Hello and welcome to the Fulgent Genetics Q2 2023 Earnings Conference Call and Webcast. [Operator Instructions] A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It's now my pleasure to turn the call over to Melanie Solomon, Investor Relations for Fulgent. Please go ahead, Melanie.

Thanks, Kevin. Good morning and welcome to the Fulgent second quarter 2023 financial results conference call. On the call with me today are Ming Hsieh, Chief Executive Officer; Paul Kim, Chief Financial Officer and Brandon Perthuis, Chief Commercial Officer. The company's press release discussing the financial results is available on the Investor Relations section of the company's website, www.fulgent.com. A replay of this call will be available shortly after the call concludes on the Investor Relations section of the company's website. 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 in 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-K for the year ended December 31st, 2022 and subsequently filed reports which are 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 second quarter of 2023 for more information, including the description of how the company calculates non-GAAP income or loss earnings or loss per share and adjusted EBITDA and a reconciliation of these financial measures to income or loss and earnings or loss per share to the most directly comparable GAAP financial measures. With that, I'd now like to turn the call over to Ming.

Thank you, Melanie. Good morning and thank you for joining our call today. I will start with some comments on the quarter then Brandon will review our product and go-to-market updates for the second quarter and Paul will conclude with the financials and outlook before we take over your questions. We are pleased with our results in the second quarter with another record core revenue reaching $67 million and less than $1 million of COVID revenue for a total of just under $68 million of revenue. Our core revenue was driven by strong results across all three areas of our diagnostics business. Precision diagnostics, anatomicpathology and pharma services, including our expanded Beacon Carrier Testing for reproductive health services. We are encouraged by the outperformance in the first half of the year and seeing good sales momentum as we move into the second half of the year. We continue to make good progress with our therapeutic business, Fulgent Pharma, our novel nano-encapsulation technology, including over 40 patents and a targeted therapy platform designed to improve therapeutic windows and pharmacodynamics profile of both new and existing cancer drugs. Our lead drug candidate, FID-007, has shown promising results for the treatment of numerous cancers, including head and neck, ampullary and pancreatic, with reduced side effects. In June, we presented safety and efficacy data from the ongoing Phase 1b study at the American Society of Clinical Oncology Annual Meeting in Chicago. In summary of 40 heavily treated patients of various cancer types with weekly dose level from 50mg/m² to 160mg/m². 18% had a partial response and 35% had a stable disease. Three out of four scoring cell carcinoma of head and neck cancer patients with a partial response had previously been treated with taxanes. No high grade neuropathy was noticed. FID-007 demonstrated preliminary evidence of anti-tumor activity in heavily pre-treated patients across various tumor types. Based on the overall tolerability, pharmacodynamics and efficacy, 125mg/m² has chosen as recommended Phase 2 dose. We received a positive response for the data from medical community and continue to optimize our manufacturing process as well as preparing the initial Phase 2 studies. We look forward to sharing additional update of the start of that trial by the end of the year. We also have a deep pipeline in pre-clinical development focusing on targeted therapies for additional cancers. I'd like to thank our employees and the shareholders for your loyalty during the quarter. We look forward to the second half of the year and the momentum we are creating with our combined business. I will now turn the call over to Brandon Perthuis, our Chief Commercial Officer, to talk about our diagnostic business results during the quarter. Brandon?

Thank you, Ming. We had a record quarter for our core business, driven by strong growth in our Precision Diagnostics division. Precision Diagnostics was up 40% year-over-year and 12% sequentially. We are seeing strong demand for our reproductive services, specifically our Beacon Expanded Care Screening product, as we have now cemented ourselves as one of the market leaders. During the quarter, we saw our other divisions meet expectations with Pharma Services having another strong quarter. However, as we previously mentioned, we expect Pharma Services to be a bit lumpy depending on the timing of the service contracts. Looking forward, our Pharma Services pipeline and backlog remain strong as we continue to leverage our expanded capabilities in multi-omics and spatial biology. Not since COVID-19 have we stress tested our technology platform like we did this quarter. Overall next-generation sequencing lab volume was up 112% year-over-year. We were able to take on this volume with minimal incremental investments and were able to perform the services with only minimal temporary increase in turnaround time. We feel time and time again, we are showing real-world evidence of the power of the Fulgent technology platform and overall lab operations and capabilities. We stated before that we are a laboratory founded, designed and built by engineers. Our mission was to create a differentiated lab operation using automation, AI and informatics to be able to scale genomic testing without the high cost of continually layering on professional hires. During the quarter, we also installed additional sequencers, the most recent and highest throughput to-date, allowing us to additionally expand our capacity and lower the cost of exome and genome sequencing. We have also recently begun consolidating our two West Coast lab operations into one. Historically, we occupied two buildings a few miles apart. Bringing them together should lead…

Thanks, Brandon. Revenue in the second quarter totaled $68 million compared to $125 million in the second quarter of 2022. Less than $1 million came from COVID-19 testing in Q2, which was not part of our guidance. Revenue from our core business totaled $67 million, which exceeded our guidance of $62 million and grew 48% year-over-year. Gross margin was 30.3%. The decline in gross margin year-over-year is primarily related to the higher cost of Anatomic Pathology revenues from InformDx, which we purchased in Q2 of 2022. Non-GAAP gross margin was 33.8%. We are pleased to have achieved a two-point improvement in our gross margin sequentially over the prior quarter as we see efforts to create efficiencies across our acquired businesses pay off. Now turning over to operating expenses. Total GAAP operating expenses were $40.4 million for the second quarter, down from $43.6 million in the first quarter of 2023. The non-GAAP operating expenses totaled $30.4 million down from $33.8 million in the first quarter of 2023. Non-GAAP operating margin increased eight percentage points sequentially to a negative 11.1%, which is primarily due to adjustments and bad debt expenses and few other items, combined with continuing operating efficiencies. Adjusted EBITDA for the second quarter was a negative $2.7 million compared to a positive $37.7 million in the second quarter of 2022. On a non-GAAP basis and excluding equity-based compensation expense and intangible asset amortization, loss for the quarter was $2.4 million or $0.08 per share based on 29.8 million weighted average shares outstanding. Turning over to the balance sheet. We ended the second quarter with approximately $847 million in cash, cash equivalents and marketable securities. The decrease from the first quarter is primarily due to cash used, approximately $25 million to pay off our margin loan in full and to purchase…

Thank you. We'll now be conducting a question-and-answer session. [Operator Instructions] Our first question is coming from Dan Leonard from Credit Suisse. Your line is now live.

Thank you and good morning.

Good morning.

Paul, your revenue guidance implies a decline in your sales run rate from Q2 levels. Why would that be?

The revenue run rate for -- can you repeat the question?

Yes, the -- you're guiding for $260 million in revenue for the full year. You did $67 million in Q2. You're guiding for $65 million in Q3, which is a decline, and it looks like $65 million in Q4 as well. So I'm wondering why sales wouldn't grow from the $67 million, why they would decline?

Okay. Yes, great question. So we had outperformance in Q1 and Q2. We're still digesting the heavy increase in volume. And we feel very good about our momentum. There definitely is potential based on what we have posted in Q1 and Q2 to outperform again. And we certainly reserve the right to post higher numbers.

And then a follow-up, Paul, I know at one point, you were hoping to get gross margins to 40% by the end of the year. What is the new target? And what are the steps that get you there?

Yes. So the gross margin target for 40% a year, that's still our hope. We certainly are pleased with the gross margin jump, which had a low point of, I believe, in the 20% to 25% in Q4. We had a significant jump from that to what we posted in the first quarter. In the first quarter, the gross margin on a non-GAAP basis was 32%. We saw a two-point improvement from Q1 to Q2, which takes us up to 34%. We certainly anticipate the gross margin numbers to grind higher into Q3 and Q4. Where we end up at the end of the year, it could certainly be at 40%. But as long as the trajectory is correct as well as the rate of the change, we think that, that indicates further strengthening of our overall business model. I think the other thing, right, that we're also taking a look at, aside from just a percentage, is the absolute contribution from gross margins. And we're very, very pleased to raise our revenues twice this year, given the fact that it's only the middle of the year.

Great. Thank you.

Thank you. Next question today is coming from David Westenberg from Piper Sandler. Your line is now live.

Hi. Thanks for taking the question and congrats on a very strong performance this quarter. Can you remind us how much of the G&A is still dedicated to COVID testing? And if there's an opportunity now to get more cost savings by just exiting that business or any plans there with COVID just generally speaking?

Yes, excellent question, David. So from an overall perspective, the majority of the activity has been fleshed out related to COVID testing. During the second quarter, specifically, we had approximately a $2 million adjustment. It was actually a credit related to the AR reserve for COVID testing. That's part of the reason on why you saw the growth I mean not the growth, but the G&A expenses being light. We had a few other items that are in there. As we look ahead into Q3 and Q4, we anticipate the G&A expenses to bounce back to something that we had in Q1 or maybe higher levels. But kind of back to your question of, is COVID relatively flushed out? The short answer is, yes. I think the reason why I comment on the expense structure is even with the bump-up in G&A for Q3 and Q4, from an overall perspective, we see very good efficiencies throughout the operating expense categories of the organization. And that's being further being added if we take a look at the overall business model, with the overall strength that we're seeing with the top line as well as the gross margin improvement.

Very helpful detail there, Paul. Thank you very much. And then can you just remind us about any -- the close date last year of Inform just trying to think about the organic revenue growth as we look in the back half of the year. I believe the only acquisition you made in the back half of the year would have been the Fulgent Pharma, if I'm correct. I know this is probably a short disclarity question here.

Yes. So InformDx, it closed during Q2 of 2022. It was about halfway through the second quarter. When we take a look at the contribution of revenue from the three categories that we have, anatomic pathology, pharma services and precision diagnostics, we see absolute growth in all three of those areas when we compare it against the numbers from last year. But what really excites us is where the acceleration of the business is coming from. So we first started off the year at $240 million of revenues, and we had the contributions from anatomic pathology, which is InformDx and then precision diagnostics, evenly split with about $13 million from pharma services, which added to the $240 million. But as we take a look at the updated guidance now at $260 million, all of that is coming from either precision diagnostics or pharma services, which are very, very lucrative and attractive markets. And it's the area that we performed very, very well in where you have sequencing and a large amount of interpretation. So we really like the way that the business is headed as we look out at the end of this year and into 2024.

Got it. Thank you very much. Just one last question on the gross margin. Can you talk about the different levers? I know you just -- you said implementing a new -- you're buying a new sequencer. In terms of carrier screening, for example, which I know you're outperforming in, there's a lot of prep work. So can you just run us through all the different levers that you're thinking about in the next year to really drive those gross margins higher? And that's my last question. Thank you.

Yes. So there's a lot of blocking and tackling that we're doing in terms of improving policies and attracting higher talent. But the fundamental reason on why we have the gross margin improvement is through automation and the utilization of our technology platform. And I'll turn it over to Ming, who can reiterate the differentiation that we have in the utilization of our technology compared to other companies.

Thanks, Paul. But David bottom line is how could we use the technology to handle more fruitful, that's really the areas we put a lot of focus. We continue to apply the technology, which we closed AI, that's the areas that we started since 1990s. But since the past 30 years -- over 30 years, definitely AI has made the tremendous impact in our life. We have been riding with this technology with my experience for the past 30 years. We continue seeing that technology to be applied to the -- in the diagnostics business, and then we continue to invest and improve the technology.

Got it. Thank you very much, Ming.

Right.

Thank you. Next question is coming from Andrew Cooper from Raymond James. Your line is now live.

Hey, everybody thanks for the question. Maybe first kind of tagging on to the back end of that. You talked about the automation and the improvement there. I think you did mention in the prepared remarks, a little bit of turnaround time increase as volumes ramped as much as they did. Can you just give us a little bit more color on sort of how much that was, whether it's worked to lower and how we should think about the turnaround times as you continue, hopefully, to grow the volumes on the inbound side?

Yes. Thanks, Andrew. Good question. The turnaround time did increase, but it was a short window, right? We did a much better job capturing market share than perhaps we were anticipated, and that's great execution by the sales team and our company. But the increase in volume was tremendous. So -- and I'm proud of the lab and how they were able to digest it. I mean the turnaround time maybe had a 25% to 50% increase for a couple to a few weeks. As Ming mentioned, during that time, we began to improve additional processes and procedures and streamline. And at this point, turnaround time is back on track. I mean I think we're around 14 or 15 days for carrier screening and exomes are back down. So it was a temporary increase and really allowed us to go into the systems and make those improvements and get it back on track. And turnaround time is something we monitor very, very closely. It's incredibly important for our clinicians. While we talked about it, we've mentioned it in our script. And going forward, we intend to meet our turnaround time, which, depending upon the product, it could be anywhere between two and six weeks. But especially in the reproductive space, that sort of two-week to three-week turnaround time is critical, and we're sort of back on track and don't see any disruption to that in the future.

Okay. That's super helpful. Go ahead.

Remember, Brandon mentioned, we also made the lab consolidation during the quarter. So we are not only trying to handle increased volume, but they will also try to make the lab operations more efficient by consolidating the two locations. So those also caused a bit of transition, but we do see a good trend for the long-term to continue to handle the higher volumes and improve the turnaround time.

Okay. Great. Super helpful. And then maybe just one more on sort of the portfolio. I think there was mentioned in the call as well of looking to penetrate the OB space in terms of carrier screening. A lot of times, I feel like we hear people talk about that being bundled with NIPT. So just the latest and greatest thinking there. And then kind of related, I think on the Fulgent Oncology side, you mentioned a near one-stop shop. So just remind us what do you feel like still needs to be added into the portfolio? How do we think about addressing some of those factors and what the time lines might be?

Yes, certainly. Thanks again for the question. We actually have Larry -- Dr. Larry Weiss with us today. So I'll let him address the Fulgent Oncology question here in a moment. But in terms of our carrier screening market penetration, it's mostly been in the infertility space. We've landed some fantastic long-term clients that are mostly infertility clinics REIs. And you're correct in that to penetrate the OB space, it is much, much easier to do so if you can bundle it within NIPT. As you're aware, we currently don't have an NIPT test. That doesn't prevent us from selling to the OBs. Again, it's just easier to do when you can bundle it. So we will be able to target the OBs, especially the OBs that are referring into some of these new clients we have and be able to leverage the continuity there. But in NIPT is something we've been looking at for a long time. We continue to evaluate the space. We continue to evaluate how we can deploy our technology in that space. So Fulgent has ongoing R&D across a lot of areas, NIPT being one of them. So but again, I think, with what we've done with carrier screening, with our turnaround time, our ability to interface and integrate some of the clinical advantages we've built with Beacon in terms of copy number and dealing with pseudogenes, the proprietary algorithms, I think there's still a great story to tell to the OB market, even in lieu of having an NIPT test at this time. So Larry, you mentioned -- he asked a question about sort of what's missing to be sort of the full one-stop shop, but I'll let you take that one.

Well, I'll tell you, we recently launched liquid biopsy for solid tumor and we hope to have an HRD test before the end of the year and maybe some additional offerings in 2024.

Great. I'll stop there. Thanks.

Thanks, Andrew.

Thank you. We reached the end of our question-and-answer session. I'd like to turn the floor back over to management for any further or closing comments.

Thank you very much for joining our call today and we are looking forward to update you about our business performance during the next few quarters. Thank you very much.

Thank you. That does conclude today's teleconference and webcast. You may disconnect your lines at this time and have a wonderful day. We thank you for your participation today.