Fulgent Genetics, Inc. (FLGT) Q3 2018 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Fulgent Genetics Third Quarter 2018 Earnings Conference Call. [Operator Instructions]. As a reminder, this conference call is being recorded. I would now like to introduce your host for today's conference, Ms. Nicole Borsje, Investor Relations. Ma'am, you may begin.

Great, thanks. Good afternoon, and welcome to the Fulgent Genetics Third Quarter 2018 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 events, including the company's actual future results may be materially different and 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 discussion 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 the previously filed 10-Q for the second quarter of 2018, 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 measures today 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 third quarter 2018 for more information, including the description of how the company calculates non-GAAP earnings and earnings per share and a reconciliation of these financial metrics to loss and loss per share, the most directly comparable GAAP financial measures. With that, I'd now like to turn the call over to Ming.

Thank you, Nicole. Good afternoon, and thank you for joining us on our call today to discuss our third quarter 2018 results. We had a good third quarter, and I am pleased with our results. I will spend a few minutes discussing the highlights of the quarter before Paul will discuss our financial results in detail. Let me first provide a brief overview of our financial results for the third quarter. Revenue totaled $5.6 million, up 25% from the third quarter last year and 4% sequentially. Billable tests in the quarter grew 37% year-over-year to 5,569. Our ASP was $1,010, up 7% compared to the second quarter of 2018. Non-GAAP gross margin in the third quarter was 55.7%, up 310 basis points from third quarter last year and flat sequentially. GAAP loss was $595,000, and non-GAAP loss was $40,000. Non-GAAP loss per share was 0 in the third quarter. Adjusted EBITDA was positive $281,000 in the third quarter. In the third quarter, we continue on the positive trajectories we have experienced since the beginning of this year. As revenue continued to increase, gross margin continued to improve and loss continued to shrink. We are seeing increase in momentum and a stabilization in our business. We are pleased to report a positive adjusted EBITDA for the second consecutive quarter. We saw strength across our businesses this quarter include momentum from some of the 2018 initiatives and the R&D spending we have discussed. Our Becaon carrier test has seen continued growth and our international business is starting to pick up. Also our [indiscernible] business has continued to do well with strong momentum with our sequencing-as-a-service agreement and -- in the quarter and are processing increased volume under this agreement. Let me provide with an update on the key areas of our businesses that we are focused for driving the growth. First, we have seen strong momentum with our high-quality comprehensive sequencing-as-a-service business. Our internal capability for these opportunities continue to improve, and are empirically involved in various complex sequencing projects for biopharmas and used at institutions as well as large labs. We are seeing projects of increasing size and complexity, and our near-term pipeline continued to grow. Second, our international business continues to grow. We have wins in Australia and Europe over the course of the year, and we have began recognizing revenue from this wins in the third quarter. Third, our newborn and prenatal business has continued introduced on the hospitals and related organizations. On that note, I would highlight that agreement we announced with StemCyte in October to partner with them on 2 tests, an expanded carrier screening test and a newborn genetic analyzing test. This has been offered through StemCyte and powered by the Fulgent's technology. First, our somatic offering can now do simultaneous assessment of RNA and DNA, and we're being highly sensitive and reliable carriage. Though volumes are still small, we are excited about our capabilities and interest into this market. And finally, I have seen improvement leverage as investment that we have made across businesses in the last year and the increased payoff with better dividend. We are encouraged by the progress we are making and the momentum we are seeing in our business. We are focused on executing well and deliver further growth as our newer initiatives continue to ramp. We're well positioned to capitalize on our market opportunity. I would like now to turn over the call to Paul to provide the detail on our financial performance in the third quarter. He will also provide an update on our outlook for 2018. Paul?

Thanks, Ming. Third quarter revenues totaled $5.6 million, an increase of 25% compared to the third quarter of 2017, and an increase of 4% sequentially. As Ming discussed, we have continued to see momentum from initiatives, such as our sequencing-as-a-service agreement, while our core business remains strong. Our international business outside of China continues to do well. And in the third quarter, international revenues, excluding China, grew 33% year-over-year. At the same time, our U.S. business has seen growing momentum, and revenues in the U.S. grew 49% year-over-year in the third quarter. Beginning in Q4, our growth rates will be normalized as the impact of a China JV will be fully behind us on a year-over-year growth rate basis. So activity is relatively low. The China JV is fully operational, and we believe -- and we continue to record our portion of revenues from the JV. Longer term, we believe the JV uniquely positions us to capture the large China market. Billable tests were 5,569 in the third quarter, an increase of 37% over Q3 of last year. Our average selling price was $1,010, up slightly from the second quarter due to product mix, which was impacted by sequencing-as-a-service agreements becoming a larger portion of our business. For many sequencing for service agreements, they are invoiced without number of billable tests, rather they are billed out by the number of lanes used in sequencers. As such, the number of billable tests were slightly lower than Q2, which translate into higher ASPs. Regardless, given the uptick that we see in our overall business in the near-term pipeline, the number of billable tests should rebound in the fourth quarter. Cost per test in the quarter was $469 on a GAAP basis and $447, excluding equity-based compensation of $121,000. After a significant test in cost per test last quarter, we're pleased to see that cost per test stabilized at these lower levels in the third quarter. Lower cost per test continues to be driven by increased operational efficiencies, higher volume and better productivity as well as introduction of our enhanced probes. Our non-GAAP gross margin was flat sequentially and improved 310 basis points year-over-year. Gross margin has generally improved and stabilized as cost per test has improved with increased efficiencies. We're pleased with the progress we've seen in gross margin and feel that additional efficiencies could lead to an even lower average cost per test in the future. Now turning to operating expenses. We have remained focused on controlling expenses, while investing in different areas of our business for growth. Our operating margin improved 350 basis points sequentially as we've seen improving efficiencies across our business. Sales and marketing expense on a GAAP basis was $1.1 million in the quarter, down from $1.3 million last quarter. We've seen improving leverage from our sales organization as the investments we've made over the last year in this area are continuing to pay off. On research and development, we continue to invest to maintain our technological advantage to expand our test menu. R&D expense was $1.4 million in Q3, up from $1.2 million last quarter. We'll continue to invest in all areas of our R&D from probes to bioinformatics and in test offerings, whether it'd be germline or somatic. We believe we can aggressive in our R&D investment, while still maintaining a business model that's able to demonstrate improvement and leverage over time. Lastly, total G&A expense was $1.3 million, down from $1.4 million in Q2. Total GAAP operating expenses were $3.9 million for the third quarter, flat from last quarter. Non-GAAP operating expenses totaled $3.4 million, flat from last quarter. Adjusted EBITDA for the third quarter was a positive for the second consecutive quarter and came in at $281,000 compared to $99,000 in Q2. On a non-GAAP basis and excluding equity-based compensation expense, loss for the quarter was $40,000 or breakeven per share based on 18 million weighted average common shares outstanding. The GAAP and non-GAAP tax rate at the end of the third quarter was 23%. Turning to the balance sheet. We remain well capitalized to support our growth, and we're comfortable with our cash position. Cash used in operating activities was approximately $105,000 compared to $57,000 used last quarter. We've continued to manage our business around cash flow breakeven with a goal of achieving sustainable cash flow generation in the coming quarters. We ended the first -- we ended the third quarter with $36.9 million in cash, cash equivalents and marketable securities with no debt. This translates to $2.05 in cash, cash equivalents per share. Now moving on to our outlook. We're pleased with the progress we have made in this year and the stability we've seen in the business. We've been gaining traction with recent initiatives and expect to see sustainable growth in the quarters ahead. More specifically, based on what we see in our pipeline and backlog, we expect revenues in the fourth quarter to be approximately $6 million, which represents a year-over-year growth of 40%. We expect our gross margin will continue to be above 50 points through the end of the year. We also remain focused on improving leverage, while investing for growth. As we continue to scale, we expect to return to GAAP profitability in the coming quarters. We remain encouraged by the momentum we're seeing and believe we still have significant opportunities ahead of us. Thank you, again, for joining our call today. Operator, you can now open it up for questions.

[Operator Instructions]. Our first question comes from Erin Wright with Crédit Suisse.

I was just curious what are the factors contributing to the rebound in test volume that you are alluding to in the fourth quarter?

Erin, thank you for the question. We continue to see the dividends paying off by our sales organization. We've seen the test samples from the domestic as well as from international. In addition, as Paul mentioned, we have also seen quite a bit of test volume from the -- our sequencing -- high-quality sequencing service business. Paul, do you have anything to...

Okay, great. And then I guess -- okay, yes. So I guess and you spoke to kind of reaching profitability in the fourth quarter and beyond, if I heard you correctly, is that really what you were kind of framing out there? And can you talk a little bit about incremental kind of sales force investment as well? And how that kind of ties into your profit outlook?

Okay. So couple of different things. We are seeing very encouraging signs that we're going to be hitting revenues of approximately $6 million in the fourth quarter. It could potentially be higher than that. And we're getting confidence of the estimates that we're making. And based on the jobs that we have in hand and based on the revenues and the billings that we currently are invoicing, that is coming from a number of different fronts. That's coming from the sequencing-as-a-service contracts that are very, very active right now. That's also coming from the continued traction that we see with our Becaon carrier test. As you remember, we introduced that at the beginning part of this year, and the quality of the test, the customers are very, very happy with. So whether it'd be from reimbursement or from the cash side, we believe that, that business will continue to look promising. The other thing that is gaining traction that we're very encouraged by is our international portion of our business, where we signed a number of contracts in Europe and Canada as well as Australia, in particular, and we're seeing very, very good growth from partners from that portion of our business. While in the meanwhile, the core pediatric part of our business continues to do well. So when you wrap all of that together, we believe that we will hit the revenue numbers of approximately $6 million in Q4, which should be a record for the company and the number of billable tests should increase. And then as far as your question and comments about profitability, on a GAAP basis, we had loss of almost $2 million in the first quarter. That was chopped in half or approximately half in the second quarter, the GAAP loss was approximately $1 million. In the third quarter, our GAAP loss that includes the loss that we had in the China JV is narrowed again by approximately half at $595,000. The stock-based compensation, that was approximately $600,000 for the quarter. So we're very, very close to profitability even on a GAAP basis. This is the second quarter that we had EBITDA positive. And I don't know whether we're going to be profitable in the fourth quarter, but profitability is very, very close to our sight. And then on the expense side, because of the leverage that we have in the business, even with the growth that we have in the fourth quarter, we believe that, that will continue to translate into narrowing losses. So to answer your question, I think, profitability, whether it's in the quarter or couple of quarters ahead, we look very, very forward to posting those numbers. And then as far as the investments that we're seeing across our business, we continue to make them. So we're not compromising any kind of opportunities that we could be making on the R&D side.

[Operator Instructions]. I am not showing any further questions at this time. Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program, and you may all disconnect. Everyone, have a great day.