastly, any milestones we can be thinking about in terms of some of the pipeline stuff, I mean you touched on HalioDx earlier, but I’m thinking about Hyb & Seq for starters, is there anything and then also the IHC technology, if there’s anything we should see backing over the next year?

[Brad Gray:]

So with both of those technologies, those pipeline programs, we hope to show more data and more progress in academic meetings or scientific meetings rather late in the year. I think the major ones where we have exhibited and shown data in the past are American Society of Human Genetics meeting in October, the AMP meeting in November and then the SITC meeting, which is the Society for Immunotherapy of Cancer meeting also in November. So look for more proof-of-concept data, the next stage of data out of both of those programs to come forward at those meetings. With Hyb & Seq, we’re continuing to focus on the chemistry, running more cycles of sequencing, demonstrating that these novel drugs that are the heart of our universal sequencing reagent behave nicely at all different types of DNA sequence. And then, of course, that we have a very simple sample prep capability that’s designed to be really as close as possible to the very low hands on time experience of traditional nCounter. So those are the areas of focus for us and probably what we’ll see next. And then on digital IHC, we’ve shown so far basically 30 FLEX IHC, we’ve shown some of the dynamics of that. Look for us to kind of more carefully characterize the sensitivity to the limits of detection and so forth for that platform. And that’s where we’re going next.

[Tycho Peterson:]

And actually one last one on the partnership front, with the biopharma partners, is there momentum building here? I’m just trying to understand to get success here are you kind of getting a lot of interest in additional partnerships based on what you’ve done with Celgene and Merck and Medivation and what’s your bandwidth...

[Brad Gray:]

I would say that to get success, every time that we’ve done another partnership with – these are very well respected companies. They’re very – I think all three projected to be – three of the drugs that we are associated with are projected to be three of the top 10 cancer drugs over the next few years. So they’re very high profile programs and every time we do that, for the next biopharma company who is considering working on our platform, they feel all the better about it because they know we went through a very rigorous due diligence process with these pharma companies. And then furthermore, when we execute in the way they have, which I’m very proud of, just a matter of months after instituting some of these programs, we’re delivering assays, we’re getting through FDA, non-significant risk determinations, we’re getting very quickly to the start of the Phase 3 studies which is the key rate-limiting step to the drug companies. As we do that and demonstrate our capabilities, I think our credibility grows and that stimulates to me. So I have really never been more optimistic about our ability to continue to expand this line of business. That being said, as always, it’s hard to predict exactly when these things happen and so we will continue, for now, to exclude incremental partnerships from any kind of guidance.

[Operator:]

Our next question comes from Dane Leone from BTIG.

[Dane Leone:]

Maybe I heard this wrong, but I thought you said you had a $5 million payment triggered from Medivation in the second quarter?

[Brad Gray:]

That’s correct.

[Dane Leone:]

But you’re guiding for $3 million, $3.5 million with some of that pre-recognized or something like that?

[Brad Gray:]

As a reminder, the revenue recognition always lags the receipt of cash in the way that we account for our deals. And the $3 million to $3.5 million in revenue guidance does include the assumed receipt of the Medivation milestone.

[James Johnson:]

Maybe just to add to that, essentially everything that we’re receiving either upfront or as milestones or as R&D funding gets pulled and part of it gets deferred and part of it gets recognized as revenue based on the percentage of completion of the project. So essentially a good part of that $5 million is going to end up sitting on our balance sheet for a while as deferred revenue.

[Dane Leone:]

And I think people are still trying to figure out the guidance in relation to the instrument revenue number in the first quarter. So is there any way you could break out what your expectation is for instrument revenue specifically in the second quarter?

[Brad Gray:]

You know Dane, we don’t provide guidance at any further level of granularity than we have. I mean, I think what I can – I may have said already, but I’ll say it probably more clearly now. We expect to make up some of the lost ground in the second quarter, but not all of that. And if you just look at the difference between $12.1 million that we delivered and the $13 million to $14 million we had in our product and service revenue guidance, you come to basically $900,000, almost a couple of million in shortfall. We [indiscernible] shortfall to instruments. We will make up some of that ground in the current quarter, but we will not make it all out up. And as a result, look for us to normalize our instrument revenue growth over the balance of the year.

[Dane Leone:]

The way it’s just kind of flowing through people’s models, it still seems like without the change in guidance and adding in some of the other factors on 2Q, it still seems like that you’re expecting kind of pretty low levels of year on year growth in the instrument category, is that a function of you’re still waiting for that funnel to build and like have a much heavier, I guess, second half, is that the way you’re kind of thinking about things?

[Brad Gray:]

I don’t think that I would describe the growth that we’re anticipating in instrument revenue in the second quarter as minimal. I would describe it as normalizing. So our growth rates – I think they were implicit in our annual guidance.

[Dane Leone:]

And the second question that people seem to still be picking on here is this is the first quarter where Prosigna revenue did not grow sequentially. Are there any – I know you guys unlocked some additional markets during the first weeks of the second quarter, in the second quarter here, they will kick in in the back half, but just in terms of what had been unlocked in the back half of 2015, I think there was an expectation to continue to see that sequential growth. Is there any commentary you can provide in terms of what you saw in the first quarter and I guess some people are also extrapolating that a strong quarter for genomic health or maybe they’ve refocused competitive efforts. I guess any insight you can provide would definitely be helpful right now.

[Brad Gray:]

I guess I’d say Prosigna is pretty small numbers and reasonably lumpy. So I don’t think people should extrapolate too much from the trend sequentially from Q4 to Q1. I mean it was a doubling year on year, which is exactly what our guidance is, which is from $2.5 million to $5 million this year, so it’s consistent with our overall guided growth rate. It is a sequential drop from Q4 to Q1, but we regularly have seen that in the past in almost aspect of our business. So I would call that standard seasonality.

[Operator:]

Our next question comes from Paul Knight of Janney Montgomery.

[Paul Knight:]

The question I think regarding this instrument uptake, how much of this do you think is from the lower ASP units you’re rolling out? Is it customers laying on that, is your salespeople spending time on a lower ASP unit, what’s your color on that?

[Brad Gray:]

We obviously look closely at that. We wanted to make sure that the SPRINT launch wasn’t in some way cannibalizing our overall instruments and causing instrument units not to grow as a result. We do not believe that’s what it is. And I think the thing that’s given us confidence in that is, one, I think the instrument mix in Q1 was consistent with what we expected it to be, which was just under 50% of SPRINT, which is what we expected to be for the year and SPRINT was up sequentially in terms of the percentage of instruments that represent it, which you would expect at this stage of a launch. So I’d say that’s growing all in the way that we expected. I’ll also say the nature of the instruments that slipped from Q1 to Q2 was also representative of the mix that we would expect. So there was no mix phenomenon either in what we closed or what we deem to have slipped from Q1 to Q2. So I’ll say that we don’t think that that’s an issue. Back to the earlier execution point and Jim and the team and I, we take tremendous pride in our ability to execute. And so we’re focused on getting it back on track. One of the things we are thinking about is how to arm our sales organization, not – to be able to capture the SPRINT opportunity both in terms of the mix of people we have in inside sales versus field based, and the processes they use, it’s about who does what to generate leads early in the process versus close them late. And so that’s something that we’re studying carefully. And we may – we will continue to of course improve the process and we may have all of the mix over time to fully capture the opportunity created by SPRINT. As an example, other companies, we’ve introduced into our system have successfully used inside sales forces who are based in a home office, a headquarters rather than in the field to carry a lot of the water with respect to cultivating instruments leads most of the way through the sales cycle. We’ve begun that process here, but we’re learning how to work most effectively together across the different parts of our sales organization. So that’s one of the things that we look to improve as well. So in summary, I’d say SPRINT is not a cause of the shortfall in instrument revenue we had either from a cannibalization perspective or because our sales reps don’t know how to sell it. But getting really great at selling SPRINT is obviously something we’re focused on and it’s going to help ensure that we don’t have the kind of shortfall we had in the first quarter in the future.

[Paul Knight:]

What stage are you at, Brad, in the 3D Biology roll out? Obviously customer seem pretty excited, but what’s the impact of 3D Biology chips at this point in the consumable item growth?

[Brad Gray:]

We’ve just gone from the first inning to the second inning. And until April at AACR, we had really only one product that did what we probably thought 3D Biology, which is look at proteins and on the basis of that one product alone, we know we closed instrument sales with customers who motivated to adopt nCounter based in part on 3D Biology. So I’m saying – I guess I’d say it’s very early days, but even with a very smart portfolio of products we think it’s motivating the growth of the installed base. That’s a very positive sign. It’s going to take a while for us to build out this portfolio to where we want it. By the end of 2016, we hope to have critical mass of the portfolio. Beginning at AACR, we have a few new things to talk about that’s going to make it incrementally helpful to drive more instrument sales. I would say in terms of when 3D Biology reagents become a meaningful contributor on the consumable revenue line, we’re probably looking at 2017. Mostly, this year it’s going to help us motivate new instrument customers.

[Operator:]

At this time, I would like to turn the call back over to Brad Gray for closing remarks.

[Brad Gray:]

Thank you all for your interest in NanoString this afternoon. We look forward to seeing many of you at upcoming investor conferences or scientific meetings. Thank you for your time.