Fulgent Genetics, Inc. (FLGT) Q2 2017 Earnings Report, Transcript and Summary

Good day ladies and gentlemen and welcome to the second quarter 2017 Fulgent Genetics earnings conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-session and instructions will follow at that time. [Operator Instructions]. As a reminder, this call is being recorded. I would now like to introduce your host for today's conference, Ms. Nicole Borsje. Ma'am, you may begin.

Great. Thanks. Good afternoon and welcome to the Fulgent Genetics second quarter 2017 financial results conference call. On the call today is Ming Hsieh, Chief Executive Officer and Paul Kim, Chief Financial Officer. The company's press release discussing its financial results is available in the Investor Relations section of the company's website, fulgentgenetics.com. An audio replay of this call will be available shortly after the call concludes. Please visit Investor Relations section of the company's website to access the audio replay. Management's prepared remarks and answers to your questions on today's call will contain forward-looking statements. These forward-looking statements represent management's estimates based on current views and assumptions, which may prove to be incorrect. As a result, matters discussed in any forward-looking statements are subject to risks, uncertainties and changes in circumstances that may cause actual results to differ from those described in the forward-looking statements. The company assumes no obligation to update any of the forward-looking statements it may make today to reflect actual results or changes in expectations. Listeners should not rely on any forward-looking statements as predictions of future events and should listen to management's remarks today with the understanding that actual results, including the company's actual future results, may be materially different than what is described in or implied by these forward-looking statements. Please review the more detailed discussions related to these forward-looking statements, including the discussions of some of the risk factors that may cause results to differ from those described in these forward-looking statements contained in the company's filings with the Securities and Exchange Commission, including its quarterly report on Form 10-Q for the first quarter of 2017 and the related press release announcing its financial results for that quarter, both of which are available on the company's website. Management's prepared remarks, including discussions of earnings and earnings per share contain financial measures not prepared in accordance with the accounting principles generally accepted in the United States or GAAP. Management has prepared these non-GAAP financial measurements because it believes they may be useful to investors for various reasons but they should not be viewed as a substitute for or superior to the company's financial results prepared in accordance with GAAP. Please see the company's press release discussing its financial results for the second quarter of 2017 for more information, including the description of how the company calculates non-GAAP earnings and earnings per share and a reconciliation of these financial measures to net loss and net loss per share, the most directly comparable GAAP financial measures. And with that, I would like to turn the call over to Ming.

Thank you. Good afternoon and welcome to Fulgent Genetics second quarter 2017 earnings conference call. We will like to thank you all for joining us today as we discuss our financial results and the development for the quarter. I will discuss the highlights from the quarter and provide updates on our business. Then, Paul will go through our financial results and provide additional color on our outlook. Let me first provide a brief overview of our financial results for the second quarter. Revenue totaled $4.6 million, growing 17% year-over-year. Billable tests grew 39% year-over-year to 3,871 in the quarter. Our ASP was 1,198, which is consistent with what we saw last quarter. GAAP loss was $25,000. And non-GAAP income was $284,000. We were generally pleased with our results this quarter as revenue was in line with our expectations and are again achieving non-GAAP profitability and generate cash from operations. As we discussed last quarter, we made a number of changes to our sales organization in order to better position ourselves to capture shares in the NGS genetic testing market. As expected, it is taking time for our new sales team to fully ramp and we expect to see this changes to our sales organization positively impact our revenue growth in the second half of the year. Non-GAAP gross margin in the second quarter was 61%, a modest decline compared to 68% last quarter. Our margin the quarter were impacted by the new hires and the investment we made in lap operations in anticipation of highest test volume growing forward. This expense combined with the lower billable test volume we saw, increased our overall cost of goods sold. However our gross margin remained the highest in the industry as a result of our technology platform and operational efficiency including lower overall cost to us per test. We expect gross margin remained strong in the coming quarters as we increase our volume. We believe will have one of the most comprehensive test menu in the industry which will enable us to provide various options for test customization and clinically actionable results. Our test menu collectively tests for approximately 7,700 genetic conditions including various cancers, cardiovascular disease, neurological disorders and pediatric conditions. We are excited to announce in August we have launched a new carrier test, which is allowing us to better address needs for the large and growing prenatal market. We expect further penetration into our customer base with additional the carrier tests. We see meaningful opportunities in this market long term and expect the carrier test volume to begin building volume. We believe we are well-positioned in capturing shares in this market, especially given our generally flexible test menu, breadth of tests panels and the competitive price. We remain focused on growing our business through a number of vectors.. in particular, we expect to leverage of the newly reorganized sales force for further penetrating the cash paying side of the market, including expansion with the largest hospital market, other labs and the research institutions. On the reimbursement and the group purchasing side, we continue to make progress by increasing number of coverage life and working with the various organizations to gain adoption to sustained long-term growth. In addition to building a relationship with new customers, we remain focused on expanding our test menu. Following the launch of our carrier test in August, we expect to introduce additional tests to address other adjacent market in future. Finally, we see additional opportunity for international expansion as we position of next-generation sequencing technology growing globally. With the JV up and running, we believe we are now really well-positioned to benefit from the growth of genetic testing in China. I would like now to turn over the call to Paul to provide greater details on our operation and financial performance in the second quarter and provide additional cover on our outlook. Paul?

Thanks Ming. Revenue for the second quarter totaled $4.6 million, an increase of 17% over the second quarter of 2016. As Ming mentioned, our newly organized sales force ahs taken time to ramp and this had an adverse impact on our topline momentum in the quarter, as expected. However, we are confident in our new sales team's ability to perform in the second half the year, which should reaccelerate revenue growth. I would also like to note, revenue recognized from Asia customers continues to decline as a proportion of our total revenue, given our Asian customers are now ordering test through our JV with Xi Long in China. Revenue from Asia represented only 11% of overall revenue in the quarter compared to 36% in the fourth quarter and 29% in the first quarter of 2017. Even with lower overall revenues, we did have growth in our U.S., Middle Eastern and European customers in the quarter and we anticipate this will accelerate in the second half of 2017 with the efforts by our new sales organization and continued introduction of products. Billable tests were 3,871 in the second quarter, an increase of 39% over Q2 last quarter [ph] and a decrease of 12% in Q1. Our average selling price was $1,198, consistent with what we saw in the first quarter. Cost per test for the quarter was $485 on a GAAP basis and $469, excluding equity-based compensation of $62,000. We saw a modest increase in the cost per test in the quarter compared to the first quarter. We hired numerous employees that made capital investments in our lab operations to equip us to handle the increased volume we anticipate going forward. As a result of our higher costs, we saw a dip in our non-GAAP gross margin, which was 61% in the quarter. Our gross margin will continue to fluctuate as our test mix varies and our volumes scale. Longer term, we still expect to see a lower average cost per test as we ramp volumes and continue to improve productivity and automation in the lab. We believe that our differentiated technology and operating efficiencies will give us an advantage with margins long term despite pricing degradation we may see in our business or in the industry overall. Moving to operating expenses. We continue to make investments to grow our business while controlling expenses. On the sales and marketing side, our expenses were lighter than expected as a result of our sales restructuring. The bulk of our new sales people began their employment in the latter part of the second quarter. Our sales and marketing team now consists of 15 individuals, which includes net additions made in the second quarter. We believe our sales and marketing team is now right sized to approach the lucrative cash market. On the research and development side, we continue to invest in enhancing our technology platform, as Ming mentioned. And are pleased to release our carrier test in August. Lastly our general and administrative expenses were slightly higher than expected due to legal and accounting work associated with the finalization of the JV. Non-GAAP operating expenses totaled $2.5 million for the quarter, consistent with $2.8 million in expenses we saw last quarter. We also recorded $105,000 portion of loss associated with the joint venture. We remain confident that with our current staffing levels coupled with our joint venture operational lab in China, we have excess capacity to handle increased volumes going forward on all fronts. Adjusted EBITDA for the second quarter was $685,000 compared to $1.2 million in the first quarter and $1.2 million in Q2 of last year. On a non-GAAP basis, excluding equity-based compensation expense, non-GAAP income for the quarter was $284,000 or $0.02 per share on 17.7 million shares outstanding. The GAAP and non-GAAP tax rate at the end of the second quarter was 38%. We are pleased once again to post non-GAAP profit despite the temporary slowdown in our topline revenue growth. Turning to the balance sheet. We remained well-capitalized to support our growth and are very comfortable with our cash position. We ended the second quarter with $46.1 million in cash, cash equivalent and marketable securities with no debt. Now moving to our outlook. Before I get into the specifics, I want to reiterate that our new sales team is still developing familiarity with their products, tests, pricing, lab process and systems. There is also a lag between when we bring new customers on and when we begin to generate revenue from those customers. Given these dynamics, we expect the third quarter revenue will be between $5.5 million and $6 million. We are also confident in our ability to ramp sales in the second half of the year and are tightening our full-year revenue guidance to $24 million to $25 million. We expect that our revenue contributions from Asia will continue to decline and will ultimately represent a very small portion of our overall revenue for the year. We have noted that product mix could shift from quarter-to-quarter as we experienced in the first two quarters of the year. That being said, we still expect to maintain strong gross margin and achieve GAAP income for the year, even as we continue to invest in our business. Overall, with new personnel additions and a growing test menu, we remain confident in our growth potential for the next two quarters and years ahead. We are well-capitalized and are measured investments for growth while remaining one of the only profitable companies in the genetic testing space, particularly with the low volume. We look forward to reporting on our successes in the quarters ahead. Operator, now open it up for questions.

[Operator Instructions]. Our first question comes from Bill Quirk with Piper Jaffray. Your line is now open.

Great. Thanks for taking the questions. So we have seen ASPs here relatively flat over the last couple of quarters. Can you just comment on the sustainability at this roughly $1,200 level?

Bill, thank you for the questions. Given our sales forces ramp up now and try to bring some of the new tests into our labs. We do see we will have benefit continue to using the new technology to reduce our cost. I do not believe our top cost we have to be an issue. So now the issue is, we need to bring higher test volume, test samples. So we remain very, very confident that we can continue driving down the cost as we bring the samples, I think.

And then a little bit more color on the ASP. So yes, ASPs were $1,200 last quarter. It was $1,200 the quarter, even with the portion of our revenues to Asia getting materially lower. We take a look at the composition of the types of tests that we sold during this quarter to last quarter and excluding the Asia revenue, they remained largely consistent. So the same proportion of exome, same proportion panels, customize panels and other tests. So everything equal. We anticipate seeing ASPs right around $1,200. The thing that can actually change that variable would be how fast we grow the carrier side of the business because that has a different ASP than, say, exomes. But I think what Ming mentioned is absolutely true meaning that we invested heavily into our lab operations. We purchased a lot of equipment in the last couple of quarters. We made numerous hires. So from a margin perspective, whether it be the carrier test, whether it be the other tests that we have, if you also incorporate the lower cost of sequencing by the industry that's out there and the additional automation that we can have with the lab, we feel very comfortable sustaining high gross margins.

Okay. And then just thinking here a little bit about 3Q and 4Q guidance, obviously it implies a pretty big step-up here in the fourth quarter. Can you just talk about the confidence in that number, Ming or Paul? And the reason why I am asking is because Paul, you did say in your prepared comments that obviously, with the sales force reshuffling and bringing those reps up to speed and they getting [indiscernible], there can obviously be some delays, natural delays in the process. So maybe you could just speak to confidence in that implied 4Q guidance? Thank you.

Yes. Bill, we are ramping up the sales teams. They are working with the various test orders, bringing the samples into the lab. They are also working with various other opportunities versus with OEMs, with research institutions and some will go through as they quite successful opportunities. So the teams we are bringing, they are pretty experienced and with existing sales team., they also were a part that we need to get orders the options close and we see some good opportunities to close in the third quarter and fourth quarter.

Okay. And then just lastly for me, in terms of the loss from the JV, I think it was $105,000. Help us think a bit about how long do you think that will be operating at a loss before that turns over to profitability?

Bill, the labs are set. So we are going through the credentials application stage. We tried to get the lab over there also be CAP-certified. And now they are starting turning to get samples now. We do reported a modest license revenue for this quarter. So the lab is starting in operation and we expect the profitability in next year.

Okay. Got it. Thank you.

And our next question comes from Erin Wright with Credit Suisse. Your line is now open.

Great. Thanks. Outside of the sales force investments, you also mentioned significant investments in equipment and some other items. What did that specifically entail? And do you think you have what you need in place and what incremental investments are embedded in your expectations near term?

Erin, that's a very good question. We did purchase the newest -- the new sequencing machines. We also bought new lab equipment. We are also starting to remodel the lab trying to adding additional capacity for tools for the quick ramp up of the sample size for the production. And in addition, we are leasing additional lab space and office space. So with all those in the preparation, we are ready to handle the large volume increase.

Okay. Great. And how should we think about the transition to third-party payors and how those relationships are all evolving so far? And did you sign on any new relationships? And when should we expect that to contribute more meaningfully? And I guess what's embedded in your near term expectations there as well? Thanks.

Yes. Erin, we expect to see some results in the third quarter and hopefully the quick ramp up in the fourth quarter this year.

And were there any new relationships that evolved in the quarter?

Yes.

Okay. Great. Thank you.

[Operator Instructions]. And our next question is from Andrew Cooper with Raymond James. Your line is now open.

Hi guys. They hit on a couple of mine, but just a quick one on tech mix and the competitive environment. I know the mix last quarter saw whole exome come down. Just kind of wanted to get your color on what you think of the competitive environment? Is it different for those tests with one of your main competitors introducing that relatively recently? And just kind of how you think about attacking new customers with those sort of tests? Thanks.

Yes. Andrew, I think as you take a look in terms of what we offer in terms of pricing, our exome pricing, we offer one of the most comprehensive and very aggressive pricing in this market. So if you compare what is our ASP in this quarter versus last quarter, it is pretty consistent. So we do believe we still have a strong competitive position in this market. Paul, do you have anything to add on?

No.

Okay.

But I think I made a comment about this little earlier and I would just agree with Ming that from an ASP perspective for those particular tests, there is always some potential of a pricing degradation. But we don't see anything drastic.

Okay. Great. That's all for me. Thanks guys.

At this time, we are showing no further questions. So ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program. You may now disconnect. Everyone have a great day.