Earnings Call: Q3 2019

Nov 4, 2019

ladies and gentlemen, and welcome to the Q3 2019 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 follow at that time. As a reminder, this conference call is being recorded. I would now like to turn the conference over to Nicole Guarci, Investor Relations. Please go ahead, ma'am. Great. Thank you. Good afternoon, and welcome to the Fulgent Genetics' 3rd 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, fultrantgenetics.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 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 Q for the Q2 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 the 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 Q3 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 income 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, Nikhil. Good afternoon, and thank you for joining us on our call today to discuss our Q3 2019 results. I will review the highlights from the Q3 before Paul discuss our financial results and outlook in detail. The Q3 was another very strong quarter for us. We once again achieved record quarterly results for both test volume and revenue, while driving ongoing improvements in gross margin and cost per test. We once again achieved GAAP profitability and generate strong cash flow. Specifically, the revenue grew 84% year over year to a record $10,300,000 Billable test increased 2 72% year over year to a new record high of 20,697. Dollars Our ASP was $500 essentially flat compared to the Q2 of 2019. While our cost protests continue to improve, further increased our gross margin. Excluding stock based compensation, cost per test improved to a record low of 1 $179 per test. Non GAAP gross margin in the 3rd quarter was 64%, up approximately 8% point from the 3rd quarter last year and up approximately 5% point sequentially. GAAP income was $1,500,000 and the non GAAP income was $2,600,000 Non GAAP earnings per share was $0.14 in the 3rd quarter. Adjustable EBITDA was positive $2,900,000 in The 3rd quarter was another record quarter for 4GIN Genetics, demonstrating the consistent attraction we are gaining in the market. Given the recent ramp, we have seen volume, we thought it will be helpful to offer more insight into our test mix and how this is driving our growth. First, our core clinical 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 panel, Our superior quality rapid turnaround time as well as competitive pricing are driving notable growth in volume. And as a result, oncology is becoming a growing portion of our revenue. 2nd, we are seeing increased demand for our sequential service business from channel partners. We have established with various institutions and pharmaceutical companies focused on genomics for the therapeutic discoveries and development. 3rd, we are satisfying several logistic partnerships with the cash paying commercial genomic laboratories. We have seen early results from these partnerships, which have provided additional fuel 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 expanded our most optimistic expectations at the start of the year. We remain measured as we look ahead and focus on increasing the sustainability of this growth. To that end, we anticipate the fluctuations in the short term demand as our strength diversify and expand our business over the long run. We are confident that investment we have made in additional sales avenues outside our core clinical business will contribute a large part of our business over time, driving increased stability and consistency. As our volume has ramped, we are seeing rapidly able to manage this increased activities due to the investment we made in bioinformatics, computer science, artificial intelligence, people and automation in the recent years. Our lab has operated more efficiently and we still have a lot of capacity for additional volume. With this increasing volume, the efficiency of our business have become more financially impaired and we can see this in our gross margin and the bottom line. Most notably we have continued to see improvements 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 the 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 end market position standpoint. Years of experience in our traditional core area of pediatric rare disease has provided expertise in variance and the interpretation as well as help to establish scientific findings, which is a treatment guideline for the certain disease. An example of this is the work I have done with the Parkinson Foundation, which is leveraging our data and expertise to develop a more efficient treatment solution for the disease. In addition, our software expertise from our engineers has not only provided proprietary approach but also ability to develop and introduce quality test within month with minimum financial investment. This enables us to both introduce TES into the market quickly where we see a need or opportunity and maintain one of the largest libraries of existing tests with no additional overhead. Further, unlike many genetic testing companies, our textiles platform give us the ability to perform all these tests in house without need for outsourcing. We believe that this financial, operational and technological distinguishes differentiate us from other genetic testing concepts in the market. To that end, we recently announced and launched PICTURE GENETIC, a patient initiative of consumer genetic testing offering, which we believe offers a new level of genetic testing capabilities to everyday consumer. We are pleased to able to bring clinical greater genetic testing results to consumers directly to enable them to make a more informative decision about their health. PICTROGENEXT is different from recreational at home genetic testing offering because they provide actionable clinical results along with genetic counseling support for those who need it. We are also offering 3 different tests through 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 don't expect to see meaningful revenue contribution from this test in the immediate term. Our low cost structure and the net efficiency enable us to sustainable provide this service to consumers at an affordable price. Overall, we have opportunity to have success driving line growth and expanding our test offering with little incremental overhead. We remain disciplined in our approach to spending and continue to see investment we have made paying off in growth. In the area of investment, we have continued to invest in research and development to enhance our test menu. In the Q3, we have announced a new test for reproductive health, which is now available for consumers. We are pleased to announce the launch of our PTTA test which identifies potential of normal in the ambuaries during an IVF process. This test has women during the IVF process and enable them to have more control over embryo selections and the transfer. Ultimately, the increase in probability of healthy pregnancy. In the last 12 months, we have launched numerous new tests with the various of vertical markets, which fueled our growth. In summary, another very strong quarter as we have seen a notable growth inflections in 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 Q3 and he also provided an update on our financial outlook for the full year 2019. Bob? Thanks, Ming. 3rd quarter revenues totaled $10,300,000 an increase of 84% compared to the Q3 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 Q3 representing 82% of total revenue in the quarter, up from 79% in the 2nd quarter. Available tests reached a new record high of 20,697 in the 3rd quarter, growing 2 72% over Q3 of last year and increasing 26% over the Q2 of 2019. Our ASP was $500 per test essentially flat from the Q2. 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 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 efficiencies we're seeing. Non GAAP gross margin improved 5 percentage points sequentially and 8 percentage points year over year. We expect that gross margin should remain strong in the coming quarters. For operating expenses, we remain committed to managing expenses while investing for future growth. With outperformance, we again delivered a positive operating margin for the 2nd quarter in a row. Non GAAP operating margin was 24 percent in Q3, an improvement of 28 percentage points year over year and 11 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 $1,700,000 in the quarter, up from $1,300,000 in the 2nd quarter. R and D expense in Q3 was $1,700,000 higher than $1,600,000 in the 2nd quarter. As Ming discussed, we continue to make investments in R and D as we grow our test menu and expand our market reach with our offerings. Lastly, G and A expense was $1,500,000 down from $1,600,000 in the 2nd quarter. Total GAAP operating expenses were $5,000,000 for the Q3, up from $4,500,000 in the 2nd quarter. Non GAAP operating expenses totaled $4,200,000 up from $3,900,000 last quarter. We're very pleased that we've been able to demonstrate strong momentum on the top line, while 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 business is paying off. Adjusted EBITDA for the Q3 was a positive $2,900,000 compared to $281,000 in the Q3 of 2018. On a non GAAP basis, excluding equity based compensation expense, income for the quarter was 2,600,000 dollars or $0.14 per share based on 19,500,000 weighted average common shares outstanding. The effective tax rate at the end of the 3rd 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 2019. Now turning over to the balance sheet, we generated very strong cash flow in the 3rd quarter on our strong results. We remain committed to generating cash from operations going forward. We remain committed to generating cash from operations going forward. As you may have seen, we filed an at the market shelf offering since the Q1, which enabled us to sell primary stock in the open market. Over the course of the quarter, we sold approximately 104,000 shares and generated approximately $1,270,000 growth in cash from this program prior to offering expenses. We ended the quarter with $43,600,000 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 4th quarter revenues will be approximately $8,000,000 which translates to revenue for the full year at 32,000,000 dollars This represents a year over year growth rate of approximately 50% for both the Q4 and the full year. I would also like to take a minute to elaborate on a point that Mig 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 are outsourcing to Fulgence. The financial results we demonstrated in recent quarters further validate our technology, operational differentiation approach to the market is sustainable longer term in this growing but highly competitive environment. Now armed with the business that not only is forecasted 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 as a service business, establishing deep collaborations with key medical institutions and making reimbursement an incremental growth driver for the future. We will provide further color and details 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. 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 Q4 just to just 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 does that impact ASPs? I'm just trying to get that ASP versus volume mix appropriate here for the Q4. Thanks. Paul, do you want to take that? Sure. So thank you for the question, Aaron. We've had a great Q3. We did 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 test and the acceptability of that and the traction, 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 and our stance is on point, and I'd 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 7,000, 8,000 tests per quarter, and now that's grown to 20,000. And looking at our prudent guidance for Q4, these customers and the 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 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're 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 test. But we don't know, quite certain how to how that's going to impact the reimbursement experience, for these organizations that are submitting the claims. So 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 6 months, provides us the input on why we want to be able to be a little metered for the Q4. 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 $26,000,000 which was a 20% increase in our business compared to 2018. Subsequent to that, we raised it to $29,000,000 and now we're raising it to $32,000,000 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 perform all these tests across the board. But when you roll all of that up, whether it be on a GAAP perspective or on a non GAAP perspective, we're very proud of our cost per test being at $170 to $180 range. And we believe with additional efficiency and with additional growth, there's meaningful room to drive those costs down further. And also, Aaron, as you probably know, the CMS reimbursement rate is a lot higher than our ASP. With the growing volume we have lately, we definitely generated the attention for the National Insurance organizations. They do see a 4GIN 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 if we purely, I think our business cannot be measured by test volume. Really how much we could drive the technology, deliver the test and build a sustainable commercial model. 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, that is a great question. If you take a look at the even though our revenue growth is almost year over year as Paul gave the guidance for 50%, Our headcount has not increased dramatically. We continue to improve in terms of our sales executives. We're 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 now from the 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 Quirk from Piper Jaffray. Your line is now open. Hi, this is Rachel on for Bill. Congratulations on the 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 to the competitive dynamic. So is the environment more stable at this point? Or do you think you will 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 the pricing pressure, we definitely have a lot of room to cut the price and we are not giving test away free. But in that sense, I think that we do need to make sure we had to build a business model, which should be sustainable. We cannot use $1 to buy $0.40 or $0.20 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 profitable. Otherwise, we cannot continue reinvest into the business or we can repay back the back to our investors. I think that in this area, I think we have room to drop the continue to drop the price as we continue to see that our cost can be continue lower as we see the volume growth. But we're ready to go for this another challenge into the area. But I think even though we've dropped the FAS this year, we still maintain our gross margin around 60%. Rachel, I'd like to add a few comments. I think your comment about the ASPs is something that several individuals they brought up. I think if you take a look at the ASPs about $500 in Q3, that's a little bit lower, but it's pretty consistent, relatively flat with what we had in the Q2. I believe in the Q2, it was like $5.10 or $5.12 The thing that's driving the ASP number is primarily mix in this competitive environment, big environment but 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 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 ASPs, which you really saw between the 1st and the second quarter, our gross margins, they continue to go up by whole percentage points. They went up by whole 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 will 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, exome 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? Yes. So 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 in the cancer related area is a significant portion of our business. Less significant, although what's notable is the revenues that we're getting from the women'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 this is Paul's answer. As we see pretty strong demand for our carrier screening test internationally. So that's one of the strong growth area. And in addition, we definitely have developed more of the relationship with the institutions, the Tensor Research Institutions. We mentioned about the Parkinson's Foundation last time. Recently, we have another contract with another major Parkinson Foundation to contract our test for them to diagnose and treat the Parkinson patients. Great. Thank We have a question from the line of David Westenberg from Guggenheim Securities. Your line is now open. Hi, thanks for taking the question. So can you explain driving the outsourced phenomenon in the quarter? You've been around for a while and kind of why do you think you're seeing kind of a step up in the volume there? Thank you. Yes. David, I think really if you take a look at the 3rd quarter results, really it's reflected our discipline fees of our investment in terms of test we introduced in the last year end of last year and early this year. We do believe the technology, it is one of the major differentiator for us. As Paul earlier mentioned, we do not separate the number of tests for cancer, carrier screening, rare disease or the service revenues because we couldn't. They all comes in from various sources and they are mixed. Fortunately, we have our automation. When the orders comes in, it's automatically tracked by the hour called the Fortune Track, the molecular barcode for every text comes in. Once we get into the system and the system will select based on the customer's request for the test, They are either from the research for the both RNA and DNA test as well as some companies required or the institutions required to clinical orders for the rare disease cancer or carrier screening test. All these things will be at the end classified by our biometric informatic pipeline and it can generate the clinical related reports. So we do feel that Fusion have the technology advantage because not only we have strong biochemistry, but we're also very strong in terms of artificial intelligence and computer science and data science. So Paul, you have anything to add on? Yes. So David, I think since the call began, the lines of the Q and A were really behind the numbers, the reason for the numbers and kind of guidance going forward. And 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 Fulton, and we're really pleased with that. Not only do we have stability within the sales organization, but we really honed in our operational capabilities as well, which is evidenced by us suggesting that volume and facilitating that, 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. 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 indicated. And we continue to produce offerings at a record pace, picture genetics being one of them, with very, very minimal investment. So armed with 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, Folgen 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 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. Appreciate that. That's a lot of good info there.