Fulgent Genetics Inc (FLGT) 2017 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Fourth Quarter 2017 Fulgent Genetics Earnings Conference Call. (Operator Instructions)

As a reminder, this call is being recorded.

I would now like to introduce your host for today's conference, Ms. Nicole Borsje, Investor Relations. You may begin.

Great, thanks.

Good afternoon, and welcome to the Fulgent Genetics fourth quarter 2017 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 on 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 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 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 third quarter of 2017, which is available on the company's Investor Relations website.

Management's prepared remarks, including discussions of earnings and earnings per share, contain financial measurements 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 fourth quarter of 2017 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 loss and loss per share of the most directly comparable GAAP financial measures.

With that, I'd like to turn the call over to Ming.

Thank you, Nicole.

Good afternoon, and thank you for joining us on our call today to discuss our fourth quarter 2017 results. I will discuss some of the business updates in the quarter, including updates on our ongoing initiatives, and then Paul will go through our financial results in detail.

Let me first provide a brief overview of our financial results in the fourth quarter.

Revenue totaled $4.3 million compared to $5.9 million in the fourth quarter last year. Tests in the quarter grew 9% year-over-year to 4,213. Our ASP was $1,016, down 8% from $1,106 in the third quarter. GAAP loss was $1.8 million, and the non-GAAP loss was $1 million. Non-GAAP loss per share was $0.06 in the fourth quarter, and the cash flow used in operation was $1.2 million.

While revenue in the fourth quarter came slightly below our expectations, we are pleased with the growth we have seen in our sessions. Looking at our session, we saw an increase in approximately 30% compared to third quarter in 2017. A meaningful part of the test volume growth was driven by our newly introduced carrier screening test, which has seen strong initial interest from largely prenatal market. Because these carrier screen tests are billed through insurance, we were not able to recognize revenue on most of the orders that we received in the fourth quarter. Paul will get into more details on the timing of revenue recognition, including a discussion on the impact of ASC 606 on our financials. Given these dynamics, the revenue we reported in the fourth quarter does not fully represent the strong growth in the test volume data we saw this quarter.

Non-GAAP loss -- margins in the fourth quarter was also impacted by the increased carrier test volume as all associated costs are recognized as these tests are processed. We also continue to invest in [lead-free] operations through hiring and the precision of equipments for anticipated volume in 2018, which impacts gross margin. Non-GAAP gross margin in the fourth quarter was 44%, down from 53% in the previous quarter.

Looking back at the year overall, we were -- incurred some challenges with our sales force reorganization and the transition of our businesses in China. We are optimistic about this progress we have made in the operational standpoint. We remain confident in our position for this year.

We remain focused on 4 areas of development as we look forward at the year ahead. First, leveraging our technology advantage to expand our test menu and capabilities. We are pleased with the initial demand we have seen from our carrier screening tests, and we are continuously investing in area to expand our test menu. Specifically, we are close to launch our somatic-based cancer test, which will combine the germ line and the somatic test to provide an analysis and results from both a tumor and a normal tissue. We expect the somatic test will help drive the test volume and the revenue in the second half of 2018.

Second, we discussed last quarter how we have expanded our lab operations, and we invested in equipment to handle increased volume that we anticipate. We expanded our square footage and now have a building dedicated solely to lab operations. Further, we have continued to work with improving automation in the lab to streamline operations and increase efficiency.

Third is sales execution. After going through changes in our sales organization, we are seeing stability and ongoing improvements in sales execution in a number of different areas. First, sequencing for service agreements. We are gaining the traction to addressing the need of customers with business agreements, particularly from several large pharma companies. Second, we [expanded] the partnership with other companies for our carrier screening test, so that we remain in discussions with several group purchasing organizations and are getting closer to sign agreements. Fourth, we recently (inaudible) our international sales team and are seeing strong growth outside of U.S. Overall, we are pleased with the increasing attraction and stability we are seeing with our sales organization and are encouraged by the opportunity we see in the quarter ahead.

As we continue to sign additional partnerships, expand our test menu and broaden our sales reach, we expect to accelerate in the future. We recognize that it has taken us some time to build our (inaudible) some of these initiatives that we have discussed in previous quarters. We are making meaningful progress in a number of these areas and hoping to deliver a number of initiatives in the year ahead. We remain confident in our technology advantage and the capability of our sales team. We want to thank you, our investors, for their support.

I would like now to turn over to Paul to provide details on our financial performance in the fourth quarter. He will provide the details in our outlook in 2018. Paul?

Thanks, Ming.

Fourth quarter revenue totaled $4.3 million, a decrease of 27% compared to the fourth quarter of 2016. As Ming previously -- as Ming briefly discussed, we saw strong growth in sessions in the fourth quarter. But much of this was due to volume from our carrier screening test. We saw very little revenue from our carrier screening test in the fourth quarter as we cannot not recognize revenue on these tests until we are reimbursed. However, under the new revenue pronouncement, ASC 606, we will estimate the collectibility of all tests going through insurance, and we will record these revenues on an accrual method starting January 1. This will allow us to recognize revenue on carrier tests before we collect from insurance.

Looking at the fourth quarter, if we had accounted for revenue under the new ASC 606 standard, we estimate that we would have recognized an incremental hundreds of thousands of additional dollars in revenue during the quarter. The accounting change would have also benefited our gross margins as costs of these tests were already included in our Q4 cost of sale.

Our insurance billings were minimal prior to the fourth quarter of 2017. And as a result, there isn't a material change to our financials under ASC 606 versus 605 for the first 3 quarters of 2017. We are required to monitor our collections regularly under the new revenue pronouncement and will be making adjustments as necessary.

Also in the fourth quarter, revenue from Asia continued to decline as these samples are going through our JV in China. Revenue from Asia represented less than 1% of our total revenue in the fourth quarter. This compares to 36% in the fourth quarter of 2016 and 12% last quarter.

Excluding revenue from Asia, our business in the U.S. and Europe remained stable and strong and grew more than 12% in Q4 compared to the third quarter. Tests, which were recorded in revenues, were 4,213 in the fourth quarter, an increase of 9% over Q4 of last year and an increase of 3% from Q3.

Our ASP was $1,016, down from $1,106 in the third quarter. Our ASPs declined in the quarter as a result of product mix, in particular more sequencing for service tests, which carry a lower ASP than our clinical genetic tests.

Our cost per test in the quarter was $604 on a GAAP basis and $571, excluding equity-based compensation of $138,000.

Average cost per test increased due to the dynamics around processing of our carrier screening tests in advance of revenue recognition. As a reminder, the cost per test include all costs of tests that were processed in the quarter in the lab regardless of timing of revenue recognition.

As a result of increased COGS, our non-GAAP gross margin came down to 44% in the fourth quarter. Our gross margin will continue to fluctuate as our test mix varies and our volumes scale. Over time, we still expect to see lower average cost per test as we ramp up our volumes, collect on insurance claims and continue to improve productivity and automation in the lab. We believe our differentiated technology and operating efficiencies will give us an advantage with margins long term despite pricing declines we may see in our business or in the industry overall.

Turning to operating expenses. We remain focused on balancing our investments for growth while managing expenses. On sales and marketing side, our expenses were $1.1 million in the quarter, down from $1.4 million last quarter. This decrease was a result of timing of marketing initiatives. We made investments in personnel and capabilities in this area throughout 2017 and believe investments we've made in sales and marketing will help drive growth in the future.

On research and development, we continue to invest in our technology platform and expanding our test menu. R&D expense in Q4 was $1.3 million, up from $1.1 million last quarter.

Lastly, G&A expenses were $1.3 million. Non-GAAP operating expenses totaled $3.3 million for the quarter.

Adjusted EBITDA for the fourth quarter was a loss of $952,000 compared to a loss of $458,000 in the third quarter and $2.3 million in Q4 of last year. On a non-GAAP basis and excluding equity-based compensation expense, non-GAAP loss for the quarter was $1 million or $0.06 per share based on 17.8 million common shares outstanding.

The GAAP and non-GAAP tax rate at the end of the fourth quarter was 18%.

For the full year 2017, total revenue grew 2.5% to $18.7 million.

Adjusted EBITDA was $471,000 compared to $6.8 million in 2016.

And non-GAAP loss was $459,000 compared to an income of $4.5 million last year.

Turning to the balance sheet. We remain well capitalized to support our growth, and we're comfortable with our cash position. We ended the fourth quarter with $40.4 million in cash, cash equivalents and marketable securities with no debt. This equates to $2.32 of cash and cash equivalents per share.

Now moving on to our outlook. As Ming mentioned, we faced some unforeseen challenges this year, which resulted in growth below our initial expectations. That being said, we're confident in the investments we have made and are pleased with the initial traction, stability and sustainability we're seeing in the business.

We still have a number of ongoing opportunities we are working for the year ahead, of which we have mixed levels of visibility. As such, we're tempering our expectations for growth in the year ahead and anticipate our revenue for the full year 2018 to be at least $20 million. This minimum revenue estimate assumes very nominal growth in our domestic and international institutional hospital business. It tempers the growth in carrier, cancer, both germ line and somatic, and biopharma sequencing for service. Based on our results in 2017, which came in below expectations, we believe this is the best approach in setting our initial guidance for 2018.

On gross margin, we anticipate an uptick in the first half of 2018, and we expect to see slight improvements as we get deeper into 2018 from that uptick.

On operating expenses, we anticipate approximately a 10% increase from 2017 as we continue to hire employees in sales, operations and research and development. This translates into nominal losses in the first half of 2018, moving towards breakeven as we finish out the year.

Overall, we remain focused on continuing to invest in our technology and executing on the sales opportunities at hand. With our capabilities and technology, we believe we can capitalize on many opportunities that will drive growth going forward.

Thank you again for joining our call. Operator, you can now open it up for questions.

(Operator Instructions) Our first question comes from Bill Quirk with Piper Jaffray.

So I guess first question, guys, is on volumes. In the third quarter call, you made a comment that volumes are up 35% through the first 5 weeks. If I'm doing the math correctly, on a sequential basis, that actually implies your volume was down 4 over 3Q outside of that first 5 weeks. Assuming that volumes are relatively ratable over the quarter, where am I going wrong in math here?

So you are correct with your initial statement. Volume was up, but sessions were up approximately 30% in the fourth quarter. However, the growth in the sessions was largely based on the launch of our carrier screening test, Bill. And as you remember, our revenue recognition for tests that go through insurance, we're not able to record revenues on until we actually collect the cash. Henceforth, the increase in volumes that we had in the fourth quarter, we were not able to record revenues on.

So we should be -- just to -- just so I have the math correct here, Paul. So we should assume that there's about a 30% increase of the little over 4,000 tests in third quarter but only 4,213 of those were delivered. Is that the right way to think about this?

4,213, yes. 4,213 were delivered and if it went through insurance, the small amount included in the 4,213 was the cash that we collected from the increase that we had in the insurance billings.

Okay, got it. So said another way, within the 4,213, you're not including the carrier screening tests where you had no collectability?

We had a very small amount of carrier screening tests as part of that 4,213. And that's actually a very good question because it also relates to gross margins. Another way to put at it is to say the reasons why gross margins were so low in the fourth quarter was because our lab processed almost 6,000 tests.

Okay, got it. All right. That...

Because we had to record the cost of sales irregardless of timing of revenue recognition.

Okay. But just so that I guess I'm clear, Paul. So the lab processed almost 6,000 tests in the quarter. You delivered results where there is some sort of revenue associated with 4,213?

That's correct.

Okay. Okay, got it. Okay. And then just thinking about your guidance of at least $20 million, juxtaposed with your comment about had ASC 606 been in effect, you would have had -- I think the comment was several hundred dollars higher in revenue. So that would have put your revenue at something closer to about $4.5 million, which, annualizing, gets you to at least $18 million. So I guess reading into that, we should assume that you're not expecting to have much traction with private payers in 2018?

The other way to look at it is to say that 2017 hasn't been a very fun year for Ming and myself because we don't like missing, and we want to make sure that we have guidance in 2018, initial guidance anyway, that we feel very comfortable with.

Our next question comes from Erin Wright with Crédit Suisse.

This is actually Hong on for Erin today. Regarding sort of the outlook that you guys just laid out, I know you mentioned that you want to -- you've embedded a fair amount of conservatism into the outlook because of sort of mixed levels of visibility. I was hoping that you could sort of expand on what you meant by sort of the underlying dynamics on sort of that comment.

So I'll take the first part of that question and then I'll have Ming weigh in. We mentioned to Bill the increased volumes that we've had, and Bill brought up a good point, if this were normalized under the new revenue pronouncement, what the Q4 revenues been. And that amount actually is going to be disclosed in our 10-K when we file that here in the coming weeks. But Q4 under the new revenue standard, taking into account the increased volumes that we've had, would have been higher, the top line results and gross margins as well, from what we had in the third quarter. And looking at the outlook for 2018, we want to have an initial guidance that is an amount that both Ming and I, we feel very comfortable with. So if you take into account the base business that we had in the fourth quarter and if you translate that out and essentially saying that it's going to be flat in 2018, that in itself alone gets us pretty close to the $20 million. We might be off by like about $1 million or $2 million. And then the additional initiatives that we have, whether it be the launch of our somatic test, which is going to happen in 2018, and Ming can talk about where that sits, or the initiatives that we have on the GPO and the reimbursement side is largely not incorporated into our initial guidance. We certainly anticipate better positioning within the hospital market won't be intact, and we're doing things so we can grow that business. In addition to that, expanding our test menu and the continued traction that we get on the Beacon carrier side certainly looks very, very promising. But I'll let Ming weigh in on the things that we essentially don't have in the guidance, which is the anticipated growth that we see in the reimbursement on the GPO side as well as where we sit with our somatic tests.

Yes. So adding to Paul's points, we need to make sure that what -- we forecast only what we can comfortably deliver. We also have many opportunities that we're working on such as the GPO side. And we do see the initial pilot of the tests starting from the GPO side. But how do we collect the money? How do we recognize this revenue? That's not included in this forecast, as well as the -- to be released, the somatic test. We do expect that the test we providing will be -- generate attraction in the market. But hopefully, in the second half of the year when the test will be launched, and we will see the opportunity to add in some growth in that area.

(Operator Instructions) Our next question comes from Andrew Cooper with Raymond James.

Just wanted to get a quick one in on kind of the Asia JV. I know back when it was initially announced, it was kind of thought of as a positive and exciting opportunity. And if we look at it now, and it's become a smaller percent of a smaller revenue number. So just kind of curious if you'd give us some color on what maybe has changed there relative to expectations when you first went down that path. That would be really helpful.

Andrew, thank you for the questions. As we've talked about the -- our investment and the JV in China, it has come under several different areas. One area is we are trying to build the -- our capabilities in China and the revenue from the China site will be the royalty payment from the China site. So we do expect some royalty payment second half of this year from the JV. In addition, when we build the China operations, it does -- also in response, we have several inquiries from the pharmaceutical companies to see that our capabilities not only can conduct some service providing in the outside of China but also inside of China. And that's a part of -- in response to our -- a response to some RFPs, inquiries. And that's why we set up operation both inside China and outside China. We do hope to see that will become some materialize in 2018, which we are not included any of our guidance.

Our next question comes from Yi Chen with H.C. Wainwright.

Could you tell us what percentage of your revenue currently are [sourced] from China? And do you expect that percentage of your total revenue to grow in the future? And outside China, what geographic -- which geographic area do you think will drive the most revenue growth in the next 2 years?

Yi, I can't hear the first part of your question. Your question was what part of our revenues currently come from which area?

China.

From China. Okay.

So China historically was a larger portion of our revenues. China revenues, just to give you a little color, in the second and the third quarter of 2017 was approximately 10% to 12% of our revenues. In the fourth quarter, revenues straight from China is less than 1%.

Okay. And do you expect the revenue from China to grow in the future?

Yes, Yi Chen, as we mentioned, we set up a lab and which lab has been certified and accredited in China. We expect to the revenue we will start in the second half of this year. And remember, those revenue, we'll collect percentage royalty from those revenues. In terms of operations, our laboratory is set up in the Fujian province -- [Fujo] but our sales and the headquarter, obviously, will be in Shanghai.

Okay. So outside Asia, do you think the U.S. is the main area that will continuously drive the revenue growth going forward?

Currently, the -- our -- in terms of our revenue last year, 60% from U.S., 40% from overseas.

Okay. So you do think that Asia is the main revenue driver going forward?

No, no, no. So a little bit of historics. So if you take a look at our revenues, your first part of the question for China, it was a larger portion of our revenues. In the fourth quarter, it was about 1%. If you take a look at our business overall for 2017, a little over half is coming straight from the U.S. and the rest from outside the U.S., including China. If you take a look at the fourth quarter, the amount of revenues from U.S. was approximately 60%, 40% from outside the U.S. And that's because China's revenues has dropped off. In terms of our guidance for 2018, based on the assumptions that we made, because we're not counting a whole lot into the guidance from revenues from China, all other prospects, and Ming certainly put color around that. If you take a look at the base level of our business, we are anticipating within the guidance about 60% or so of the $20 million coming from the United States. But should the somatic test or the traction with the GPOs -- should it gain traction, so we end up 2018 better than what we initially guided, the somatic tests and the traction that we're getting on the reimbursement side should also largely be in the U.S. So another way to put it is to say that we believe that our revenues, wherever we end up for 2018, won't be at least 60% in the United States.

At this time, I'm showing no further questions. Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program, and you may now disconnect. Everyone, have a great day.