Earnings Call Transcript - FLGT Q3 2023

Melanie Solomon, Investor Relations

Thanks, Kevin. Good morning and welcome to the Fulgent third quarter 2023 financial results conference call. On the call 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 than what is described in or implied by these forward-looking statements. Please review the more detailed discussions related to these forward-looking statements, including 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 filing with the Securities and Exchange Commission, including the previously filed 10-K for the year ended December 31, 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 third 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, the most directly comparable GAAP financial measures. With that, I'd now like to turn the call over to Ming.

Ming Hsieh, CEO

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 update from the third quarter. And Paul will conclude with the financials and outlook before we take your questions. We are pleased with our results in the third quarter, with $85 million of total revenue due to our successful collection effort. We recognized an additional $19 million of revenue from previously built COVID-19 tests. Our core revenue of $66 million was driven by momentum in precision diagnostics as we expected. The revenue for the anatomic pathology was seasonally lower in the third quarter. Pharma Services, which we had said is a lumpy business, decreased in the third quarter as we anticipated. Given these results, we are pleased to affirm our guidance for the full year of $260 million of core revenue. We continue to make good progress with our novel nanoencapsulation technology, which includes over 40 patents and a target therapy platform designed to improve the therapeutic windows and the pharmacokinetics 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, neck, ancillary, and pancreatic cancers with reduced side effects. This weekend, we will present additional data, including all ongoing studies of FID-007 at the Society for Immunotherapy of Cancer annual meeting ongoing now in San Diego. We'll then have the poster available on our website. From this data, we are moving forward with Phase II studies in head and neck cancer. We have submitted our Phase II clinical protocol to the FDA and expect an initial study in the first quarter of 2024. We are excited about reaching this next milestone for pharma and bringing FID-007 to more patients in clinical settings. I'd like to thank our employees and the shareholders for your loyalty during the past quarter. We're looking forward to closing out a strong year and capitalizing on the momentum we see ahead. I will now turn over the call to Brandon, our Chief Commercial Officer, to talk about our Diagnostics business results during the quarter.

Brandon Perthuis, Chief Commercial Officer

Thank you, Ming. We had yet another solid quarter led by continued momentum in our Precision Diagnostics division. Core revenue for the third quarter totaled $66 million, down 2% sequentially and up 17% year-over-year. Breaking it down further, Precision Diagnostics came in at $37.5 million, an increase of 16% sequentially and 45% year-over-year. As we have mentioned in previous calls, because of the nature of the contracts and awards, our Pharma Services business will be lumpy. This was the case for the third quarter. Pharma Services came in at $3.7 million, down 50% sequentially and up 19% year-over-year. That said, our Pharma Services pipeline looks strong with new partnerships coming online. In addition, our capabilities today are broader than ever before, giving our clients the opportunity to work with a multi-disciplinary team experienced in pathology, multiomics, oncology, spatial transcriptomics, liquid biopsy, single-cell sequencing, proteomics, and more. We are confident that Pharma Services will be an integral part of our success going forward. Our Beacon carrier screening portfolio of tests continues to be a significant growth driver for Precision Diagnostics. As a reminder, carrier screening assesses the risk of passing on certain genetic conditions to children. This test is for anyone who is currently pregnant, considering pregnancy, or planning to become pregnant in the future. Our Beacon test menu now includes seven preset panels ranging from six to 787 genes. However, we have the ability to customize panels for our clients, which is something not widely available in the market. This is proving to be an important differentiator. Turnaround time has been stable and is now one of the fastest in the industry with a mean turnaround time of 12 days. The focus now is to continue to gain market share in the infertility space and begin initial planning for a rollout to the OB market. During the third quarter, we entered into a new agreement with Progyny for Beacon carrier screening. Progyny is a leading benefits management company specializing in fertility and family-building solutions. This new agreement allows us to provide reproductive genetic testing to the Progyny member network. This is an important agreement for Fulgent since many of our reproductive clients see Progyny patients. Along with our robust managed care contracts, this new agreement puts Fulgent in a strong position for coverage and reimbursement. An area of focus for R&D during the quarter was to update our hereditary cancer panels. As the field continues to generate more and more data, we need to continually look at what we're offering to make sure our panels are as clinically relevant for patients and providers as possible. In making these updates, our team focused on getting well-defined options to providers. Our focus panels are now closely aligned with the latest NCCN guidelines, and the genes included on these panels are high to moderate risk factors for cancer as noted in the guidelines and associated with direct actionability. The comprehensive panels are broader and include the focus genes as well as low-risk genes and candidate genes that may provide information about the cause of cancer in the family but may not be associated with actionable guidelines at this time. Our comprehensive offerings for hereditary cancer testing, coupled with our test menu for solid tumors and hematological malignancies, makes us an attractive choice for clinicians. We are often asked about further M&A or strategic investment opportunities. This is an area we spend a lot of time on, consistently evaluating companies and technologies. However, we are being highly selective. We are seeing the investments we have made in our business pay off with meaningful organic growth and continuing strengthening of our position in the market. While there are likely opportunities for us to strengthen through M&A, we will continue to be measured in our approach.

Paul Kim, CFO

Thanks, Brandon. Revenue in the third quarter totaled $85 million compared to $106 million in the third quarter of 2022. Approximately $19 million came from COVID-19 testing in Q3, which was not part of our guidance. Revenue from our core business totaled $66 million, which exceeded our guidance of $65 million and grew 17% year-over-year. Gross margin was 47%. The increase in gross margin year-over-year is primarily related to COVID-19 revenues of $19 million, recognized on previously built tests due to successful insurance collection on appeals. Now, turning to operating expenses. Total GAAP operating expenses were $39.6 million for the third quarter, down from $40.4 million in the second quarter of 2023. Non-GAAP operating expenses totaled $29.4 million, down from $30.4 million in the second quarter of 2023. Non-GAAP operating margin increased 27 percentage points sequentially to 15.4%, primarily due to COVID-19 testing revenue recognized in the quarter. We recognized a tax expense of $20 million in the third quarter as we put up a reserve against our deferred tax assets. Due to being in a loss position, we reserved for these deferred tax assets in full. With our performance in gross margins and operating margins in the third quarter, had we used the previous statutory rate instead of booking the valuation allowance, we would have further exceeded our projections. Adjusted EBITDA for the third quarter was $18.1 million compared to $19.7 million in the third quarter of 2022. On a non-GAAP basis and excluding equity-based compensation expense of intangible asset amortization, the loss for the quarter was $11.7 million, or $0.39 per share based on 30 million weighted average shares outstanding. Turning to the balance sheet, we ended the third quarter with approximately $851 million in cash, cash equivalents, and marketable securities. Cash, cash equivalents, and marketable securities increased $4 million from Q2, of which $3 million was an increase in investments. We were active with our share repurchase program in the third quarter. We repurchased approximately 80,000 shares of our common stock at an aggregate cost of $2.2 million at an average price of $27.65 under the stock repurchase program announced in March of 2022. Subsequent to the end of the quarter, as of October 31, we have since repurchased approximately 533,000 shares at an aggregated cost of $13.7 million. As of October 31, 2023, a total of approximately $159 million remained available for future repurchases of our common stock under the stock repurchase program. Moving on to our outlook for 2023. We're reiterating core revenue guidance of $260 million. This number does not include additional revenues from COVID-19 testing. Excluding the $19 million of COVID-19 revenues, the non-GAAP gross margin improved 2 percentage points in Q3 to 36%, and we estimate Q4 non-GAAP gross margins to remain relatively the same or slightly higher. We expect that our ongoing integration efforts with our recent acquisitions will create efficiencies that will result in improved gross margins and operating margins in 2024. For the full year 2023, utilizing a non-GAAP tax provision, an average share count of 30 million, we maintain net non-GAAP loss of $0.95 per share for our shareholders, excluding stock-based compensation and amortization of intangible assets, as well as any one-time charges. Given our strong balance sheet and cash position, and the way we've been balancing our investments, we wanted to provide guidance on our expected cash position at the close of the year. Our investments in our therapeutics business have been lower than anticipated this year, and we continue to be active with our share repurchase program. Our core business is performing well, and we have some welcome unexpected COVID-19 testing revenues. As such, excluding any stock repurchases since Q3 or other expenditures outside the ordinary course, we expect to end the year with approximately $830 million of cash, cash equivalents, and investments. Overall, we have strengthened our core business, bolstered our portfolio through strategic acquisitions, and improved our financial performance in 2023. We're pleased with our trajectory and see good momentum ahead. Thank you for joining our call today.

David Westenberg, Analyst

Hi, thank you for taking the question and congrats on the strong work here. So can you talk about any of the COVID reimbursement payment? I mean, I think you guys have mostly exited COVID. I mean, is there any COVID testing remaining or how should we think about that as an option from here out?

Ming Hsieh, CEO

Yes. Brandon, do you want to take that question?

Brandon Perthuis, Chief Commercial Officer

Yeah, certainly. Thanks, Dave. There's very little ongoing COVID testing that is active. However, we continue to appeal claims and continue to collect on accounts receivable from when COVID testing was much higher. So I think that's what you're seeing today. I think you're seeing the payoff of a robust revenue cycle management team and the payoff of a company that is going to do all we can to collect on the work that we've done. So it was essentially a collections effort, and I’m proud of the team for doing a good job collecting on the tests that we ran during the spike of COVID.

Paul Kim, CFO

David, at the beginning of the year, we excluded COVID from our core guidance and from an operational standpoint. When we did this, we indicated that the assumptions we made by excluding it were conservative. We're pleased to report that the adjustments you're seeing are on the positive side. This also highlights our overall efficiencies in how we conduct our business, whether in appeals or in our operations. We're definitely pleased with the increase we're seeing related to COVID, but we will continue to keep that out of our guidance.

David Westenberg, Analyst

No, I appreciate the conservatism on not having it in the guidance, but I would ask, is there any potential for any one-time payment? And I realize like on a go-forward basis, I mean, this isn't necessarily how we all are going to value the company, but just for mechanical purposes or…

Brandon Perthuis, Chief Commercial Officer

Yeah, there is. Our collection efforts are ongoing. Our appeals efforts are ongoing. So is there a chance we have additional collections from COVID-19 in Q4 and beyond? Yes. Something we're counting on? No. But yeah, I mean we're continuing to do work on those appeals and on those collections, yes.

David Westenberg, Analyst

Okay. Great. And then you mentioned the Pharma revenue being a little bit lumpy. Just overall across the industry, we are seeing pharma taking a little bit more of a conservative approach with their spending. How confident are you? And is this lumps and maybe not just kind of weakening macro overall because across the industry, we are seeing some of that weakening macro.

Brandon Perthuis, Chief Commercial Officer

I believe we're starting with a somewhat smaller number. It doesn't seem to be a change in the macro environment. We still need to build a larger client base for these services. Fulgent has to focus on acquiring more clients, increasing market share, and reaching out to existing clients to promote the new services in that division. For us, it’s just a matter of timing. The pipeline appears strong as we’re bringing on new partnerships and clients. Therefore, I don't observe a significant macro shift; it's more about timing. To achieve a more consistent growth trajectory, we must continue filling our sales funnel, onboarding new partnerships, and encouraging clients to utilize all the new products and services we've introduced.

Paul Kim, CFO

David, Brandon, and I have been commenting on Pharma Services and the nature of that business being lumpy, as Brandon mentioned. The other thing is the sales cycle is longer in terms of duration. But if you kind of take a step back and look at the overall performance of Pharma Services, we did approximately $10 million in 2022. And in 2023, even with the lumpiness, we are anticipating within our guidance to do approximately $21 million to $22 million. So we're anticipating to have over a 100% increase in that business. We anticipated the Pharma Services revenues to be lower in Q3 and Q4, anticipating when the work will be serviced and recognizable in terms of revenues. But as Brandon indicated, we are really excited about this business and our funnel is full.

David Westenberg, Analyst

Got it. Great. I'll just ask one more and let Andrew have some more questions. I know you're going to begin Phase II early next year. While you're not providing 2024 guidance, I would love to hear about the anticipated spending for that project specifically, particularly if there is a significant increase in R&D spending associated with it. Thank you.

Ming Hsieh, CEO

Yes, David. I believe our budget projection remains strong, with an annual burn rate of approximately $15 million. The Phase II study will focus on the second line of therapy for head and neck cancer patients and will involve a combination therapy as recommended by experts in this area. We are optimistic about our position and the market potential. Regarding R&D spending, the $50 million we have allocated will cover not only the clinical trials but also all ongoing new drug development efforts. We anticipate maintaining an annual burn rate of about $50 million.

David Westenberg, Analyst

Thank you so much.

Andrew Cooper, Analyst

Sorry, I had myself muted. Thank you for the questions. I guess just want to maybe first ask a little bit about the guidance, just the sequential revenue, the core being sort of flattish, maybe down a touch as sort of what you're pointing to. So maybe just a sense for how much of that might be seasonality in your minds versus maybe something that is moving a little bit more materially from quarter-to-quarter.

Brandon Perthuis, Chief Commercial Officer

Thanks for the question, Andrew. No, there certainly is some seasonality in it, especially as it relates to our Anatomic Pathology division. That's something we are planning on. In addition, it still goes back to some of our Pharma Services and needing to get those projects through the door, get them signed out so we can book those revenues. So that's another thing we're planning on in Q4, just seeing some additional lumpiness in the Pharma Services business. But the Precision Diagnostics still has tremendous momentum. Beacon volumes are doing incredibly well. Our oncology business is doing well. So we expect to see that continued momentum into the fourth quarter. But again, taking a bit of a conservative approach as it relates to some of the seasonality around AP and some of the Pharma Services.

Andrew Cooper, Analyst

Okay, helpful. And a couple of those are areas I wanted to hit on as well. So maybe starting with AP. If I have my numbers right for Precision Diagnostics and Pharma Services for this quarter, I think AP was a little bit lower than we were looking for and I think lower than you were looking for at least at the start of the year when you originally guided for that segment. So sort of what's going on there? Can you give us a little bit of an update in AP and how we should be thinking about that business, given it is a pretty hefty chunk of the overall, but not the one that we've talked about much today?

Brandon Perthuis, Chief Commercial Officer

Yes, certainly. No, it is. And we're still continuing to sort of push through that acquisition and doing the work there to implement our technologies, our procedures and the focus has been improving the operation and improving those margins. I think we're making some good progress there, but perhaps taking a little bit longer than we anticipated to work through that acquisition. But things are generally trending in the right direction. It's a pretty stable business, you're right. So there's a little bit of a downtrend that we saw, which could be a little bit of seasonality into the back half of the year. We are monitoring our accounts for profitability. So to a very small degree, we've exited some areas where maybe we didn't have favorable reimbursement or for whatever reason, the mix wasn't a profitable account for us. So we are looking into some account-level profitability. That may play a small role in it. But long term, we're continuing to invest in that business. We've made some changes to the go-to-market strategy and sales structure. We are onboarding some additional salespeople in the back half of this year and early next year. We believe we have an incredible product offering in AP, and our subspecialty trained pathologists are some of the best in the United States. Turnaround times are fantastic. So we do believe it's an area we can grow, and hopefully, some of the investments we've made recently will pay off into next year.

Andrew Cooper, Analyst

Okay. Great. That's helpful. And then just on Fulgent Oncology, I know last quarter we talked about adding some incremental heads starting to build that rollout beyond the West Coast where you initially started. So would love just an update on sort of how that's going, what the reception has been, maybe where you are in some of those hiring processes that I know don't happen overnight.

Brandon Perthuis, Chief Commercial Officer

Yeah, thank you. They certainly don't happen overnight. And as you've seen, we are quite selective with who we onboard into the sales team. We have brought on two new headcounts. They're not on the West Coast; they're in different territories. So that geographical expansion we talked about is happening. There's obviously a ramp period for these new reps. They don't step in selling on day one, even though they would love to. But the reps we've brought on board are industry veterans and experts. So they do bring with them that client-level and market expertise. So we are enthusiastic about their potential long-term to drive new sales for Fulgent Oncology. And we're continuing to look for additional sales talent. But again, it's sort of more of an opportunistic thing when we find the right people in the right territories. We don't have a ton of open positions right now that we're just trying to fill. So we'll continue to do that. The product offering is going well. I think we've done a good job with that rollout. So it's something that's a long-term vision for the company, and we'll continue to layer on capabilities and salespeople as we move forward.

Andrew Cooper, Analyst

Okay. That's helpful. And then maybe just one on Beacon as well. Pretty big immediate step-up early in the year in terms of the volumes and the share gains there. So just would love any commentary on sort of whether that's stabilized? Are you continuing to take share in that IVF setting? And then what are some of the guideposts we should really be looking for as we think about that build-out in that initial effort to make the transition into the OB-GYN setting as well?

Brandon Perthuis, Chief Commercial Officer

As we’ve previously mentioned, there was significant disruption in that area. Clients were left without a provider on short notice and had to quickly secure a new lab. This created a hectic situation for both the clients and Fulgent, along with other laboratories. Most of that business found a new home, and Fulgent greatly benefited from that. However, some clients may have rushed their decisions and are not entirely satisfied with the laboratories they chose, due to various factors like panel content, turnaround time, and customer service. Now that clients have had time to evaluate their options, they are realizing that Fulgent might have been a better choice. The initial rush has slowed, and now we are focused on attracting clients who can see Fulgent as a superior service provider compared to what they're currently experiencing. In the OB space, there’s an opportunity for us as it represents a large total addressable market. Historically, NIPT and carrier screening have often been linked, and while that remains true, we believe there is a portion of the market willing to consider them separately. Our turnaround time is approximately 12 days, with some results being delivered in as little as nine days. Both OB and infertility clinics have shown appreciation for this turnaround and our capability to customize panels ranging from a few genes to nearly 800. We have successfully marketed Beacon, and I believe even in the absence of NIPT, we can capture the attention of some OB doctors with our offerings.

Paul Kim, CFO

And Andrew, the numbers back that up, meaning that earlier, Brandon talked about some of our assumptions in anatomic pathology and that being relatively muted. But if you take a look at the performance that we had in Precision Diagnostics, which is the most lucrative part of the market and it’s the area that we believe that we shine in terms of our capabilities and services. In Q1, the revenues for Precision Diagnostics were a little under $29 million. In Q2, it was between $32 million and $33 million. And in this quarter, it's between $37 million and $38 million. So in terms of the growth rate and the acceleration and the performance that we've been having in this particular sector within a very short time frame, it’s been really impactful on the company.

Andrew Cooper, Analyst

No, that's helpful and certainly appreciate that growth profile there. Maybe just one more for me, kind of higher level. When we think about the FDA LDT regulations, I think we'll see whether they go in, how they're written or not. But how do you think about that and what that means to you? Some of the pitch that you make, obviously, the turnaround time piece isn't affected, but that ability to customize under sort of a tweak or really overhauled LDT regime, how do we think about what that might mean? And sort of what's the plan to the degree that this does go in as written because those customizations presumably become at least more difficult. So just would love kind of your thoughts on, one, the regulation in general and two, how that specifically plays in for Fulgent and the strategy you guys take, especially with Beacon?

Brandon Perthuis, Chief Commercial Officer

That's a great question. We're monitoring the situation as closely as every other lab. The authorities have exercised jurisdictional discretion for many years and have relied on Laboratory Developed Tests with CAP and CLIA validation. There are around 22,000 genetic tests available on our test menu, and it’s uncertain how the FDA will manage the regulation of so many tests per lab. We anticipate they will focus on higher-risk and higher-volume genetic testing. However, it's difficult to predict exactly how this will unfold. Regardless of the outcome, we will be ready. We possess the necessary subject matter expertise and operational capabilities. We are closely observing the situation, as it may prove challenging to implement changes after so many years in the genetic testing arena. Nevertheless, we will continue to monitor developments and respond appropriately with our expertise in this field.

Lawrence Weiss, Chief Medical Officer

Yes. Our quality systems are in place and very professional. So whatever the FDA throws at us, we feel like we can respond in a timely fashion.

Andrew Cooper, Analyst

We are observing the situation closely and understand it is challenging to intervene after years of genetic testing. However, we will continue to monitor developments and act appropriately with our expertise in the field. Our quality systems are robust and professional, so we believe we can respond promptly to any requests from the FDA.

Brandon Perthuis, Chief Commercial Officer

Andrew, it sounds like you have some connectivity issues.

Andrew Cooper, Analyst

I just said I would stop there. Hopefully you can hear me now. Apologies.

Brandon Perthuis, Chief Commercial Officer

Yes, we can. Thank you, Andrew.

Operator, Operator

Certainly. We’ll now be conducting a question-and-answer session. Our first question today is coming from David Westenberg from Piper Sandler. Your line is now live. Thank you. We've reached the end of our question-and-answer session. And ladies and gentlemen, 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.