Fulgent Genetics, Inc. (FLGT) Q3 2017 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen and welcome to our Q3 2017 Fulgent Genetics Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time. [Operator Instructions]. As a reminder, today's conference may be recorded. I'd now like to turn the call over to Ms. Nicole Borsje. Ma'am, you may begin.

Great. Thanks. Good afternoon and welcome to the Fulgent Genetics third 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 the 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, 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 previously filed 10-Q for the second quarter of 2017 which is available on the company's Investor Relations 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, as the most directly comparable GAAP financial measures. With that, I would now like to turn the call over to Ming.

Thank you, Nicole. Good afternoon and thank you for joining Fulgent Genetics third quarter 2017 conference call. We would like to thank you all for joining us today as we discuss our results. I would discuss some business updates in the quarter and then Paul will go through our financial results in detail. Let me first provide a brief overview of our financial results in the third quarter. Revenue totaled a $4.5 million compared to $5 million in the third quarter last year. Billable test in the quarter rose 19% year-over-year to $4,072. Our ASP was 1,106 down 8% from 1,198 in the second quarter. GAAP loss was $1.1 million and non-GAAP loss was $442,000. Non-cash loss per share was $0.02 in the third quarter and the cash flow from operations was positive $500,000. Our results in the quarter came below our expectations as thick and longer than we expected for our new sales organization to fully rent, which has impact our topline growth. While we were disappointed in this results, we believe we have a proper ingredients to re-accelerate our growth in the future. This include slowing three areas. One technology; we now have the most comprehensive test menu in that industry for where's the market including carrier screening, pediatrics, cardiology, immunology, in the germline cancer. We continue to invest development capabilities in R&D, DNA as well as somatic cancer. Second operations, we continue to expand our lab and invest in increment. We're also refining our process, include further automation and integration, which increases our quality, turnaround time and the efficiency. Three, the sales team, we have the right team in place and experience a meaningful jump in orders since end of the third quarter, which I'll discuss in more detail in a moment. With these ingredients in the growing market, we're ready to capitalize many opportunities, which will accelerate growth in future. Non-GAAP gross margin in the third quarter were 53% down from 61% in the last quarter. Our gross margin in the quarter was impacted by the gross investment we made in our lab operations as we anticipate the higher test warning going forward. This investment include our overall cost of goods, so they include having more employees, depreciated from expansion in square footage as well as purchasing more equipments. We announced the launch of our comprehensive carrier test in August, which we briefly discussed on our last earnings call. We were pleased to see where good initial demand for this test following the launch. While our carrier test didn't have a meaningful impact on our revenue in the third quarter, we have seen strong order warning recently through various agreements that we executed with clinic networks. We're also in the process of expanding our test offering in the oncology market, including plan to lunch our somatic base test in the first of 2018. This offered include the combination of germline and the somatic test which will include detailed analysis and the results from both tumor and normal tissue. Although it has taken longer than expected for our sales forces to fully rent, the team remains highly focused on executing and making incremental progress on the set that would lead much higher test awarding in 2018. I'll provide some color on this progress as we're seeing. First, the institution, domestic team has recently come over two dozen new accounts. We should leave noticeable increase in order of volume in the month of October, while I don't see impact of this new account to our third quarter results, it is encouraging sign for warning in the months ahead. This team also working on the exclusion of grievance, which should lead us sustained ongoing business in the key accounts. Second, the reimbursement team is in the process of signing additional third-party payers and are working with various group person organization to try volume start in 2018. Third we had several people in our international team to address some market outside the U.S. including Canada, Australia and the Middle East. Fourth, we're seeing more proposals opportunities in our sequencing for our service community with the seller large bio pharma organizations. We've recently seen some of this opportunities and are working through orders and also we have given some meaningful impact of this order in the third quarter. We are expected to see prospect going forward. Certainly, our China JV is working hard to drive business to his left and we are expecting to see meaningful growth in 2018. I would now to turn over the call to Paul to provide greater details on our operation and the financial performance in the third quarter. He'll will also provide an update of our outlook, Paul.

Thank you, Ming. Third quarter revenues totaled $4.5 million, a decrease of 10% to the third quarter 2016. As Ming discussed, our results came in below our expectations as our new sales force has taken additional time to fully ramp. We have also been investing in our lab operations and expanding our test menu to best position ourselves for growth in 2018. I would also remind you that our revenue from Asia continues to decline as these samples are now going to our JV and our Asia revenues represented 4% of our total revenue in the third quarter. This compares to 23% of the third quarter of 2016 and 11% last quarter. Excluding revenue from Asia, our business in the U.S. and Europe remained stable. Billable test were 4,072 in the third quarter an increase of 19% over our Q3 of last year and an increase of 5% from Q2. Our ASP was 1,106 down from 1,198 in the second quarter. Our ASPs have ticked down due to the growing portion of our revenues we're receiving from sequencing service agreements with biopharma organizations which are sold under contract at a lower price per test and carry lower gross margins. Cost per test for the quarter was $557 on a GAAP basis and $524 excluding equity-based compensation of $133,000. Cost per test increased slightly in the quarter due to investments we made in our lab operations, which Ming discussed. As a result of the increased COGS our non-GAAP gross margin came down more than we were expecting to 53% of the quarter. Our gross margin will continue to fluctuate as our test mix varies and our volumes scale. Longer-term we still continue to expect to see a lower average cost per test as we ramp our 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 declines we may see in our business or in the industry overall. Now looking at operating expenses, we remain focused on balancing our investments for growth while managing expenses. On the sales and marketing side, our expenses were $1.4 million in the quarter, up from $851,000 last quarter. This increase was due to spending on various initiatives, including hiring overseas and domestically and partnering and program launch expenses related to our new test for targeted markets including oncology. Also, we beefed up our reimbursement team to handle the recent tick-up in orders. We believe these marketing investments will bring us incremental business in the future. On research and development, we continue to invest in our technology platform and expanding our test menu, which led to R&D expenses of $1.1 million up from $920,000 last quarter. Lastly our G&A expenses were $1.2 million. Non-GAAP operating expenses totaled $3.3 million for the quarter. Adjusted EBITDA for the third quarter was a loss of $450,000 compared to earnings of $685,000 in the second quarter and $2.1 million in Q3 last year. On a non-GAAP basis and excluding equity-based compensation expense, non-GAAP loss for the quarter was $442,000 or $0.02 per share based on $17.8 million common shares outstanding. The GAAP and non-GAAP tax rate at the end of the year -- at the end of the third quarter was 36%. Although we reported non-GAAP loss this quarter, we expect to return to a profit in the coming quarters at the recent investments we made in the business began to pay off. Turning to the balance sheet, we remain well-capitalized to support our growth and we're comfortable with our cash position. We ended third quarter with $43.9 million in cash, cash equivalent and marketable securities with no debt. This equates to $2.47 per cash and a book value per share of $3.11 and enterprise value of approximately $25 million for the business. Moving on to our outlook, while we're disappointed in the progress we saw in the quarter, we remain focused on leveraging our investment and expanded test offerings to drive growth in the quarters ahead. As Ming indicated, we have been some promising indications that our business should reaccelerate in the coming year. We saw a meaningful increase in billable test volume in the month of October with our sales team recently signed a number of new client who have secured multiple sequencing for service orders. Specifically, our overall billable orders jumped more than 35% in the month of October, compared to the average monthly orders that we saw in July, August as well as September. This momentum continued in the first week of November through today. The increase came from various key accounts we won in recent months for existing test as well as newly launched carrier test. Although we expect orders will increase significantly in the fourth quarter, we expect that fourth quarter revenues will be approximately $5 million, which implies a full-year revenue guidance of approximately $20 million. We're projecting a relatively small sequential revenue growth rate of approximately 10% for the following reasons. First a meaningful portion of our volume growth is related to our new carrier test for which we have not been able to recognize the revenue until we collect cash from insurers. Second, although we're very excited about our big leg up in October as well as early November orders, we have revenue expectations in the fourth quarter as we have not yet seen orders for the rest of November as well as December. Third, we expect that our revenue contribution from Asia will continue to decline and that will represent a very small portion of our overall revenue in the quarter. We are closely monitoring the recent order momentum we have seen and we believe the revenue impact of our new sales organization will be felt in full force in 2018. On the bottom line, despite recognizing a GAAP loss in the quarter, we expect to be a non-GAAP profit and positive cash flow for operations for the full-year. Although we were disappointed with our results for this quarter we remain focused on continuing to invest in our technology and streamlining operations through automation and integration. With our technology and capabilities in the laboratory, we believe we can capitalize on many opportunities that will drive growth going forward. Thank you again for joining us and our call today. Operator, now open it up for questions.

[Operator instructions] And our first question comes from the line of Bill Quirk from Piper Jaffray. Sir you may begin.

Great. Thanks. Good afternoon, everybody. Paul, I appreciate the order, color around the fourth quarter. Can you go into little bit more detail there? Is this the bio-Pharm partnerships? Is this the core genetics business? Is it carrier screening? Is it all three? Just trying to get a handle on I guess how broad that order improvement is. And then secondly, I guess why you why you think so down so much in the summer and now are starting to see them you accelerate nicely. Just curious if you could fill in some more details there, thanks.

So, Bill, I'll probably cover some of those first and then Paul can add on some to my comments. First of all, I think we offer pretty diversified test offering. We do see significant attention from various research institutions sending their sequencing service for us. So, we're working with them, serve them, working to tuning their test to their founders and help them conduct their scientific research. So that's one of the areas we've seen traction. And also, we're invest heavily into the testing with several of the pharmaceutical companies, which has converted to their genetic service tool to the third-party labs. We are still in the areas of competing that area. We haven’t lost any of those opportunity here and we're seeing more and more coming. But this company's success take a long time to validate the lab and go through their processes. We're seeing more of those opportunities also working now and we do expect to convert some of them in 2018. So, in terms of what our institutions we continue seeing the institutions adding the services to us and those are the areas we're seeing the positive signs. Paul, you can probably go ahead.

Yeah so, I agree with Ming. It's been broad both in terms of what they’ve been ordering as well as the customers. As I indicated the new sales organization they converted over two dozen accounts already and the increase in orders, it's coming from those accounts as well as existing accounts as they continue to develop relationships, contacts and let them know are about our full-service offerings. And the orders they comprise of sequencing for service from bio-Pharma organization. It also comprises a big slug of our newly launched carrier tests as well as all of our other available tests and we could have been more bullish in terms of our forecast for the fourth quarter, but we've missed quite a few quarters in a row. So, we're just pampering our expectations altogether. And then lastly because we are building out the carrier test through our insurance, we had to incorporate conservatism because the test-through insurance we're not able to recognize revenue until we get cash collection.

Hey got it. Thanks guys.

Thank you. And our next question comes from the line of Erin Wright from Credit Suisse. Sir you may begin.

Hi. Thanks. This is actually Hong on for Erin. Just two quick questions from us. So, given some of the contracts that you've talked about in October, how do we think about average deals pricing forward given some of the sequencing contracts that you just mentioned? And then our second question, can you just talk about some ongoing shifts, like can you just disclose any indications of some of the ongoing household and just any shifts in the regulatory environment in general, thanks?

So as far as the ASPs for the recent uptick in the orders, because a nice chunk of it was related to the carrier base test, we believe the ASPs will be nominally lower than what we've reported on average for all of our tests. And then as far as sequencing for service, those carry slightly lower ASPs as well, but the composition of the remaining items are from the institutional side of the business and that's pretty reflective of the ASP's that we had before. And as far as the regulatory environment and the proposals that are looming out there, we don't think that that will greatly impact our business.

Okay. Great. Thank you.

Thank you. And our next question comes from Andrew Cooper from Raymond James. You may begin.

Hey guys, first one, we've heard about couple of different payers including United talk about requiring more prior authorization for some of the bigger gene panel tests. Just wanted to get your perspective on it if that changed anything about trying to go to the commercial payer market or any color you could provide there?

Yeah Andrew, this is a pretty good question. We do work with insurance companies now discussion about the bigger panel reimbursement. Actually, we're encouraged to see the signs. We do get reimbursement from the United Technology Insurance now. So, our experience what the various carriers is it's been pretty good. We're not in network with all the carriers. We're out of network, but the way we have streamlined our billing procedures when everything is said and done, the way we actually bill out the amount that we're allowed to bill out, we don't think that that will significantly impact our business just based on the efficiencies that we have in the operation.

Great. Thanks. And just one more for me as we look at the gross margin or the average cost per test and think about how much of the increase we saw sequentially was volume driven as opposed to the incremental expenses that you're wearing in terms of building out some of the automation in the hiring and things like that? Just what the underlying go-forward might look like? Any color there would be great please.

So almost all the increase we had in our cost structure was intentional, meaning that we continue to make investments in terms of equipment. We expanded our laboratory. We actually have a separate location for bioinformatics team down the street, which is about half a mile from our lab. So, the old headquarters it’s going to be solely dedicated for the anticipated volume going forward. The other thing that we did was we beefed up the number of hires that we had internally for the operations. So, it's equipment, facilities and headcount and we're very excited about the readiness that we have for the operations and going forward as volumes, they pick up, we should be able to see in the numbers the uplift that we have in the gross margins based on our investment.

Great. Thanks. I'll follow-up offline.

Thank you. Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program and you may all disconnect. Everyone have a great day.