Earnings Call Transcript - FLGT Q1 2020

Operator, Operator

Good afternoon ladies and gentlemen, and welcome to the Q1 2020 Fulgent Genetics Earnings Conference Call. As a reminder this call is being recorded. I would now like to hand the conference over to your host today, Ms. Nicole Borsje, with Investor Relations. Please go ahead.

Nicole Borsje, Investor Relations

Great, thanks. Good afternoon, and welcome to the Fulgent Genetics first quarter 2020 financial results conference call. On the call today we have Ming Hsieh, Chief Executive Officer; Paul Kim, Chief Financial Officer; and Brandon Perthuis, Chief Commercial 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 such 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 full year 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 first quarter of 2020 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 earnings per share, the most directly comparable GAAP financial measures. With that, I'd now like to turn the call over to Ming. Ming?

Ming Hsieh, CEO

Thank you, Nicole. Good afternoon and thank you for joining our call today to discuss our first quarter 2020 results. I will review the highlights from our first quarter before handing over to our Chief Commercial Officer, Brandon Perthuis, to provide updates on our go-to-market strategy. And finally, Paul will discuss our financial results and our outlook in detail. While we had a good start to the year, the global proliferation of the novel coronavirus has had a meaningful impact on our business, both in terms of demands of our core testing business, as well as on our operation. Specifically, due to early decisive action we took to recover our company to address the large market need for testing solutions aimed at this pandemic. As we discussed briefly on our last earnings call, we were quick to pivot our resources to focus on development and the launch of testing solutions for COVID-19 in the first quarter. I will speak on these dynamics in detail in a moment, but first, I will provide a quick update on our results for the first quarter. Revenue was in line with our expectations for the first quarter, growing 44% year-over-year to $7.8 million. Billable tests increased 75% year-over-year to 13,163. Our ASP was $589, essentially flat with what we saw in Q4. While cost per test increased 18% from Q4. Non-GAAP gross margins in the first quarter were 51%, up approximately 300 basis points from the first quarter last year and down approximately 8 percentage points sequentially. This sequential decline in gross margin was due to both test mix along with investment and expenses related to the rollout of our COVID-19 tests. Adjusted EBITDA loss was $506,000 in the first quarter. Before I get into the impact of COVID-19, I want to spend a few minutes discussing what we saw across our core business. As you can imagine, we saw a significant slowdown in test volume activity beginning in March. As we began to institute shelter-in-place mandates, the non-essential testing for traditional genetic testing materially decreased. During January and February, our oncology, reproductive health, and pediatric business continued to drive the majority of the revenue we saw. Our customer base continued to diversify as we added more core customers and saw strength across all segments of our businesses before experiencing a slowdown in March. As you all know, the coronavirus has caused significant disruption in our everyday life, which has impacted businesses around the world in various ways. I would like to discuss how this has impacted our business operations, as well as how we plan to capture market share in the COVID-19 testing solutions to drive incremental revenue. First, from an operations standpoint, our lab in Tempe City continues to operate and process samples under strict health and safety precautions. Due to our lab offering screening products for COVID-19, it qualifies as an essential business under California's shelter-in-place mandate. So we have been able to operate normally without any disruption. In fact, we expanded our lab capacity during this crisis and invested in resources to achieve our safety certification required to handle COVID-19 tests. Because of this investment, we are able to offer end-to-end tests for COVID that are largely appealing to our customers. Outside the lab, our employees have been operating remotely, coming into the office on an as-needed basis with minimal disruption. We are thankful to our employees both in the lab and at home, who have continued to support our operations around the clock during these challenging times. From a product development standpoint, we have been working on several different initiatives since the virus began to spread in February. Our goal has been to develop quick quality tests that are readily available and accessible to both healthcare providers and individuals to help alleviate the shortage we have seen in testing capacities in the overall market. We have announced and launched two distinct tests for COVID-19. One of our tests is based on RT-PCR technology, which is the most common approach for COVID-19 tests in the market today. Launched in early April, this has offered the most rapid turnaround time, given their more limited targeting of two distinct regions with COVID-19. In March, we also launched a test based on next-generation sequencing technology, which uses a more comprehensive laboratory and combination method to detect the virus that caused COVID-19. While the complexity of this NGS test results in a longer turnaround time, we believe this test can be utilized to collect data that can be used by research institutes to learn more about the nature of the virus and potentially assist in the development of vaccines or treatment options. In addition, the NGS-based test is not limited by the need for reagents, which have been difficult to source due to the overwhelming market demand. In addition to the two tests we have launched for healthcare providers, we also have been working on an at-home test kit for COVID-19 through our consumer initiative genetic testing platform, Picture Genetics. Brandon will talk more about this momentarily. We are pleased with our ability to develop and launch this test in such a short amount of time, given the resources required and the relative size of our organization. Over the years, we have discussed a lot about our flexible technology platform and how it enables us to offer one of the broadest genetic test menus in the market. Our ability to deliver this test for COVID-19 is a testament to the fact that our technology is truly differentiated. The platform we have built has enabled us to pivot quickly to offer a wide range of testing solutions with minimal incremental overhead. Paul will discuss the financial impact of COVID-19 in more detail. But on a high level, the investment we made in this quarter in developing tests for COVID-19 resulted in incremental expenditures of approximately $1 million. Additionally, across our business, including the procurement of our supplies, which is still difficult to solve, we are confident that we will see a strong return on this investment, which will be beneficial to our business in the long term. While the circumstances surrounding COVID-19 are unfortunate, our hearts are with those affected; we believe our response to the need for testing has strengthened the whole Fulgent platform and technology, setting it apart from others in the market. Looking ahead to the rest of this year, we will continue to focus on offering accessible testing solutions for COVID-19 products without losing sight of our core business opportunities, which we hope will pick up as we continue to believe in the long-term need for genetic testing. On the FLIMS side, we also believe our TPT will be quicker, with the addressable market being larger than before this pandemic. With that, I would like to turn the call over to Brandon Perthuis to provide an update on our go-to-market initiatives, including insights on the demand we're seeing for our COVID-19 test. Brandon?

Brandon Perthuis, CRO

Thanks, Ming. As Ming mentioned, our hearts go out to everyone who has been impacted by the COVID-19 pandemic. We hope to all emerge from this stronger than we were before. I would like to take a few minutes to discuss our core business and our new tests for COVID-19, which are uniquely meeting the needs of various organizations. During the quarter, we made testing for our core business more accessible through online ordering for our rare disease, oncology, and reproductive health clients. By adding these capabilities to our fully operational laboratory, we continue to deliver high-quality results to customers with no negative impact on turnaround time. Sequencing as a service had a strong quarter; it continues to be a growth area for our company as we expand our reach with biopharma and contract research organizations. During this difficult time, we remain committed to delivering the same high-quality services that our customers have come to expect from Fulgent. Turning to COVID-19, as Ming mentioned, we launched two tests for COVID-19: NGS and RT-PCR. We have seen demand from hospital systems, clinics, large corporations, and other healthcare providers for preclinical testing via RT-PCR. We are also seeing interest for our next-generation sequencing test as researchers turn to sequencing the genome of SARS-CoV-2. Many of these organizations are new clients to Fulgent, and it is likely these newly formed relationships will expand to other services we provide in the future. Operationally, we have added an additional shift at our laboratory and are now fully operational seven days a week. This has increased our capacity for COVID-19 testing, and we are now processing thousands of tests per day. We continue to see a significant need for our services, but perhaps more importantly, we continue to receive outstanding feedback from our clients. Our turnaround time on COVID-19 tests has averaged less than 24 hours, which has been critical to our success. We have received feedback that many labs are taking two to three days to deliver results, with some labs taking as long as five to seven days. The custom portal we built for COVID-19 makes results accessible to healthcare providers across a variety of platforms and makes it easy for them to differentiate between detected, not detected, or indeterminate results. This portal has also helped with the necessary reporting as mandated by local and state organizations. Healthcare providers have been extremely pleased with this new portal and our overall service. One notable example of a new customer relationship stemming from our COVID-19 testing solution is with a nationwide network of specialty care clinics. This customer is leveraging our COVID-19 testing solutions across its more than 2,000 locations to screen patients who need to be seen at the clinics for other chronic care. Our rapid turnaround time and the ease of our platform were the primary reasons we won this business over others we competed against. Moving forward, our commercial team continues to be focused on making our COVID-19 test readily available to patients, and we expect to see continued demand as the need for testing associated with reopening the country is likely to be elevated for some period of time. In addition to serving hospitals and clinics with our COVID-19 tests, we recently submitted an emergency use authorization to the FDA for our at-home COVID-19 test, Picture by Fulgent. As a reminder, Picture Genetics is our consumer-initiated platform, which we launched in 2019. These COVID test kits will be offered through our Picture Genetics website and will be available to individuals who screen as eligible through an online portal. Individuals would receive results back within a matter of days. We believe our at-home test can play a major role in fighting this virus. Conducting the test collection at home conserves valuable time and PPE resources that clinicians would otherwise require to perform these tests on patients. The price for the service will include bidirectional shipping and a telehealth component. Many patients will be able to follow this with their health insurance, which should reimburse for most of the costs of the test according to the new CMS fee schedule for high-throughput COVID-19 testing. We are in the early stages of our go-to-market strategy for this service, but we intend to dedicate significant resources to letting consumers know this test is available. Given the uncertainty around the FDA response, we cannot offer much more insight into the impact of this at-home test at the moment, but we will communicate any notable updates as appropriate. Though the progress we made as a company related to COVID-19 has been considerable, we also look forward to our non-COVID-19 business picking back up as the lockdown across the country slowly begins to lift. I'll now turn the call over to Paul to provide details on our financial performance in the first quarter, as well as an update on our outlook.

Paul Kim, CFO

Thank you, Brandon. First quarter revenues totaled $7.8 million, an increase of 44% compared to the first quarter of 2019. Our U.S. business remains the most significant driver of our momentum. Revenue from the U.S. grew 56% year-over-year in the first quarter, representing 73% of revenues during the quarter. As Ming indicated, our business continued to diversify and we did not have a single customer during this quarter who comprised more than 10% of revenue. Billable tests in the quarter totaled 13,163, growing 75% organically over Q1 of last year. The vast majority of this volume was from our core business and unrelated to COVID-19, although we did start to see some of this volume come in at the very last week of the quarter. Subsequent to March 31, the COVID volume has been tremendous. Our ASP in the first quarter was $589, essentially flat with the fourth quarter. Cost per test for the quarter was $308 on a GAAP basis and $291, excluding equity-based compensation of $231,000. Our non-GAAP gross margin improved approximately 300 basis points year-over-year to 51%, but declined approximately 8 percentage points sequentially. There were two primary reasons for the increase in cost per test and lower gross margin this quarter. First, the higher costs of procuring reagents and supplies and kits related to the mix of tests, specifically the COVID-19 tests. The second was the increased personnel costs related to the expansion of our lab capabilities, also to address the demand for COVID-19 offerings. Now turning to operating expenses. As Ming indicated, we made significant investments in the development of tests for COVID-19, which amounted to approximately $1 million in total costs across all areas including COGS of our business. As a result, we saw a non-GAAP operating margin decline approximately 19 percentage points sequentially to negative 13%. These incremental expenses were distributed across our cost of revenues, R&D, sales and marketing, as well as SG&A, with a somewhat out proportioned size to R&D and COGS. Our GAAP operating expenses were $5.6 million for the first quarter, up from $5.2 million in the fourth quarter. Non-GAAP operating expenses totaled $4.9 million, up from $4.4 million last quarter. We believe that we will see a strong ROI from the investments we've made in our COVID-19 test offerings almost immediately, and we believe these investments are extremely beneficial to our business in the longer term. Adjusted EBITDA loss for the first quarter was $506,000 compared to $712,000 in the first quarter of 2019. On a non-GAAP basis and excluding equity-based compensation expense, loss for the quarter was $749,000 or $0.03 per share based on $21.6 million weighted average common shares outstanding. Now turning over to the balance sheet; we remain very comfortable with our current cash and liquidity position. We ended the first quarter with $70.6 million in cash and marketable securities with no debt. As indicated in our press release, we generated cash flow from operations in the quarter of $1.4 million. Now moving on to our outlook, given the uncertainty we're seeing in the broader market, including the slowdown in demand for our core testing business coupled with the volatility associated with test volumes for COVID-19, we feel that it is prudent to withdraw the full year 2020 outlook as we previously provided. However, as it relates to the second quarter, we expect revenues to be flat to slightly down compared with the first quarter. There are a few variables we’re taking into account when evaluating our overall guidance for Q2, including how much revenue we could generate from sales of our COVID-19 tests balanced with the weakness we're currently seeing in the traditional genetic testing market. While we have already seen very healthy demand for our COVID-19 test offerings, it has only been about a month since our launch. In addition, pricing on these tests is lower than what we usually see from our core test offerings, causing a drag to our ASP. Having said that, the volume is ramping exponentially, and the reception to our tests has been overwhelming since our launch in April. To keep up with the enormous volume, we're hiring across all departments of our company. We're also maintaining positive gross margins on these tests, which should expand further as we scale. In summary, it is too early to gauge what the incremental revenue contribution would be, and we're not in a position to offer revenue guidance for the full year 2020 given the very short history of these dynamics. Overall, while the start to our year was unlike anything we could have planned, the opportunity for us is promising as we look to provide testing solutions for COVID-19 in these uncertain and unprecedented times. We feel that our technology platform and our differentiated approach to genetic testing, combined with our strong capital structure and business discipline have positioned us well to sustain and grow our business. We also believe that our capabilities as an organization will be stronger now that we can address larger screening markets on top of genetic testing. Thank you again for joining our call today. Operator, you can open it up for questions.

Operator, Operator

Our first question comes from Erin Wright with Credit Suisse. Please go ahead.

Erin Wright, Analyst

Can you speak to the nature and magnitude of the volume dynamics that you were seeing, particularly at the end of March for the core business or the non-COVID business? Obviously, some of the COVID testing is helping to offset that I guess. I'm trying to think about how we should consider any sort of recovery and sort of the magnitude of that trajectory over the course of March and into April? Thanks.

Paul Kim, CFO

Erin, this is Paul. I think a lot of people have seen that for traditional laboratory testing, including genetic testing, that the drop-off from the traditional business related to the environment of COVID-19 has been anywhere from 25% to 30%, down to 50% for some businesses. I would say ours is on the lighter side, rather than a scenario that's like 30%.

Erin Wright, Analyst

Okay, that's helpful. And how should we think about some of the volume coming back, like how quickly can some of the volume realistically come back given the test mix dynamics that you're seeing?

Paul Kim, CFO

Sure. Brandon, do you want to address that one?

Brandon Perthuis, CRO

Yes, sure. Erin, Brandon here, it's a great question. I think it's difficult for us to answer that. I mean we're certainly seeing the country begin to reopen. We're seeing some of these stay-at-home orders being lifted. So we expect there to be a backlog of patients that will need access to testing. The drop-off in volume doesn't mean fewer patients that need to be tested. It just means these patients didn't have access to testing. As these hospitals reopen for other than emergency care and critical surgeries, as people get access to their clinics and to their physicians, we expect the patients that were not tested during this time will still need the types of products and services we have. The timing of that, obviously, it's hard to predict. And it depends on how fast we can open the country back up. But certainly, we think that there will be a bit of digestion on this backlog as time moves on.

Erin Wright, Analyst

Okay, great. And then on the specialty care clinics, can you speak to how big that win is for you? And does that relationship span the entire offering and/or how can you expand sort of that relationship, it sounds like a good win for you? Thanks.

Paul Kim, CFO

Brandon, do you want to address that one?

Brandon Perthuis, CRO

Yes, sure. Erin, Brandon again. It was absolutely a significant win for our company. It was competitive. We won the business based on our turnaround time, our service, our portal, the things that make a difference when it comes to the test. Currently, it is exclusive to COVID-19 testing, but I think this relationship has a lot of potential to expand into other services Fulgent provides.

Erin Wright, Analyst

Okay, great. And just one more, you said revenue in the second quarter to be flat to slightly down. Does that assume a continuation of the trends you're currently seeing or any sort of improvement, and does it include both your COVID testing capabilities and your dynamics across the core testing market? Thanks.

Paul Kim, CFO

So Erin, this is Paul. The short answer is yes; that includes both, but we also want to be prudent about guiding to any kind of a number. Because I think we're one of the few companies speaking about this immediate quarter. I think the difficulty for us in trying to gauge where Q2 might come in isn't related to our genetic testing business; we actually feel very good about that and there is a backlog as Brandon has mentioned. I think it's nor is it related to our optimism regarding demand and volumes related to COVID-19. I think it's just a short period of time that we've had. As we indicated, we launched one test toward the second half of March and the other one on April 9. So it's really been about a month, a little less than a month for the RT-PCR test since we have launched. The growth and reception that we've had just within three to four weeks has been overwhelming, and it's been growing exponentially. So trying to assess what the volatility and trajectories might be within the short period of time that we've been offering the COVID tests is difficult to project into any kind of prudent guidance, even if we're talking about the second quarter.

Operator, Operator

And your next question comes from the line of Steven Mah with Piper Sandler. Please go ahead.

Steven Mah, Analyst

Thanks for taking the call and questions. One follow-on question to Erin and then I'm going to ask coronavirus questions. But on the Q1, what run rate on volume were you tracking without the coronavirus impact? I am just trying to get sort of an estimate on the potential backlog you guys have?

Paul Kim, CFO

Yes, so if you take a look at the composition of the $7.8 million that we achieved in the first quarter, the vast majority, more than the vast majority, you know, I might even use the word virtually, our revenues came from the orders that we received in the back half of December, January, and February. We saw the drop off happen starting in March, and then it precipitated to go lower. Giving you a little bit more information; after it went lower, it essentially leveled out during the month of April.

Steven Mah, Analyst

Okay, that's helpful. So okay, that’s helpful. Okay, moving on to coronavirus side, yes I know you guys have said that adoption rate is pretty substantial right now. And you guys are hiring to meet that demand. Maybe can you give us a little bit of color on your capacity for this COVID-19 testing? And also, what is the split between the RT-PCR version and the NGS version?

Ming Hsieh, CEO

Steve, this is Ming. I'll probably address the first part and then let Brandon address the second part. In terms of lab capacity, currently we are able to process up to 5,000 tests per day and we're looking forward to expand to up to 10,000 at the end of the quarter. This really depends on the demand from the market. Currently, as you may know, there's a lot of shortages in terms of the collection kits, reagents, and equipment. So we're balancing those kind of demands now as we've seen the demands kick in, and we’re adding capacity gradually. We do have the capability to add up to 10,000 per day. We are also running three shifts to make sure we have personnel shifted from some of the traditional genetic business to run the COVID-19 related business in the RT-PCR and NGS. In terms of NGS, it is much, much slower than the RT-PCR and also costs a lot more. But the benefit we have is from dealing with research institutions and pharma; they are very much looking forward to knowing more and deeper about this virus. I think it's a - for in terms of comparison, we almost see about a 10 to 1 ratio in terms of the test. But for those tests, we see all the positives or for some capacity it's inconclusive. We have NGS method for confirmation, and it also gives us a lot better understanding of how this virus develops or mutates. Brandon, do you want to cover something more?

Brandon Perthuis, CRO

Sure Ming, I think you did a good job there. Steven, thanks for the question. The vast majority of the clinical testing we're doing is RT-PCR mostly because of the turnaround time. As Ming mentioned, it’s difficult to turn NGS around faster than two or three days. We believe this test needs to be delivered within 24 hours. So the majority of our clinical testing is RT-PCR, but we are seeing requests and demands from organizations doing research. They want to sequence the genome. So we do see some requests for our NGS tests as well. The NGS test could absolutely be used as a clinical test. Again, it's just slower, but should we ever have any supply chain issues or any disruption, we would be able to pivot to NGS as necessary.

Steven Mah, Analyst

Right. Maybe a follow-up question. So yes, it looks like the NGS version is more of a research use for academic institutions, academic labs, biopharma for vaccines, therapies, strain identification, mutation tracking. Is that revenue going to be categorized under testing revenue or should we consider them more as a sequencing as a service business?

Paul Kim, CFO

It will still be in testing revenue. The NGS test we would label as an NGS test just like our NGS tests for genetic testing.

Steven Mah, Analyst

Okay, got it. Yes and then my final COVID-19 question, the at-home test should we think about that as just a home sampling device that gets sent back to you for testing? It's not a - actually point of care device, right?

Paul Kim, CFO

Brandon, do you want to take that?

Brandon Perthuis, CRO

Yes, Steven, that’s correct. It is an at-home collection. So we would mail the care to the patient's home. The CDC has authorized now some simpler collection that patients can do themselves, so the mid-turbinate nasal swab is easy to self-administer. The tests would be collected at the patient's home, put in our kit and then mailed to Fulgent, where laboratory processing will happen. They would have results back within approximately 24 hours.

Ming Hsieh, CEO

To add to Brandon's point, the last one, Steven, we are also evaluating several different technologies, which are considered at-home tests for the virus, self-tests, as well as the IgG/IgM serologic tests.

Operator, Operator

And we have no further questions at this time.

Paul Kim, CFO

Nicole, back to you.

Nicole Borsje, Investor Relations

Great, thanks everyone for joining us on the call today. Please feel free to reach out if you have any additional questions. Thanks.

Ming Hsieh, CEO

Thank you.

Operator, Operator

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