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Operator
Hello, and welcome to the Fulgen Genetics Q2 2023 Earnings Conference Call and Webcast. If anyone should require operator assistance, please press star zero on your telephone keypad. A question and answer session will follow the formal presentation. You may press star one at any time to be placed in the question queue. As a reminder, this conference is being recorded. It's now my pleasure to turn the call over to Melanie Salomon, Investor Relations for Fulgen. Please go ahead, Melanie.
Melanie Salomon
Thanks, Kevin. Good morning and welcome to the Fulgent second quarter 2023 financial results conference call. On the call with me today are Ming Hsieh, Chief Executive Officer, Paul Kim, Chief Financial Officer, and Brandon Perthews, 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. The 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 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 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 second 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.
Kevin
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 updates for the second quarter. And Paul will conclude with the financials and outlook before we take over your questions. We are pleased with our results in the second quarter with another record core revenue reaching $67 million and less than $1 million of COVID revenue for a total of just under $68 million of revenues. Our core revenue was driven by strong results across all three areas of our diagnostic business, precision diagnosis, anatomic pathology, and pharma services, including our expanded beacon carry testing for reproductive health service. We are encouraged by the outperformance in the first half of the year, and seeing good sales momentum as we move into the second half of the year. We continue to make good progress with our therapeutic business. Bosium Pharma, our novel nano-encapsulation technology, including our 4D patterns and the target therapy platform designed to improve therapeutic windows and the pharmacodynamic profile of both new and existing cancer drugs. Our lead drug candidate, FID-07, has shown promising results for treatment of numerous cancers, including head and neck, anterior and pancreatic, with reduced side effects. In June, we presented safety and efficacy data from the ongoing Phase 1b study at the American Society of Clinical Oncology Annual Meeting in Chicago. In summary, of 40 heavily treated patients of various cancer types with a weekly dose level from 50 milligram per square meter to 160 milligram per square meter, 18% had a partial response and 35% had a stable disease. Three out of four squaring cell carcinoma of head and neck cancer patients with partial response had previously been treated with taxin. No high-grade neuropathy was noticed. FID-07 demonstrated preliminary evidence of anti-tumor activity in heavily pretreated patients across various tumor types. Based on the overall tolerability from cold dynamics and the efficacy, 125 milligram per square meter has chosen as recommended phase two dose. We received a positive response for the data from medical community and continue to optimize our manufacture process as well as preparing the initial phase two studies. We look forward to share an additional update of the start of that trial by end of the year. We also have a deep pipeline in preclinical development, focusing on targeted therapies for additional cancers. I'd like to thank our employees and the shareholders for your loyalty during the quarter. We look forward to the second half of the year and the momentum we are creating with our combined business. I will now turn over the call over to Brandon Perthes, our chief commercial officer, to talk about our diagnostic business results during the quarter. Brandon.
Melanie
Thank you, Ming. We had a record quarter for our core business, driven by strong growth in our precision diagnostic division. Precision diagnostics was up 40% year over year and 12% sequentially. We are seeing strong demand for our reproductive services, specifically our Beacon Expanded Care Screening product, as we have now cemented ourselves as one of the market leaders. During the quarter, we saw our other divisions meet expectations, with Pharma Services having another strong quarter. However, as we previously mentioned, we expect Pharma Services to be a bit lumpy, depending on the timing of the service contracts. Looking forward, our Pharma Services pipeline and backlog remains strong, as we continue to leverage our expanded capabilities in multiomics and spatial biology. Not since COVID-19 have we stress tested our technology platform like we did this quarter. Overall next generation sequencing lab volume was up 112% year over year. We were able to take on this volume with minimal incremental investments and were able to perform the services with only minimal temporary increase in turnaround time. We feel time and time again we are showing real-world evidence of the power of the Fulgen technology platform and overall lab operations and capabilities. We stated before that we are a laboratory founded, designed, and built by engineers. Our mission was to create a differentiated lab operation using automation, AI, and informatics to be able to scale genomic testing without the high cost of continually layering on professional hires. During the quarter, we also installed additional sequencers the most recent and highest throughput to date, allowing us to additionally expand our capacity and lower the cost of exome and genome sequencing. We have also recently begun consolidating our two West Coast lab operations into one. Historically, we occupied two buildings a few miles apart. Bringing them together should lead to new operational and cost efficiencies. We aim for the move to be completed by the end of the third quarter. Beacon expanded care screening continues to be a key growth driver for our company. Fulgent stands out in this space as one of the few labs that controls the end-to-end product offering, allowing us to have a better handle on cost and turnaround time. As we ramp volume, we are focused on process improvements to continue to lower costs and improve turnaround time. We've done a good job capturing meaningful market share in the infertility space, and we'll look to penetrate the OB market in the future. While most clinicians today are using a panel of around 400 genes at standard of care, We've already built the next version, which includes 787 genes, and we are seeing more and more adoption of this larger panel. Our thought process is that clinicians will continue to look for broader coverage, which is what we've seen over the last few years, going from approximately 100 genes to approximately 400 genes. Before too long, the most efficient test could be an exome, at which time we'll be ready to address with our proprietary sequence alignment tools, bioinformatics, and capture probes, along with our robust sequencing capacity. Our anatomic pathology division continues to perform well, with a lot of our focus on continuing to improve operations. These improvements include standardization of systems, revenue cycle management, logistics, and managed care, among others. In addition, we have been investing heavily in digital pathology. Digital pathology is revolutionizing the space, leading to better turnaround time, cost, and quality. For example, shipping prepared glass slides to our labs and to our clients had the burden of at least one day shipping and associated costs plus the physical storage. Now we can scan, digitize, and share electronically immediately. In addition, we have built one of the only end-to-end solutions to allow our clients to view the digital images or even sign out their own cases. Turning to Fulgine Oncology, now with both our Lumera solid tumor profile and our Lumera Heme NGS approved and priced by MoldyX at $3,288, and $2,950, respectively, we turn our attention to expanding beyond our soft launch on the West Coast. We have placed a small number of reps in strategic territories across the nation and expect this team to continue to grow. Armed with a multidisciplinary portfolio, Folded Oncology is a near one-stop shop for specialty oncology testing. We feel very strongly that we will be able to continue to penetrate the community oncology segment beyond the West Coast and establish ourselves as a national contender in precision cancer diagnostics. As Ming mentioned, we are pleased with the performance during the second quarter, and we remain encouraged by the business prospects we see moving forward. I'll now turn the call over to our CFO, Paul Kim, to walk through the detailed financials. Paul?
Ming
Thanks, Brandon. Revenue in the second quarter totaled $68 million, compared to $125 million in the second quarter of 2022. Less than $1 million came from COVID-19 testing and Q2, which was not part of our guidance. Revenue from our core business totaled $67 million, which exceeded our guidance of $62 million and grew 48% year over year. Gross margin was 30.3%. The decline in gross margin year over year is primarily related to the higher cost of anatomic pathology revenues from Informed DX, which we purchased in Q2 of 2022. Non-GAAP gross margin was 33.8%. We are pleased to have achieved a two-point improvement in our gross margin sequentially over the prior quarter as we see efforts to create efficiencies across our acquired businesses pay off. Now turning over to operating expenses. Total GAAP operating expenses are $40.4 million for the second quarter, down from $43.6 million in the first quarter of 2023. Non-GAAP operating expenses total $30.4 million down from 33.8 million in the first quarter of 2023. Non-GAAP operating margin increased eight percentage points sequentially to a negative 11.1%, which is primarily due to adjustments and bad debt expenses and few other items combined with continuing operating efficiencies. Adjusted EBITDA for the second quarter was a negative 2.7 million, compared to a positive $37.7 million in the second quarter of 2022. On a non-GAAP basis and excluding equity-based compensation expense and intangible asset amortization, loss for the quarter was $2.4 million or $0.08 per share based on 29.8 million weighted average shares outstanding. Turning over to the balance sheet, we ended the second quarter with approximately $847 million in cash cash equivalents and marketable securities. The decrease from the first quarter is primarily due to cash used approximately $25 million to pay off our margin loan in full and to purchase real estate. From operations, cash provided by operating activities for the second quarter was a positive $9.7 million. Moving on to our outlook for 2023, given the outperformance in the second quarter, we're raising our core revenue guidance to $260 million. The number does not anticipate additional revenue from COVID-19 testing. Looking ahead, we expect gross margin and operating margins to continue to improve as we implement efficiencies to our integration efforts with our recent acquisitions. The margin improvement is forecast to be incremental for the remainder of the year as we plan to make further investments and resources to position the company for longer-term growth. For the fall year 2023, utilizing an estimated 28% tax rate and a share count of $30 million, we now expect their non-GAAP losses to narrow to $0.95 per share from the previous expectation of $1.25 for shareholders excluding stock-based compensation, amortization of intangible assets, as well as any one-time charges. Overall, we have further strengthened our core business, bolstered our portfolio through strategic acquisitions, and are already seeing improved financial performance in the first two quarters of 2023 and see good momentum ahead. Thank you for joining the call today. Operator, you may now open it up for questions.
Operator
Thank you. And I'll be conducting your question and answer session. If you'd like to be placed in the question queue, please press star 1 at this time. You may press star two if you'd like to move your question from the queue. One moment, please, while we poll for questions. Our first question is coming from Dan Leonard from Credit Suisse. Your line is now live.
Dan Leonard
Thank you, and good morning. Good morning. Paul, your revenue guidance implies a decline in your sales run rate from Q2 levels. Why would that be?
Ming
Do you think the revenue run rate for Q2 Can you repeat the question?
Dan Leonard
Yeah. You're guiding for $260 million in revenue for the full year. You did $67 million in Q2. You're guiding for $65 in Q3, which is a decline, and it looks like $65 in Q4 as well. So I'm wondering why sales wouldn't grow from the $67 million, why they would decline.
Ming
Okay. Yeah, great question. We had outperformance in Q1 and Q2. We're still digesting the heavy increase in volume. And we feel very good about our momentum. There definitely is potential based on, you know, what we have posted in Q1 and Q2 to outperform again. And, you know, we certainly reserve the right to post higher numbers.
Dan Leonard
Understood. And then a follow-up, Paul. I know at one point you were – hoping to get gross margins to 40% by the end of the year. What is the new target and what are the steps that get you there?
Ming
So the gross margin target for 40% a year, that's still our hope. We certainly are pleased with the gross margin jump, which had a low point of, I believe, in the 20% to 25% in Q4. We had a significant jump from that to what we posted in the first quarter. In the first quarter, the gross margin on a non-GAAP basis was 32%. We saw a two-point improvement from Q1 to Q2, which takes us up to 34%. We certainly anticipate the gross margin numbers to grind higher into Q3 and Q4. Where we end up at the end of the year, it could certainly be at 40%. But as long as the trajectory is correct, as well as the rate of the change, We think that that indicates, you know, further strengthening of our overall business model. I think the other thing, right, that we're also taking a look at, aside from just a percentage, is the absolute contribution, you know, from gross margins. And we're very, very pleased to raise our revenues twice this year, you know, given the fact that it's only the middle of the year.
Dan Leonard
Great. Thank you.
Operator
Thank you. Next question today is coming from David Westenberg from Piper Sandler. Your line is now live.
David Westenberg
Hi. Thanks for taking the question, and congrats on a very strong performance this quarter. Can you remind us how much of the GNA is still dedicated to COVID testing and, you know, if there's an opportunity now to get more cost savings by just, you know, exiting that business or any plans there with COVID just generally speaking?
Ming
Yeah. Excellent question, David. So from an overall perspective, the majority of the activity has been flushed out related to COVID testing. During the second quarter specifically, we had approximately a $2 million adjustment. It was actually a credit related to the AR reserve for COVID testing. That's part of the reason on why you saw the gross, I mean, not the gross, but the GNA expenses being light. We had a few other items that are in there. As we, you know, look ahead into Q3 and Q4, we anticipate the G&A expenses to bounce back to something that we had in Q1 or maybe, you know, higher levels. But kind of back to your question of, you know, is COVID, you know, relatively flushed out? The short answer is yes. I think, you know, the reason why I comment on the expense structure is, you know, even with the, you know, a bump up in G&A, for Q3 and Q4, from an overall perspective, we see, you know, very good efficiencies throughout the operating expense categories, you know, of the organization. And that's being, you know, further, you know, being, you know, added if we take a look at the overall business model, you know, with the overall strength that we're seeing with the top line as well as the gross margin improvement.
David Westenberg
Very helpful detail there, Paul. Thank you very much. And then can you just remind us about the closed date last year of InForm? I'm just trying to think about the organic revenue growth as we look in the back half of the year. I believe the only acquisition you made in the back half of the year would have been the Bolton Pharma, if I'm correct. I know this is probably a short just clarity question here.
Ming
Yeah. So InForm DX closed last year. During Q2 of 2022, it was about halfway through the second quarter. When we take a look at the contributions of revenue from the three categories that we have, anatomic pathology, pharma services, and precision diagnostics, we see absolute growth in all three of those areas. When we compare it against the numbers from last year, But, you know, what really excites us is where the acceleration of the business is coming from. So we first started off the year at $240 million of revenues, and we had the contributions from anatomic pathology, you know, which is inform DX, and then precision diagnostics evenly split with about $13 million from pharma services, which added to the 240. But, you know, as we take a look at the updated guidance now at $260 million, All of that is coming from either precision diagnostics or pharma services, which are very, very lucrative and attractive markets. And it's the area that we perform very, very well in, where you have sequencing and a large amount of interpretation. So we really like the way that the business is headed as we look out at the end of this year and into 2024. Got it.
David Westenberg
No, thank you very much. Just one last question on the gross margins. Can you talk about the different levers? I know you said you're buying a new sequencer. In terms of carrier screening, for example, which I know you're outperforming in, there's a lot of prep work. So can you just run us through all the different levers that you're thinking about in the next year to really drive those gross margins higher? And that's my last question. Thank you.
Ming
Yeah. So there's a lot of blocking and tackling that we're doing, you know, in terms of in terms of improving policies and attracting higher talent. But the fundamental reason on why we have the gross margin improvement is through automation and the utilization of our technology platform. And I'll turn it over to Ming, who can reiterate the differentiation that we have in the utilization of our technology compared to other companies.
Kevin
Yeah, thanks, Paul. But the bottom line is how could we use the technology to handle more people? That's really the area that we put a lot of focus. We continue to apply the technology, which we call the AI. That's the area that we started in since the 1990s. But since the past 30 years, over 30 years, definitely AI has made a tremendous impact in our life. We have been riding with this technology with my experience for the past 30 years. We continue seeing that technology to be applied in the diagnosis business, and then we continue to invest and improve that technology.
David Westenberg
Got it. Thank you very much, Ming. Great job.
Operator
Like, your next question is coming from Andrew Cooper from Raymond James. Your line is now live.
Andrew Cooper
Hey, everybody. Thanks for the question. Maybe first kind of tagging on to the back end of that, you know, you talk about the automation and the improvements there. I think you did mention in the prepared remarks a little bit of turnaround time increase as volumes ramped as much as they did. Can you just give us a little bit more color on sort of how much that was, you know, whether it's worked lower or
Melanie
um and how we should think about the uh the turnaround times as you continue hopefully to grow to grow the volumes on the in downside yeah thanks andrew um good question um the turnaround time did increase but it was it was a short window right the you know we did a much better job capturing market share than perhaps we were anticipated and that's that's great execution by the sales team in our company um but the increase in volume was was tremendous so And I'm proud of the lab and how they were able to digest it. I mean, the turnaround time maybe had, you know, a 25 to 50% increase for a couple to a few weeks. And as Ming mentioned, you know, during that time, we began to improve additional processes and procedures and streamline. And at this point, turnaround time is back on track. I mean, I think we're, you know, around 14 or 15 days for carrier screening and, you know, exomes are back down. It was a temporary increase and really allowed us to go into the systems and make those improvements and get it back on track. And turnaround time is something we monitor very, very closely. It's incredibly important for our clinicians. While we talk about it, we mention it in our script. And going forward, we intend to meet our turnaround time, which depending upon the product, could be anywhere between two and six weeks. But especially in the reproductive space, You know, that sort of two-week to three-week turnaround time is critical, and we're sort of back on track and don't see, you know, any disruption to that in the future. Okay, great.
Kevin
That's super helpful. Yeah, I think that remember Brandon mentioned we also made the lab consolidation during the quarter. So we are not only trying to handle increased volume, but we also try to make the lab operation more efficient. by consolidating two locations. Those also caused a bit of a transition, but we do see that it's a good trend for the long term to continue to handle the higher volumes and improve the turnaround time.
Andrew Cooper
Okay, great. Super helpful. Maybe just one more on sort of the portfolio. I think, you know, there was the mention in the call as well of looking to penetrate the OB space in terms of carrier screening. You know, a lot of times I feel like we hear people talk about that being bundled with NIPT. So just the latest and greatest thinking there. And then kind of related, I think on the flogging oncology side, you mentioned a near one-stop shop. So just remind us, you know, what do you feel like still needs to be added to the portfolio? How do we think about, you know, you know, addressing some of those factors and what the timelines might be.
Melanie
Yeah, certainly. Thanks again for the question. We actually have Dr. Larry Weitz with us today, so I'll let him address the full gene oncology question here in a moment. But in terms of, you know, our care screening market penetration, it's mostly been in the infertility space. We've landed some fantastic long-term clients that are mostly infertility clinics, you know, REIs, And you're correct in that to penetrate the OB space, it is much, much easier to do so if you can bundle it with NIPT. As you're aware, we currently don't have an NIPT test. That doesn't prevent us from selling to the OBs. You know, again, it's just easier to do when you can bundle it. So we will be able to target the OBs, especially the OBs that are, you know, referring into some of these new clients we have and be able to leverage the continuity there. But NIPT is something we've been looking at for a long time. We continue to evaluate the space. We continue to evaluate how we can deploy our technology in that space. So Fulgent has ongoing R&D across a lot of areas, NIPT being one of them. But again, I think with what we've done with carrier screening, with our turnaround time, our ability to interface and integrate Some of the clinical advantages we've built with Deakin in terms of copy number and dealing with pseudogenes and proprietary algorithms, I think there's still a great story to tell to the OB market, even in lieu of having an NIPT test at this time. So, Larry, he asked a question about sort of what's missing to be sort of the full one-stop shop, but I'll let you take that one.
Larry Weitz
Well, I'll tell you, we recently launched liquid biopsy for solid tumor, and we hope to have an HRD test before the end of the year. and maybe some additional offerings in 2024. Great.
Andrew Cooper
I'll stop there.
Operator
Thanks.
Melanie
Thanks, Andrew.
Operator
Thank you. We reached the end of our question and answer session. I'd like to turn the floor back over to management for any further closing comments.
Kevin
Thank you, Ron, for you joining the call today. And we are looking forward to update you about our business performance in the next few quarters. Thank you very much.
Operator
Thank you. That does conclude today's teleconference and webcast. You may disconnect your line at this time and have a wonderful day. We thank you for your participation today.
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