Greetings, and welcome to the Fulgent Genetics First Quarter 2024 Conference Call and Webcast. [Operator Instructions]. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Melanie Solomon, Investor Relations for Fulgent Genetics. Thank you. You may begin.

Good morning, and welcome to the Fulgent First Quarter 2024 Financial Results Conference Call. On the call 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.fulgentgenetics.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 that 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 looking 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 the 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 31, 2023, 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 expensed in the United States reported GAAP. Management has prepared these non-GAAP financial measures because it believes they may be useful to investors for various reasons, but these measures 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 first quarter of 2024 for more information, including the description of how the company calculates non-GAAP income or loss, earnings or loss per share, non-GAAP operating margin and adjusted EBITDA, and a reconciliation of these financial measures to income or loss, earnings or loss per share and operating margin, 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 first quarter and our therapeutic development business, then Brandon will review our product total market update for our laboratory service business in the first quarter. Paul will conclude with the financials and outlook before we take your questions. We are pleased with our results in the first quarter. With $64.5 million in total revenue, we recognized $1.3 million of revenue on previously built COVID-19 test. Excluding COVID-19 revenue, first quarter core revenue of $63.2 million was driven by momentum in precision diagnostics, particularly in reproductive health and oncology. All Fulgent revenue at this time originated from our laboratory services business previously referred as our clinical diagnostics business. Brandon will discuss this business further. Turning to our therapeutic development business. We continue to make good progress with the Fulgent Pharma. Our novel nanoencapsulation technology includes over 30 issued or active patents and active patent applications and the target therapy platform designed to improve therapeutic windows and pharmacokinetics profile of both new and existing cancer drugs. We are excited about this platform because it's potential to yield several drug candidates. We believe that our lead drug candidate, FID-007 has shown promise results in clinical trials today for treatment of numerous cancers, include head and neck, ampullary and then pancreatic. An abstract of preliminary HNSCC clinical results from our Phase 1/1b study has shown -- has been accepted for presentation at the 2024 ASCO Annual Meeting, which will be held May 31 through June 4 in Chicago. Our Phase II clinical protocol for second line treatment of HNSCC was accepted by the FDA, and we expect to enroll first patient this quarter. We look to bring FID-007 to more patients in the…

Thank you, Ming. Our laboratory services business includes precision diagnostics, anatomic pathology and biopharma services. These 3 represent our core revenue streams and do not include COVID-19 testing revenue. First quarter core revenue was up approximately $500,000 year-over-year, however, down about $3.3 million sequentially. The sequential decline was attributed to timing of biopharma service contracts and a decline in our anatomic pathology revenue. However, looking at our precision diagnostics revenue stream, precision diagnostics was up $9.5 million or 34% year-over-year and increased $2 million or 6% sequentially. The growth in precision diagnostics was led by reproductive health and oncology. We saw volumes continue to trend up late in the first quarter, and we exited the quarter with great momentum. We believe this momentum will carry into the second quarter. Thus, we expect approximately 10% sequential core revenue growth for the second quarter. In terms of reproductive health, the outperformance was driven by our Beacon expanded carrier screening product. We continue to execute on the operational front, delivering excellent turnaround time, clinical support and comprehensive gene content leading to increased detection rates. We also continue to execute on the commercial front, winning new accounts and working with our B2B partners to win new accounts. We have a robust pipeline for Beacon opportunities. Thus, we are predicting continued growth in this area. Our Beacon volume has mostly been limited to IVF clinics due to carrier screening often being coupled with noninvasive prenatal testing, or NIPT, at the OB-GYN level. However, for the first time, we are launching a new NIPT test. This will allow us to shift gears and focus more on the OB-GYN market. This will include hiring a new sales team with OB-GYN experience currently in progress. Our new NIPT test, which we marketed as KNOVA spelled K-N-O-V-A is a…

Revenue in the first quarter of 2024 totaled $64.5 million compared to $66.2 million in the first quarter of 2023, $1.3 million came from COVID-19 testing in Q1, which was not part of our guidance. Revenue from our core business totaled $63.2 million. Gross margin was 34.3%. The increase in gross margin year-over-year is primarily related to a decrease in overall compensation expense as we optimize our cost structure. Total GAAP operating expenses were $43.9 million for the first quarter, a decrease from $176.4 million in the fourth quarter of 2023, primarily related to the onetime noncash goodwill impairment charge incurred in the fourth quarter. Non-GAAP operating expenses totaled $32.4 million, decreased from $45.1 million in the fourth quarter of 2023. Non-GAAP operating margin increased approximately 12 percentage points sequentially to a minus 12.9%, primarily due to lower bad debt reserve and legal fees. Adjusted EBITDA loss for the first quarter was $3.2 million compared to a loss of $7.2 million in the first quarter of 2023. On a non-GAAP basis and excluding equity-based compensation expense and intangible asset amortization, loss for the quarter was $269,000 or $0.01 per share based on 30 million weighted average shares outstanding. Turning to the balance sheet. We ended the first quarter with approximately $846.2 million in cash, cash equivalents and marketable securities. We are reiterating our outlook for 2024 provided in February. With minimal revenue from COVID-19 testing expected, we're guiding to core revenue, which is total laboratory services revenue for the company without COVID-19 testing revenue. We continue to expect total core revenues to be approximately $280 million for 2024, representing core growth of 7% year-over-year. There's no revenues from our therapeutics development business anticipated in our 2024 guidance. Turning to expected margins for 2024, excluding COVID-19 revenue and stock-based compensation, we…

[Operator Instructions] Our first question comes from the line of Dan Leonard with UBS.

My first question, perhaps for you, Brandon. What gives you comfort on the revenue ramp required to hit that $280 million sales target for the year? And I think you gave a second quarter target, that 10% sequential growth, but it wasn't clear to me if that was just precision diagnostics or if that was the entire lab services business.

Thanks for the question, Dan. That would be for the entire lab services business. So what's giving us the confidence in the guide and the momentum, it's what we're seeing come through the front door, right? We're winning new opportunities. We're gaining market share in reproductive health. We're gaining market share in oncology. Our anatomic pathology business is beginning to stabilize. We had contracts in place for biopharma services that were not delivered in Q1. I mentioned a timing issue. Those contracts are in place, they will roll into Q2. So really across the -- those revenue streams, we see that momentum. And that gives us, like I said, the confidence in the annual guide, but also the double-digit growth we expect in Q2.

Appreciate that. And then my follow-up question, I was hoping you could touch on the implications of those finalized lab-developed test regulations that were issued earlier in the week, the implications for Fulgent.

Yes, certainly. I mean, obviously, a big development and new development. We're still digesting some of that information. But our initial read on that, Dan, we believe it bodes well for Fulgent. There are -- appears to be some exceptions that are made for products that are already marketed that may not have to go through a full PMA process. I mean, obviously, Fulgent has a large test menu already on the market. So that seems to bode well for Fulgent. In addition, there seems to be some exceptions for New York State approved test, which we have several of. So our read on it is we're in a good place with what we've learned so far. Obviously, we will still be under those regulations, just perhaps not a big need for PMAs. And we believe we have the quality systems expertise and ability to adhere to these guidelines. So it's likely to perhaps even strengthen our position in this marketplace. Perhaps increasing the bar and barrier for entry for new laboratories. So we'll obviously be monitoring this very closely, and we look forward to working with the FDA closely on these new regulations.

Our next question comes from the line of David Westenberg with Piper Sandler.

I'm actually -- my questions actually are going to be kind of continuation of some of Dan's question. I did love the 10% growth sequentially. Can you maybe run us through some of the things that you saw in March that give you confidence? Do you think maybe January, February might have been maybe more weather impacted? Or was there a big customer win? Just kind of run us through why March might have been so much better than January and February?

Yes. I think it's safe to say it was a big customer win, but not just one big customer win. There were multiple customer wins that happened late in the quarter. In addition, as I mentioned, there was some biopharma business that we were able to close in the quarter contractually, but not deliver in the quarter, but I would say that most of our confidence is coming from that precision diagnostics momentum, which was Fulgent gaining market share late in the quarter that we believe is going to continue throughout the rest of the year.

Got you. Okay. And I wanted to also hit on the FDA changes. Do you think any of those, for example, the new NIPT offering is going to go -- have to go to the FDA for a 510(k)? And I mean you do have a very big rare disease portfolio. Any thoughts to cost on getting into compliance as we look to the years? I know maybe you're not ready to -- or it still requires a look given the fact that this was all just this week?

Yes, thanks for the question. You're right. It's hot off the press. We certainly haven't been able to model what the cost could look like. But again, our read on it is tasks that are currently on the market would be exempted from a PMA process, not exempted from regulation. We would still have to adhere the FDA quality standards and quality guidelines and reporting, and we believe we have those systems in place, and we've been working on something similar for the IVDR stuff in Europe. So I think we're in a good place to adhere those guidelines. And certainly, there's no disruption to our product offering. We can continue to offer these products. So we'll see how that PMA exemption continues to play out for products that are already on the market. But again, we think that's a big part of this that bodes well for Fulgent considering the amount of products we currently offer.

Okay. Great. And then I'll ask an actual original question here. So just in terms of the go-to-market strategy with the OB-GYN community. How are -- how is that -- I mean, what's the investment going to look like? Are you going to target maybe submarkets first then expand like you would with -- I think when you talked about like Fulgent oncology? Or are you just going to go maybe high-level system wins? I'm just trying to think about the pacing of SG&A over the course of the next couple of years as you add that call point on. So that's really what I'm targeting in there.

Yes. Thanks for the question. I think what we're currently planning right now is ramping to a new -- net new sales head count of around 20 people by the end of 2024. Again, this is a novel NIPT product. It's not lost on us that relate to this market and relate to this game. But we've talked about this for a while that we were interested in this market, but we did not want to launch another similar product that was on the market. So I think we were able to develop this product, be a differentiated product. We do expect volume to start slowly. We will be offering this novel product. So there will be some education involved in why this product is different and how this product leads to additional diagnostic yields and we'll be able to detect a significant number of conditions that are currently being missed, buy products on the market. So a long answer to your question of we will build the sales team gradually throughout the year. In terms of a regionality approach, we believe there's no particular reason to focus in certain regions other than just based on population density and where pregnancies are happening. But other than population density, I don't see any reason that we have to focus on certain regions or states. So I would consider this a national rollout, but again, starting slowly throughout the year.

Our final question comes from the line of Andrew Cooper with Raymond James.

Maybe just first kind of following up on the OB-GYN launch. Just to make sure we understand the guide, nice beat on the bottom line in 1Q, but some step down in the margins from here. Is part of that in terms of reiterating the guidance layering in incremental costs from this KNOVA ramp in build-out? Or was that already contemplated in the prior guide?

Yes. Thank you for that question. The operating expense structure that we have experienced, including the first quarter, we've had benefits from particularly like collection and lower fees from an operating expense perspective. If you take a look at our operating expenses in Q2, Q3 and Q4, that should be more normalized, which is consistent with the original guide that we had. So excluding stock-based compensation, we anticipate the operating expenses to be approximately $43 million in each one of the quarters of Q2, Q3 and Q4. But I think the real highlight of what we wanted to point out was, one, the elevated revenues and the expansion of the business that Brandon indicated. So what we're indicating for the second quarter is core revenues to be approximately or in excess of about $70 million. That already puts us at a $280 million annual core revenue rate, which we're very, very pleased with. The other thing that I want to point out is our gross margin. We've been talking about increasing our gross margins for some period of time. And with the acquisitions that we made a year or 2 ago, if you take a look at our gross margins, excluding stock-based compensation and if you strip out the COVID-19 revenues, in 2023 in the first quarter, we had our gross margins at approximately 28%, and then that increased to about 33%. And then in Q3 and Q4 of 2023, it was approximately 35%. This quarter, that gross margin rate was approximately 36%. But starting in the second quarter of 2024, we anticipate our gross margins excluding stock-based compensation to be approximately 40% or higher. We think that, that will grind even higher than that in Q3 and Q4 to approximately 42%. So what we see is, one, our core revenues are being intact because we raised our guidance from $260 million to $280 million, but we see the gross margins continue to grind higher for the business, which we're very proud of.

Okay. That is helpful. Maybe next just on AP. I know precision diagnostics, you spend a lot of time on doing very well. I do want to dive in a little bit just on anything that you've seen on the anatomic pathology side in terms of competitive landscape or any share shift and maybe what you attribute that to and how you can get that business back to a little bit healthier growth there?

Yes, certainly. Thanks for the question. I think one of the things we've done there is a revamp of the sort of go-to-market strategy and the sales organization. I don't want to get into the details specifically, but sort of the focus of the sales team, their roles and responsibilities, wasn't overly calibrated to hunting and finding new business. So we -- this year, in January this year, we've revamped that and change that go-to-market strategy. In addition, we've layered on some additional sales leadership and additional sales head count for that area. So we expect that team to perform better this year. I wouldn't say there's been any macro changes in the competitive landscape or market share. We continue to see consolidation with physician groups. And sometimes that would lead to creation of these super groups and physicians-owned laboratories, so they continue to be a competitor. But our goal there is to blocking and tackling and getting back to growing that business. We have the quality turnaround time, the subspecialty trained pathologists, the product menu, to be successful in that space. For some time, we've talked about synergies with the precision diagnostics division and the ability to cross-sell. I would say over the last year or so, we've been sort of more focused on fixing and growing the AP business, but as we're beginning to see that business stabilize, I think we're getting to the point now where we can spend more time and energy on these opportunities to cross sell. For example, perhaps cross-selling the germline hereditary oncology to many of our AP clients, which include GI, GU and derm. So we continue to invest in that business, again, focusing on operations there, improving operational efficiencies. But obviously, importantly, we do want to see that business return to top line growth.

Ladies and gentlemen, that concludes our Q&A session. And this concludes our call today. We thank you for your interest and participation. You may now disconnect your lines.