Talk about snatching victory from the jaws of defeat! Guardant announced earnings after market close on August 6, and after-market activity portended a double-digit percentage share price decline the next day. During the day on August 7, Guardant announced that Guardant360 (G360) had received long-awaited FDA approval for solid tumors, and GH stock closed up on the day. Were earnings that bad? Was the FDA news that good? Let me try to parse this all out.
Earnings Report Headline Items
Earnings press release: https://investors.guardanthealth.com/news-releases/news-rele…. Seeking Alpha’s conference call transcript: https://seekingalpha.com/article/4366126-guardant-health-inc…. (Thanks, Seeking Alpha.) Unless stated otherwise, all italicized quotations are from the Seeking Alpha transcript.
[This paragraph is unchanged from last quarter. Please note: GAAP stands for Generally-Accepted Accounting Principles. U.S.-based companies must report GAAP figures. Some companies also report “adjusted” or “non-GAAP” results. Please also note: A “basis point” is one-hundredth of 1%. Language around comparing percentages can be confusing; if operating margin went from 10% to 11%, is that a 1% increase or a 10% increase? Saying that the operating margin increased 100 basis points, however, is unambiguous.]
2Q20 Revenue: $66.3 million In terms of growth rate, this is a significant decline, largely due to the impact of COVID-19 on visits to oncologists and the pace of clinical trial progression. Wall Street expected revenues of $59.2 million.
Revenue in $ millions 1Q 2Q 3Q 4Q FY Comments 2017 8.5 10.2 11.1 20.0 = 49.8 2018 16.7 19.4 21.7 32.9 = 90.6 Y-o-Y 96.1% 90.1% 94.9% 64.3% 81.9% 2019 36.7 54.0 60.8 62.9 = 214.4 Early 2Q NILE results published Y-o-Y 119.6% 178.5% 180.5% 91.3% 136.5% 2020 67.5 66.3 Y-o-Y 84.2% 22.8%
2Q20 Tests: 13,694 clinical; 2,805 biopharmaceutical; 16,499 total These numbers are clearly impacted by COVID-19, especially the biopharmaceutical tests, which are largely for patients in clinical trials.
**Clinical** 1Q 2Q 3Q 4Q FY 2015 11,805 2016 18,643 Y-o-Y 57.9% 2017 25,754 Y-o-Y 38.1% 2018 7,027 8,596 29,592 Y-o-Y 14% 14.9% 2019 9,521 11,875 13,259 15,270 = 49,925 Y-o-Y 31% 77% 88.7% 77.6% 68.7% 2020 15,257 13,694 Y-o-Y 60.2% 15.3% **Biopharmaceutical** 1Q 2Q 3Q 4Q FY 2016 1,830 2017 6,286 Y-o-Y 243.5% 2018 2,505 3,009 10,370 Y-o-Y 67% 65.0% 2019 3,762 5,285 5,280 6,316 = 20,643 Y-o-Y 61% 112% 110.8% 109.9% 99.1% 2020 5,266 2,805 Y-o-Y 40.0% -46.9% **Total** 1Q 2Q 3Q 4Q FY 2015 11,805 2016 20,473 Y-o-Y 73.4% 2017 31,895 Y-o-Y 55.8% 2018 9,532 11,605 39,962 Y-o-Y 25.3% 2019 13,283 17,160 18,539 21,586 = 70,568 Y-o-Y 94.5% 86.0% 76.6% 2020 20,523 16,499 Y-o-Y 54.5% -3.9%
2Q20 Average Selling Price: $2893 clinical; $4054 biopharmaceutical; $3090 total Clinical’s continued increase was due to improved reimbursement for Medicare non-lung tests under the new Local Coverage Determination (LCD). Biopharmaceutical’s ASP improvement was, like last quarter, due to a mix toward OMNI.
**Clinical** 1Q 2Q 3Q 4Q 2019 $1800 $1839 $2319 $2049 2020 2489 2893 Y-o-Y 38.3% 57.3% **Biopharmaceutical** 1Q 2Q 3Q 4Q 2018 $2966 $3286 $3491 $3571 2019 3109 3827 4052 4142 Y-o-Y 4.8% 16.5% 16.1% 109.9% 2020 4230 4054 Y-o-Y 36.1% 5.9% **Total** 1Q 2Q 3Q 4Q 2018 $1920 $2421 2019 $2171 $2451 2812 2660 Y-o-Y 46.5% 9.9% 2020 2936 3090 Y-o-Y 35.2% 26.1%
Development Services Revenue: $15.3 million I didn’t include this in my analysis last quarter, mostly because I viewed the data as too “lumpy” to draw meaningful conclusions, and it is a relatively small percentage of revenues (17% so far this year). But I felt as if it was worth examining this quarter to help flesh out our understanding of Guardant’s business. This type of revenue occurs when Guardant does work for a partner to ensure that Guardant’s assay recognizes a specific cancer mutation targeted by the partner’s drug, and works with its partner to gain FDA approval of its tool as a companion diagnostic (CDx) for the partner’s drug. A recent example of this is Janssen (part of Johnson & Johnson) looking for a CDx for amivantamab, which treats a specific, uncommon EGFR mutation in non-small cell lung cancer (NSCLC). If Guardant is successful, G360 will identify this mutation (EGFR exon 20 insertions). If amivantamab gains FDA approval and G360 is approved as a CDx for amivantamab, Janssen is likely to help push NSCLC oncologists toward using the G360 test. Probably somewhere between 1-4% of NSCLC patients have this particular mutation, so Janssen’s drug wouldn’t likely be widely prescribed. But Janssen wants to capture as much of that 1-4% as possible, and patients and their oncologists will benefit if the proper mutation is identified and a highly-specific drug is prescribed. Chief Financial Officer (CFO) Derek Bertocci notes that, “… we do not expect development services to remain at this record peak for the second half of 2020.”
$ millions 1Q 2Q 3Q 4Q 2018 $2.5 $1.6 $3.4 $4.8 2019 7.8 11.9 8.7 5.5 2020 7.3 15.3
2Q20 Gross Margin: 66.2%: Gross margins declined from recent highs principally due to lower test volumes, but also because development services revenue tends to carry lower margins than diagnostic test revenues.
Gross Margin 1Q 2Q 3Q 4Q 2017 25.1% 27.1% 22.2% 54.3% 2018 44.6% 48.6% 53.7% 57.6% 2019 63.1% 68.8% 69.6% 65.3% 2020 69.6% 66.2%
2Q20 Earnings: $-54.6 million ($-0.57 per diluted share) : I start this series in 2019 because the share count was meaningfully different in 2018. I will omit year-over-year comparisons until earnings consistently turn positive. Earnings are mostly pretty uninteresting right now except to the extent that (1) they differ from Wall Street’s expectations, and (2) we can find trends that point toward eventual profitability. With well over $10/sh. in cash, equivalents, and marketable securities (and no debt), Guardant can absorb losses like these for years. Hopefully, it won’t take that long (more later). Wall Street expected $-0.38.
Earnings per Share (non-GAAP) 1Q 2Q 3Q 4Q 2019 -0.30 -0.13 -0.14 -0.84 2020 -0.29 -0.57
2Q20 Cash Flow From Operations (CFFO): $-23.4 million; Free Cash Flow (FCF): $-32.9 million Guardant is still too young to talk a lot about cash flow trends. For numbers to improve from here, though, I think we’ll need to see increased diagnostic test volume.
CFO Bertocci did his best to give guidance without giving guidance. “The impact of COVID-19 created headwinds for the oncology space during the second quarter and due to its unpredictable evolution, we do not believe that we can reasonably estimate the magnitude or duration of specific impacts on our business. Accordingly, we are not reinstating financial guidance at this time. … we exited the second quarter with clinical test volumes similar to the levels we saw prior to the impacts from COVID-19. That said, we believe the effects from COVID are likely to continue to impact the oncology space in the near term and we anticipate third quarter clinical volumes will be up modestly from the first quarter. ”
GH earnings day share price: $85.61 +3.46% (vs. S&P 500 +0.06%)
Pipeline and Clinical Trials
Here is how President and co-founder Dr. AmirAli Talasaz explained this new product, launched in late June: “Each Guardant360 test provides critical genomic information on various tumor profiles and we have now collected this genomic information from more than 100,000 patients to date. GuardantINFORM combines this robust genomic data with the identified clinical information for each patient. This clinical genomic data set offers our biopharma partners real-world insight into how patients are treated based on their mutation profiles as well as pattern of drug resistance and tumor evolution. The most notable applications for GuardantINFORM include targeted drug development and label expansion, clinical trial optimization by incorporating real-world clinical genomic data into trial design and control arm development as well as post-marketing studies.”. Given my TMF handle, you can imagine that I approve of Guardant turning their database into a product. I’ll go out on a limb here, because Guardant has not disclosed this. A common theme in SoftBank’s investments is a strength in artificial intelligence (AI). Therefore, I’d be surprised if there is no AI in the GuardantINFORM platform, but please realize that I’m drawing inferences here that may not be accurate.
ECLIPSE is the clinical trial pitting the LUNAR-2 assay against colonoscopy in patients with average-risk of colorectal cancer. Guardant continues expanding the number of sites in the trial. They are now at 130 sites, up from 100 last quarter and nearing their target of 150. They continue to believe they will complete trial enrollment within the 24-month period they originally planned.
Other Random Musings
One analyst asked about increased competitive pressures. Chief Executive Officer (CEO) and co-founder Dr. Helmy Eltoukhy indicated that there were competitors in the space when Guardant first joined it and some of them remain in the space. He expressed extreme confidence in GuardantOMNI, describing it as “… head and shoulders above …” anyone else’s offering. I would have felt a little better if he extended the effusive praise to G360 as well.
Guardant May Introduce a COVID-19 Test
Guardant has developed their saliva-based test for the presence of the COVID-19 virus. They are using it on a regular basis to test their own employees to keep their facilities safe. They have filed an EUA (emergency use authorization) with the FDA and are working to find a partner to market the test, should they gain EUA approval. Management continues to stress that they view this as a “social responsibility”, and not a “new business line”. That said, they also hope not to take a loss on these efforts.
Keeping an Eye on Expenses
Guardant breaks out three sets of operating expenses: Research and development; Sales and marketing; and General and Administrative. During the earnings conference call, CFO Bertocci went through each of these, comparing them to last year. The year-over-year gains were eye-popping. Although I harbor some concerns, I thought it would be more appropriate to compare 2Q20 expenses against 1Q20 expenses. R&D expenses were up 86% year-over-year, but down 2% quarter-over-quarter. What has changed since last year? Guardant launched the ECLIPSE clinical trial, filed with the FDA for G360 approval, and developed a COVID-19 test. You can see why I don’t think 2Q19 is a useful comparison. Sales and marketing expenses grew 29% year-over-year, but were down less than 1% quarter-over-quarter. In the past year, they’ve added sales headcount and expanded programs around liquid biopsy education. General and administrative (G&A) expenses were up 177% over 2Q19 and 88% over 1Q20. The vast majority of this was due to $18.3 million in stock-based compensation (SBC) awarded in the second quarter. While I don’t want to downplay this amount, I will note that this hasn’t been an ongoing expense for Guardant, at least not at these levels. The last time the two co-founders received options or stock awards was 2017. Some executives received awards more recently, but those seemed to be associated with onboarding or promotions. Absent the SBC, G&A grew 41% year-over-year and decreased ~4.5% quarter-over-quarter. Given that operating expenses seem to be holding somewhat steady for now, shall we play some numbers games?
I’m taking a very “back of the envelope” approach here, so I’m guaranteed to be wrong. If I’m lucky, I won’t be too far off, but that’s not assured. With those caveats… Operating expenses – using the first half of 2020 as a run-rate – are $361 million for a full year. That’s the nut we have to crack to attain profitability. If we average the last six quarters, what amount of revenue would Guardant have to achieve for gross profit to exceed operating expenses? Assuming that gross margin stays constant at the six-quarter average, Guardant would have to grow revenue by ~130% to get to roughly breakeven. Is that asking a lot? It depends. Guardant grew revenue 82% in 2018 and 136% in 2019, coming off the successful NILE clinical trial. I don’t think we can count on similar growth in 2020. Will 2020’s slower revenue growth be just a pandemic-induced lull, or the start of a new trend? I can’t know that answer, but I’d vote for “lull”, given that 1Q20 revenues were >80% above 1Q19. Perhaps FDA approval of G360 will help reignite revenue growth. Speaking of which…
FDA Approval for G360
During the earnings conference call, CEO Dr. Eltoukhy had this to say about the FDA approval they hoped to receive: “We believe FDA approval will help to accelerate wider adoption of guideline-recommended genomic profiling, increasing the number of advanced cancer patients who receive potentially life-changing treatments. Specifically, we expect FDA approval to: strengthen reimbursement by advancing conversations with private payers and further improving existing Medicare coverage; extend momentum for our companion diagnostics business through increased opportunities to work with biopharma in the clinical setting; and over the medium to long term, advance the use of Guardant360 with physicians who have been slow to adopt CGP.” [CGP stands for Comprehensive Genomic Profiling, which is indeed “guideline-recommended”, and not as prevalent as it probably should be.] As we now know (and as I mentioned earlier), FDA approval of G360 was announced the next day. We’ll learn over the next few quarters whether the expected benefits are forthcoming.
The pandemic certainly hit Guardant Health’s testing volumes this quarter, slowed their growth rates, and led them to report a much wider quarterly loss than Wall Street expected. A generous stock-based compensation grant may not have improved Wall Street’s mood. However, FDA approval of G360 changed the mood quickly. In my opinion, this is a still-evolving story and patience is needed. I will want to watch whether growth reaccelerates, post-pandemic. I will also want to watch whether FDA approval does indeed change the landscape for insurance reimbursement for their tests as well as increase oncologist acceptance. This may take a year or more to fully unfold. But I think the advantages of liquid biopsy over tissue biopsy are compelling, and that Guardant has a very bright, very motivated management team. Guardant’s balance sheet is strong, and I think they’re well-positioned to capitalize on this opportunity.
I hope this was useful for you. If you have any questions or comments, please post them. I am not up-to-date on every board where this is posted. If you want me to see your response quickly, please reply to my post rather than just a post in the same thread.
Thanks and best wishes,
TMFDatabaseBob (long: GH; a family member is long JNJ)
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Please note: I am not a member of any newsletter team. My opinions are my own and do not necessarily reflect those of the TMF advisers. I am not an investment professional, merely an investor.