Fulgent Genetics, Inc. (FLGT) Q3 2019 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Q3 2019 Fulgent Genetics Earnings Conference Call. [Operator Instructions] As a reminder, this conference call is being recorded. I would now like to turn the conference over to Nicole Borsje, Investor Relations. Please go ahead, Ma'am.

Great. Thank you. Good afternoon, and welcome to the Fulgent Genetics Third Quarter 2019 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 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 the previously filed 10-Q for the first quarter of 2019, 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 accounting principles generally accepted in the United States or GAAP. Management has presented these non-GAAP financial measures 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 2019 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 income and incomes 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 2019 results. I will review the highlights from the third quarter before Paul discusses our financial results and outlook in detail. The third quarter was another very strong quarter for us. We once again achieved a record quarterly results for both test volume and the revenue, while driving ongoing improvements in gross margin and the cost per test. We once again achieved the GAAP profitability and a generally strong cash flow, specifically, the revenue growth 84% year-over-year to a record $10.3 million. Billable tests increased 272% year-over-year to a new record high of 20,697. Our ASP was $500 essentially flat compared to the second quarter of 2019. While our cost per test continue to improve, further increased our gross margin, excluding stock-based compensation costs per test improved to a record low of $179 per test. Non-GAAP gross margin in the third quarter was 64% up approximately 8 percentage point from the third quarter last year and up approximately 5 percentage point sequentially. GAAP income was $1.5 million and a non-GAAP income was $2.6 million. Non-GAAP earnings per share was $0.14 in the third quarter, and adjustable EBITDA was positive $2.19 in the third quarter. The third quarter was another record quarter for Fulgent Genetics, demonstrating the consistent traction we are gaining in the market given the recent ramp we have seen with -- to offer more insight into our test mix and how it is driving our growth. First, our core critical business, we are seeing strong demand for both our oncology test and our reproductive health business. Especially on the oncology side, we have seen increasing demand for our hereditary cancer panels. Our superior quality rapid turnaround time as well as the competitive pricing are driving notable growth in volume. And as a result, oncology is to become a growing portion of our revenue sector. Second, we are seeing increasing demand for our sequencing service business from our channel partners, we have established with the various institutions and the pharmaceutical companies focus on genomics for the therapeutic discoveries and the development. Third, we are certifying several logistic partnerships with the cash paying commercial genomic laboratories. We have seen early results from these partnerships. We have provided additional fields for the recent growth. We are pleased with this recent ramp in volumes that we have experienced, but at the same time, we remain balanced in our growth expectations for the quarters ahead. Though recent growth has translated into results that have expensed [ph] our most optimistic expectations at the start of the year, we remain and make sure as we look ahead and focus our increase seeing the sustainability of business growth. To that end, we anticipate the fluctuation in the short term demand as our spreads diversify and expand our business over the long run. We are confident that the investments we have made in additional sales, revenues, offset our core clinical business will contribute a large part of our business over time, driving increased stability and consistency. As our volume has ramped, I have rapid [Indiscernible] to be able to manage is the increased activities due to the investment we made in biometric, bioinformatics, computer science, artificial intelligence, people and automation in the recent years. Our lab has out-driven more efficiently and we still have a lot of capacity for additional volumes. With this increase in volume, that is envisioning [ph] our business have become a more financially strong. And we can see this in our growth margin and the bottom line. Most notably, we have continued to see improvement in our cost per test, due to the benefit of the scale and automation. We are confident that with the cost among the lowest in the industry, we have flexibility and the capability to drive a wider market. Aside from this financial advantage, our technology platform provides an even greater edge from the competitive and market position standpoint. Years of experience in our traditional core areas of pediatric, rare disease has provided the expertise to the inquiry and the interpretation as well as help to establish scientific findings, which a treatment guideline for a certain disease. An example of this is the work we have done with the Parkinson Foundation which is leveraging our data and expertise to develop a more efficient the treatment solutions for the disease. In addition, our software [Indiscernible] from our engineers has not only provided a proprietary approach, but also our ability to develop and to introduce quality test with each -- with a minimal financial investment. This enables us to both introduce the test into the market quickly, where we see a need or opportunity and to maintain to one of the largest libraries of existing tests with no additional overheads. Further, unlike many genetic testing companies, our technology platform give us the ability to perform all these tests in-house result need all [Indiscernible]. We believe that this financial, operational and technological distinguishes, differentiate us from other genetic testing companies in the market. To that end, we recently announced and launched a Picture Genetic, a patient initiative is a consumer genetic testing offering, which we believe offers a new level of genetic testing capabilities to everyday consumer. We are pleased to be able to bring clinical greater genetic testing results to consumers directly to enable them to make a more informative decision about their health. Picture Genetics is different from record [Indiscernible] at-home genetic testing offerings because they provide actionable clinical results along with a genetic counseling support for those who need it. We are also offering three different tests to the Picture Genetic product line. Parenting, Wellness and the Newborn. Our Parenting and the Wellness tests are available online now, while Newborn will be available later this year. We are excited about this opportunity to reach consumers more directly, but at the same time we do expect to see meaningful revenue contribution from this test in the immediate term. Our low cost structure and the [Indiscernible] that enable us to be sustainable provide this service to consumers at an affordable price. Overall, we have the opportunity to have success driving top line growth and expanding our test offerings with legal incremental overhead. We remain disciplined in our approach to spending, and continue to see investments we have made paying off in growth. In that area of investment, we have continued to invest in research and development to enhance our test. In the third quarter we have announced a new test for reproductive health, which is now available for consumers. We are pleased to announce the launch of a PGT-A a test which identifies the potential abnormal in the embryos during an IVF process. This test has a woman doing the IVF process and that enable them to have more control over embryo selections and the transfer. Ultimately the increase in probability of a healthy pregnancy. In the last 12 months we have launched numerous new tests with the words for vertical markets, which has fuelled our growth. In summary, we had another very strong quarter as we have seen and notable growth inflections our business. Looking ahead, we remain confident and optimistic about our market position and opportunity. I would like now to turn over the call to Paul Kim, our CFO to provide details on our financial performance in the third quarter. And he will also provide an update on our financial outlook for the full year 2019. Paul?

Thanks Ming. Third quarter revenues totaled $10.3 million, an increase of 84% compared to the third quarter of 2018. Our U.S. business has continued to be the most significant driver of our momentum. Revenue from the U.S. grew 159% year-over-year and in the third quarter representing 82% of total revenue in the quarter, up from 79% in the second quarter. Billable test reached a new record high of 20,697 in the third quarter growing 272% over Q3 of last year, and increasing 26% over the second quarter of 2019. Our ASP was $500 per test essentially flat from the second quarter. Cost per test for the quarter was $188 on a GAAP basis and $179 excluding equity based compensation of 174,000. We have seen ongoing improvements in cost per test, which continues to benefit from operational efficiencies. Higher test volume, better productivity and the use of our proprietary technology including probes and informatics. Our gross margin continues to improve as a result of the efficiency, we're seeing. Non-GAAP gross margin improved five percentage points sequentially and eight percentage points year-over-year. We expect that gross margins should remain strong in the coming quarters. For operating expenses, we remain committed to managing expenses, while investing for future growth. With their continued top line outperformance, we again delivered a positive operating margin for the second quarter in a row. Non-GAAP operating margin was 24% in Q3 an improvement of 28 percentage points year-over-year and eleven percentage points sequentially. We will continue to see quarterly fluctuations in the near term as we scale. Sales and marketing expense on a GAAP basis was $1.7 million in the quarter, up from $1.3 million in the second quarter. R&D expense in Q3 was $1.7 million higher than $1.6 million in the second quarter. As Ming discussed, we continue to make investments in R&D as we grow our test menu and expand our market reach with our offerings. Lastly, G&A expense was $1.5 million down from $1.6 million in the second quarter. Total GAAP operating expenses were $5 million for the third quarter, up from $4.5 million in the second quarter. Non-GAAP operating expenses totaled $4.2 million up from $3.9 million last quarter. We're very pleased that we've been able to demonstrate strong momentum in the top line, but only marginally increasing expenses. This is a testament to our core competency in terms of the efficiency of our science, leverage of our model and shows that discipline we have been building in our businesses paying on. Adjusted EBITDA for the third quarter was a positive $2.9 million compared to $281,000 in the third quarter of 2018. On a non-GAAP basis excluding equity based compensation expense, income for the quarter was $2.6 million or $0.14 per share based on 19.5 million weighted average common shares outstanding. The effective tax rate at the end of the third quarter was 3.6% and on a non-GAAP tax rate was 2.3% due to us recording a full valuation allowance at the early part of 2010. Now turning over to the balance sheet, we generated very strong cash flow in the third quarter on our strong results. Cash provided by operating activities was approximately $3.9 million compared to 675,000 last quarters. We remain committed to generating cash from operations going forward. As you may have seen, we filed an aftermarket shelf offering for the full year which enabled us to sell primary stock in the open market. Over the course of a quarter, we sold approximately 104,000 shares and generated approximately $1.27 million growth in cash from this program prior to offering expenses. We ended the quarter with $43.6 million in cash, cash equivalents and marketable securities with no debt on the balance sheet. This equates to $2.24 in cash, cash equivalents per share. Now moving on to our outlook. As Ming discussed, we continue to see strength across our business, and we expect to see elevated test volumes in the periods ahead. We remain confident in our business, as we head into the end of the year, but at the same time we want to be measured in our guidance given the rapid inflection we saw in test volume in the last few quarters. Also, we’re applying additional conservatism given the pending impact of CMS coverage for hereditary cancer tests going forward. While the majority of our business is cash paying, with no reimbursement risk, we expect that we can see an indirect impact from these changes given the fact that we act as a reference lab to several cash paying commercial genomic customers, who receive CMS reimbursement for hereditary cancer tests. As such, we anticipate the fourth quarter revenues will be approximately $8 million, which translates to revenue for the full year at $32 million. This represents a year-over-year growth rate of approximately 50% for both the fourth quarter and the full year. I would also like to take a minute to elaborate on a point that Ming maybe made earlier regarding outsourcing test volume. We do not, and have not in the past, outsourced any of our testing capabilities. In fact, a growing number of commercial organizations have recently recognized our abilities and now we're outsourcing to Fulgent. The financial results we demonstrated in recent quarters further validate our technologies, operational differentiation and approach to the market for sustainable longer term, in this growing but highly competitive environment. Now, armed with a business that not only is forecast of the group to grow 50% in 2019, but generating cash and with one of the lowest cost structures in the industry, our focus going forward will be on our commercialization strategy. This will entail focusing on international growth, further building on our sequencing of the service business, establishing deep collaborations with key medical institutions and making reimbursement, and incremental growth driver for the future. We will provide further color and detail surrounding our commercialization strategy in the future. Overall, we believe this quarter results show how our differentiation allows us to compete effectively, as we both make genetic testing more affordable for consumers, while maintaining a disciplined, and a sustainable cost structure. We believe, the same differentiation will provide attractive financial results, and translate into sustainability for our business. We look forward to finishing the year on a strong note. Thank you for joining our call today. Operator, now you can open it up for questions.

[Operator instructing] We have a question from the line of Erin Wright from Credit Suisse. Your line is now open.

Great, thanks. Can you detail some of the key drivers of the volume growth, I guess in the quarter. And also the outlook for the fourth quarter, it just suggests a step down. I guess, what are you assuming in terms of the volume versus price dynamics and the indirect impact of the CMS reimbursement on Hereditary Cancer Screening. I guess how did that impact ASPs. I'm just trying to get that ASP versus volume mix appropriate here for the fourth quarter? Thanks.

Paul, do you think that?

Sure. So thank you for the question Erin. We've had a great third quarter. We've done very well in sustaining our core business, the Pediatric rare disease market. But a lot of the growth during the quarter came from the introduction of the new tests and the acceptability of that and attraction which really began at the early part of 2019. So whether it be in the area of oncology, whether it be in the area of women's reproductive health, or whether it be in the area of our biopharma relationships, they've all shown quite remarkable growth. I think your question about Q4 in our stance is on point, and I like to elaborate on that. If you take a look at our business, our business has really grown tremendously particularly in the area of volume in the past several quarters. At the beginning part of the year, our volume was approximately 7000, 8000 tests per quarter and now have grown to 20,000. And looking at our prudent guidance for Q4, these customers and their relationships, which provided the fast growth and the incremental growth, we feel very good with. But then again at the same time, these are new partners. So we believe, as we continue to work with them we’ll have better predictability, as to how much growth we can get from those relationships. If you take a look at -- if you take a look at these customers, and what I said earlier, we feel very confident in the diversity and the strength of our organization, particularly in the area of what we're actually selling. These new customers not only diversify us from a customer perspective, but it also provides diversification as to the types of tests that we sell. I think, the other comment that we made is many of these customers they outsource to us, and they are cash paying customers. And they're the ones that are submitting claims to the CMS and these other agencies. The CMS just came out with an announcement providing some detail on what they would provide for reimbursement. Having it be an FDA approved path, but we don't know quite certain as to how that's going to impact the reimbursement experience what these organizations that are submitting the claims. And I think based on that, and then also based on the fact that we don't want to get too ahead of ourselves given that our volumes nearly tripled in the last six months, provides us the input on why we want to be able to be a little metered for the fourth quarter. I think having said that, if you take a look at the progression of the business, we've raised the estimates on almost every call. I think we began the year at having a business and guidance be at $26 million, which was a 20% increase in our business compared to 2018. Subsequent to that, we raised the $29 million and now we're raising it to $32 million. I think, having said all of that, one of the things that we're really proud of is our cost structure. We believe, we have one of the lowest costs out there in the industry even for the small amount of volumes that we have, and we -- when we perform all these tasks across the board. But when you roll all of that out, whether it be on a GAAP perspective or on a non-GAAP perspective, we're very proud of our cost per task being in $170 to $180 range. And we believe with additional efficiency and with additional growth, there is meaningful room to drive those costs down further.

And Also Erin as you probably know, the CMS has the reimbursement rate, that's a lot higher than our ASP. With the growing volume we have lately we've definitely generated the attention for the National Insurance, the organizations. They do see Fulgent Genetics is a viable player in this market. Definitely, we have a business, the capability, technology and the discipline to sustain this market for long run. I think, it was purely, I think that our business cannot be measured by test of volume. Really how much we could drive the technology, deliver the test and build a sustainable, commercial models. I think that’s really our strength in this business.

Okay. That's really helpful. And then, also how should we be thinking about your hiring efforts going forward? I guess where do -- where does your total sales headcount stand now and where should we think about that trending kind of over the next year or so? Thanks.

Yes, Erin this is a great question. If you take a look, even though our revenue growth is almost year-over-year as Paul gave you the guidance for 50%. Our head count has now increases dramatically. We continue to improve in terms of the -- our sales executives, more balanced our people's capabilities in the region. This year, we have great growth in the North American business, but we are expanding internationally. So our headcount is now increased from about 120 people at the start of the year to about 140 people now.

Okay. All right. Thank you so much.

Your next question comes from the line of Bill Clark from Piper Jaffray. Your line is now open.

Hi, this is Rachel [ph] in for Bill. Congratulations on a nice quarter. So can you tell us the latest in the pricing environment? You’ve lowered the ASPs earlier this year. And presumably in response the competitive dynamic. So is the environment more stable at this point, or do you think you'll need to do a series of price cuts over the next several years?

That's a great question. And if you take a look in terms of all the pricing pressure, we definitely have a lot of room to cut the price. And that we're not to give that away. But in that sense, I think that we do need to make sure we had to build a business model, which should be sustainable, and that we cannot use a dollar to buy 40 cents or 20 cents of revenue. I think as we demonstrated in this market, the discipline, we do have a lower cost, but we have to maintain the business, be it profitable otherwise we cannot continue to reinvest into the business or repay back the – back to our investors. I think that in this area, I think we have room to drop -- to continue drop the price, as we continue to see our costs can be continued lower, as we see volume growth. But we're ready to go forward is another challenge into the area. But I think that even though we’ve dropped the price this year, we still maintain that our gross margin of around 60%.

Rachel, I'd like to add a few comments. I think your comment about the ASP is something that several individuals they brought up. I think, if you take a look at the ASP is about $500 in Q3, it’s a little bit lower, but it's pretty consistent relatively flat with what we had in the second quarter. I believe in the second quarter it was like $510 to $512. The thing that's driving the ASP number is primarily mix, and just competitive environment, a big environment, a very very competitive. I think the pricing pressure is always there, but between Q2 and Q3 it's largely driven to mix. I think what Ming said was absolutely spot on. Based on what we achieved, we believe that we can continue to drive down the cost which we believe will be important for the long run, because companies with the most efficient and the lowest cost structures are usually one of the ones that are left you know through consolidation and so forth. So we think that that is very very critical. I think the other thing to take note aside from the ASPs is given the relative flat or the drop in the ASP what you really saw between the first and the second quarter. Our gross margins, they continue to go up by four percentage points, they went up a four percentage points from Q1 to Q2 and they continue to increase. We believe, combined with our capabilities and combined with the evidence, the financial evidence that we have right now, which says, even if ASPs continue to go down whether it be mix driven or whether it be market driven, we believe having a very very efficient structure applying our technology into our business operations, achieving higher and higher gross margins, won't give us more levers to use, as we address this market.

Great. Thank you. And then can you also give us a sense of the product mix between legacy rare disease testing, carrier screening, external [ph] and other major categories. And then also, several large reference labs talked about private payers shrinking their networks. Have you seen any evidence of this, or do you expect to see any of this pressure in the future? Thank you.

Yes, I'll take on the first part of that, and Ming can comment on your last part of the issue. We don't break out the types of tests. We don't do that internally, but based on the new customers that we have, and the nature of what they're ordering, the amount of business that we're getting from oncology and the cancer related area is a significant portion of our business. Less significant, although it's notable is the revenues that we're getting from the worker's reproductive health area as well as the sequencing for service business. And then Ming, do you want to make a commentary on her last part of the question?

Yes. I think as Paul has answered, is we see pretty strong demands for our carrier screen test internationally. So it does, it’s one of the strong growth area. And in addition, we definitely have to offer more of the relationship with the institutions of cancer research institutions. We mentioned about the Parkinson Foundation last name. Recently, we have another contract with another major Parkinson Foundation to contract our work test for them to diagnose and treat Parkinson's patients.

Great. Thank you. [Operator Instructions] We have a question from the line of David Westenberg from Guggenheim. Your line is now open.

Hi. Thanks for taking the question. So can you explain what's driving the outside phenomenon in the quarter? You've been around for a while, and kind of why do you think you're seeing and kind of a step up in the volume there. Thank you.

Yes. David. I think this is really -- if you take a look the third quarter results, really it’s reflected our distances of our investment in terms of the test. We introduced them in the last year, end of the last year, and early this year. We do believe, with the technology it is one of the major differentiator for us. As Paul earlier mentioned, we do not as separate -- the number of our tests for cancer or carrier screening, rare disease or the service revenues, because we couldn't, they all come in from various sources and they are mixed. Fortunately, we have our automation. When the orders comes in, is automatic is tracked by the -- by the hour called The Fortune track, the [Indiscernible] for every test comes in. Once it gets into the system, and the system will select based on the customer request for the test. They are either from the research for the both our main DNA test as well as some of the cost companies that required, the institutions required [Indiscernible] through the orders for the rare disease or carrier screening test. All these things will be at the end classified by the our – bioinformatics [ph] pipeline and it can generate the critical related -- the reports. So we do feel Fulgent have that technology advantage, because we not only have strong biochemistry, but we were also very strong in terms of artificial intelligence and computer science, so and data science. So Paul, you have anything to add on?

Yes, so David I think you know since the call began, the lines of a Q&A I will say you know we're really behind the numbers, the reason for the numbers and kind of guidance going forward. And you know we believe that growing the business at 50% achieving what we achieved, pretty much speaks for itself. I think looking beneath the numbers this year so far has been a year of stability for Fulgent. And we're really pleased with that. Not only do we have stability within the sales organization, but we really homed in our operational capabilities as well, which is evidenced by us suggesting that volume and facilitating that you know meeting the requirements of the customer, both from a cap perspective, from a quality perspective, and we're very pleased because digesting that volume was handled relatively easily and we have excess capacity even still. So we can take on a lot more volume. I think from an engineering perspective, we made a number of improvements and enhancements within our technical organization as Ming has -- Ming has indicated. And we continue to produce offerings at a record pace, Picture Genetics being one of them, with a very very minimal investment. So on but all of that, the foundation of the organization, the whole of the organization feels very different than it did about a year ago. And given the fact that we do have this momentum and we know better than ever our core competency and we know better than ever how tough this market is. And Ming and I we continue to learn every day, but we're very skeptical as well. We believe, this is a business that we're running. It should be measured. We need to have our focus on growth, but we believe, going forward Fulgent is very well poised for that. That is why we're going to be very very aggressive in our commercialization strategy addressing the international markets, because a lot of the growth behind the numbers came from the U.S. area here in 2019. We're also going to continue to make deeper collaborations with the major institutions. And we feel very good about announcing some of those in the coming quarters. And we believe we're making good progress on the reimbursement side. So making sure that we get aggressive on the commercialization, marketing our capabilities, we believe will be key in driving our growth for the future.

I appreciate. That’s all I’ve got.

[Operator Instructions] And there are no further questions at this time. Speakers, do you have any closing remarks?

All right. Thank you everyone for the call. And we are looking forward to provide you with our update in the coming quarters. Thank you.

Ladies and gentlemen, this concludes today's conference call. Thank you for your participation and have a wonderful day. You may all disconnect.