Hello, and welcome to the Fulgent Genetics Q3 2023 Earnings Conference Call and Webcast. [Operator Instructions] A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It's now my pleasure to turn the call over to Melanie Solomon, Investor Relations. Please go ahead.

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 Invest 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 for 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 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.

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 go -- products 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 additional $19 million of revenue from previously built COVID-19 test. Our core revenue of $66 million was driven by momentum in precision diagnostics as we expected. The revenue for the anatomic pathology were seasonally lower in the third quarter. Pharma Service, 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 [Technical Difficulty], our novel nanoencapsulation technology 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 promise results for the treatment of numerous cancers including hand, neck, ancillary and pancreatic with reduced side effects. In the weekend, we will present additional data, including all ongoing studies of FID-007 at Society for Immunotherapy of Cancer annual meeting ongoing on 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 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 close out a strong year and capitalize on the momentum what we see ahead. I will now turn over the call over to Brandon, our Chief Commercial Officer, to talk about our Diagnostics business results during the quarter. Brandon?

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 the 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 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…

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 reserve 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, loss for the quarter was $17.7 -- I'm sorry, $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…

Certainly. We’ll now be conducting a question-and-answer session. [Operator Instructions] Our first question today is coming from David Westenberg from Piper Sandler. Your line is now live.

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?

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

Yeah, certainly. Thanks, Dave. There's very little ongoing COVID testing that is accurate. However, we continue to appeal claims and continue to collect on AR 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 proud of the team to -- they've done a good job to collect on the test that we ran during the spike of COVID.

David, at the beginning of the year, we stripped out COVID from our core guidance and from an operational perspective. And when we did that, we commented that the assumptions that we made and not including that, we felt was conservative. So these kinds of adjustments that you're seeing are -- we're pleased to report that they're on the positive side. And I think the other thing that it points to is our overall efficiencies in the way that we're conducting our business, whether it be appeals or the way that we're running the operations. So we certainly are pleased with the uplift that we're getting from COVID, but we're going to continue to not have that within our guidance.

No, I appreciate the conservatism on not having in the guidance, but I would ask, is there any potential for any one more 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…

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.

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 there is -- across the industry, we are seeing some of that weakening macro.

Yeah. I think we're starting with a little bit smaller number perhaps. So I don't think what we're seeing is a macro environment change. I think we have -- we don't yet have a large client base for these services is something we're building out. So I think Fulgent needs to do is continue to get more clients, needs to continue to get more market share and needs to continue to get out to our existing clients to sell the new services we've launched in that division. So I think for us, it's just sort of a timing thing. The pipeline does look strong. We are onboarding new partnerships and new clients. So I don't think we're seeing that macro shift. I think for us, it's just a timing. And ultimately, to have a more steady trajectory, we need to continue to fill that sales funnel, need to continue to onboard new partnerships and continue to get those clients to take advantage of all the new products and services we've launched.

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 were anticipated within our guidance to do approximately $21 million, $22 million. So we're anticipated to have over 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.

Got it. Great. I'll just ask one more and let Andrew have some more questions. So just -- I know you're going to begin Phase II, I think, early next year. So I know you're not giving 2024 guidance, but I would be -- I would love to hear about maybe anticipated spend on maybe some of these -- some of that or that project specifically, if there is a major increase in R&D spend associated with that as a step-up. Thank you.

Yes, David. I think that our -- the budget projection still solid. We are still around $15 million annually burn rate. So for the Phase II study, it's going to be the Phase II study at the second line of therapy for the head and neck cancer patients. So it is a combining -- combinational therapy, which is suggested by the experts in this field. We feel very good about our position and the market potential. But in terms of R&D spending, the $50 million that we allocated is not only for the clinical trials, but all the new drug development efforts combined together. So we still expect about a $50 million annual burn rate.

Thank you so much.

Thank you. Next question today is coming from Andrew Cooper from Raymond James. Your line is now live.

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.

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.

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 sort of 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?

Yes, certainly. No, it is. And we're still continuing to sort of [full despite] (ph) 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 process there -- 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 a little bit of a downtrend that we saw, 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 into 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, 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 and are continuing to invest will pay off into next year.

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.

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 other 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, they're industry experts. So they do bring with them that client level expertise 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. So -- 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.

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?

Well, as we've discussed before, I mean, there was massive disruption in that space, right? So clients were left without a provider on short notice. So those clients had to find a new lab relatively quickly. So it was certainly hectic there for a while for the clients as well as for Fulgent and other laboratories. But most of that business had to find a new home and it did. And like as you said, Fulgent benefited tremendously from that. I think what we're seeing now is some of those clients were a bit rushed in their decision-making process. And perhaps not entirely pleased with some of the laboratories they've chosen for a variety of reasons, whether it's panel content, turnaround time, customer service. So now what we're seeing is clients have had the time to digest everything now seeing that Fulgent may have been a better choice. So while the -- like you said, the mad dash kind of happened, now it's more of a grind to find clients where Fulgent can be a better service provider than what they're currently getting. In terms of the OB space, it's something we have -- it's a bright spot in our radar. It's a huge TAM. It's a big opportunity for us. We've commented historically that often NIPT and carrier screening are coupled together. That's true. But I think what we're seeing right now with the dynamics in carrier screening, I do believe that there is a subset of that market that would be willing to separate the two. I think with our turnaround time, which is, again, right now around 12 days, we're signing some of these out as fast as nine days, I think the OB and the infertility clinics appreciate that turnaround time, our ability to customize these panels from anywhere between a handful of genes all the way up to almost 800. I think we've done a phenomenal job going to market with Beacon. And even in lieu of NIPT, I think we can get the attention of some of these OB doctors with Beacon.

And Andrew, the numbers, they 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, it was 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.

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?

I mean, it's a good question. We're monitoring it as closely as every other lab out there, right? I mean this -- they’ve been exercising jurisdictional discretion for many years, have leaned on LDTs with CAP and CLIA validation. So like there's something like 22,000 genetic tests on the Fulgent test menu. We're not sure how the FDA will approach regulating 22,000 tests per lab, for example. We think they're going to target some of the higher-risk genetic testing, some of the higher-volume genetic testing. But look, it's hard to say, it's hard to predict. However, it shakes out, we'll be prepared, right? We have the subject matter expertise. We have the operational expertise. So it's something we're watching and waiting. I think it is a -- quite a difficult task to step in and try to do this after all these years and all these genetic testing. But again, we will watch it, we will monitor it, and we will respond accordingly with the expertise we have here in that area. Larry, you have some additional feedback on the FDA?

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.

[Technical Difficulty]

Andrew, it sounds like you have some connectivity issues.

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

Yes, we can. Thank you, Andrew.

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.