Below is a cross-post from The Motley Fool Premium Boards. I thought it appropriate to delay a little before posting to the public boards. Toward the end of the post, I talk about stock-based compensation (SBC), which had caused a large earnings miss. I admitted confusion and that I must be missing something because I couldn’t reconcile the SBC amount. mekong22 – a respected member here on Saul’s board – came to the rescue and provided the explanation I was missing. Kudos to him, and he’s indicated that he’ll do the same on this board. So, when you get to that section, please free to merely skim for context – a better explanation is forthcoming! I know that Saul isn’t a big fan of including SBC in earnings results, so perhaps many of you will not find my SBC presentation interesting. Of course, please feel free to skim or skip any parts you want.
Guardant Health’s results are being impacted by the pandemic. They weren’t horrible, but revenue growth has slowed considerably. GAAP losses were much larger than expected, and I dig into the reason why. Although GH stock was down post-earnings, it has had a very nice run since the last earnings report. Counterintuitively, that probably negatively affected this earnings report. I’ll try to make sense of all of this but, as you’ll see, I’m going to need some help from Investor Relations. I haven’t gotten a response yet.
Earnings Report Headline Items
https://investors.guardanthealth.com/press-releases/press-re…. Seeking Alpha’s conference call transcript: https://seekingalpha.com/article/4385686-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.]
3Q20 Revenue: $74.6 million This is a record quarterly result. In terms of growth rate, it is a decline, largely due to the impact of COVID-19 on visits to oncologists and the pace of clinical trial progression. Wall Street expected revenues in a $65.9-66.0 million range.
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 74.6 Pandemic hits U.S. late 1Q20
Y-o-Y 84.2% 22.8% 22.5%
3Q20 Tests: 16,950 clinical; 3,071 biopharmaceutical; 20,021 total These numbers are clearly impacted by COVID-19, especially the biopharmaceutical tests, which are largely for patients in clinical trials. It is mildly encouraging that total tests grew against last year’s 3Q total, but the growth is anemic compared to prior growth rates, and total test count is below pre-pandemic peaks.
**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 16,950
Y-o-Y 60.2% 15.3% 27.8%
**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 3,071
Y-o-Y 40.0% -46.9% -41.8%
**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 20,021
Y-o-Y 54.5% -3.9% 8.0%
3Q20 Average Selling Price (ASP): $2852 clinical; $3919 biopharmaceutical; $3016 total Clinical’s year-over-year increase was due to improved reimbursement for Medicare non-lung tests under the new Local Coverage Determination (LCD). Biopharmaceutical’s ASP decline was, like last quarter, due to a mix away from OMNI. The sequential decline in clinical ASP is mildly troubling. It is a slight decline, so perhaps this is more of a plateau until Medicare-approved rates improve and/or more private payers approve G360. While not revealing any concrete plans, management expressed optimism about ASP improvement over the medium- to long-term.
**Clinical**
1Q 2Q 3Q 4Q
2019 $1800 $1839 $2319 $2049
2020 2489 2893 2852
Y-o-Y 38.3% 57.3% 23.0%
**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 3919
Y-o-Y 36.1% 5.9% -3.3%
**Total**
1Q 2Q 3Q 4Q
2018 $1920 $2421
2019 $2171 $2451 2812 2660
Y-o-Y 46.5% 9.9%
2020 2936 3090 3016
Y-o-Y 35.2% 26.1% 7.3%
3Q20 Development Services (and other) Revenue: $14.2 million This is typically revenue from partners wanting Guardant 360 to become a companion diagnostic (CDx) for the partner’s drug. Once CDx status is approved, these pharmaceutical partners become advocates with oncologists for use of G360. This is a lumpy revenue stream, so year-over-year comparisons aren’t very useful – just look for long-term trends. During the 2Q20 earnings conference call, Chief Financial Officer (CFO) Derek Bertocci had guided downward from the 2Q20 peak. Now he suggests that Development services revenue will remain strong for the rest of 2020. Rather than bemoan the sequential decline, I am encouraged that CDx-related revenue appears to be still near-peak. Please realize, though, that this revenue line isn’t purely about CDx anymore. CFO Bertocci disclosed that ~$1 million of this revenue line came from COVID testing. There may or may not be revenue from other products here. More later.
$ 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 14.2
3Q20 Gross Margin: 71.6%: I am very pleased to see gross margins exceed 70% for the first time, despite a sequential decline in test volumes and a high percentage of development services revenue, which 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% 71.6%
3Q20 Earnings: $-77.7 million ($-0.78 per diluted share) : Wall Street expected somewhere between $-0.36 and $-0.38. I’ll comment later on the greater than expected GAAP losses.
Earnings per Share (GAAP)
1Q 2Q 3Q 4Q
2019 -0.30 -0.13 -0.14 -0.84
2020 -0.29 -0.57 -0.78
3Q20 Cash Flow From Operations (CFFO): $-8.1 million; Free Cash Flow (FCF): $-17.8 million These are small outflows. Guardant has over $1 billion in cash and securities, and no debt.
Guidance
As was the case last quarter, CFO Bertocci did his best to give guidance without giving guidance. “The impact of COVID-19 created headwinds for the oncology space during the third 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’re not reinstating financial guidance at this time. … we believe the effects from COVID are likely to continue to impact the oncology space in the near term. … there has been a resurgence of COVID cases in some regions across the US. And we are seeing signs indicating that this resurgence will adversely affect clinical volumes. While we have been successful in continuing to serve our customers in this environment, we expect that clinical volumes for the fourth quarter will only grow modestly in the low single digits compared to the third quarter 2020 given this resurgence. Regarding our Biopharma business, we expect that Biopharma sample volumes will continue to grow in Q4 at rate similar to Q3. We expect development services revenue to remain strong and be comparable to Q3.”
GH earnings day share price: $112.961 -3.80% (vs. S&P 500 -0.03%) I have seen a pattern this quarter of share price declines when earnings are reported unless the results are utterly fantastic.
New Products, Pipeline, and Clinical Trials
Guardant 360 – CDx and LDT
Why is Guardant 360 (G360) under a “new products” section heading? Fresh on the heels of FDA approval for G360, Guardant has decided to turn it into two products. G360 CDx (companion diagnostic) is the FDA-approved version of the product that we know and love. G360 LDT seems like it is probably G360 CDx but with a broader diagnostic panel, seemingly focused on tests that might be helpful in choosing newer classes of oncology drugs. There isn’t a ton of information on Guardant’s website about G360 LDT yet, although there is some information in SEC Form 10-Q for this quarter. Although one might expect LDT to be more expensive since it features more tests, the reverse might be true, at least in the short-term. With FDA approval, G360 CDx will get a new medical billing code, while G360 LDT will continue to use the existing G360 code. I guess we’ll see how this evolves over time.
GuardantINFORM
As I mentioned last quarter, GuardantINFORM takes a “big data” approach to cancer analysis, based on the database of test results and outcomes of patients who have undergone the G360 tests. President and co-founder Dr. AmirAli Talasaz, indicated, “We are excited by the number of deals we have signed to date and by the number of active discussions that are going with additional customers.” Guardant has not said (that I could find) where revenue from this product would be recognized. Since I believe it is mainly geared toward supporting biopharma companies, I would guess that this falls under “Development services” revenue, especially since the name of that revenue line has been changed – just this quarter – to “Development Services and other”. It is possible that this product is part of the reason why that revenue line is running so “hot”. It is also possible that this product was part of the nice boost in gross margins we saw earlier. But I am stating both those possibilities without good evidence. Alternatively, it is possible that any money from this product is sitting in “Deferred revenue”, waiting to be recognized in the future. It seems reasonable to me, though, that a software-based product would likely be margin-enhancing, and we did see a record gross margin. I’ve sent an e-mail to Investor Relations asking for clarification regarding how GuardantINFORM revenue will be treated, but I haven’t received a response yet.
LUNAR-1 and COBRA
This is the second quarter in a row where there was no discussion of LUNAR-1 or the COBRA trial. LUNAR-1’s focus is detecting disease recurrence.
LUNAR-2 and ECLIPSE
ECLIPSE is the clinical trial pitting the LUNAR-2 assay against colonoscopy in patients with average-risk of colorectal cancer. It sounds as if Guardant is very close to having all 150 clinical trial sites up and running, and they continue to believe they will complete trial enrollment within the 24-month period they originally planned (i.e., ~November 2021). Perhaps interestingly, the USPSTF (United States Preventative Services Taskforce) expanded the colorectal cancer screening guidelines to include the 45-49 age group, which were already part of the ECLIPSE trial design. As a reminder, LUNAR-2 is Guardant’s initial offering in the “early cancer detection” market, and the current focus is on colorectal cancer.
Other Random Musings
Guardant Has Introduced a COVID-19 Test
Last quarter, I reported that Guardant had developed a saliva-based test for the presence of the COVID-19 virus. They were able to gain an EUA (emergency use authorization) from the FDA for this test. Guardant is testing their own employees on a regular basis to keep their facilities safe. They have also made it available to “select partner organizations”. The SEC Form 10-Q confirms that Guardant-19 (as it’s called) revenue is recognized in “Development services and other”. This is likely the main reason why the name of the revenue line was amended to add “… and other”. Guardant continues to maintain that they’ve entered the COVID testing space because (1) they want to keep their employees safe, and (2) they are in a position to provide help addressing a worldwide problem, so they feel morally compelled to do so. Cancer remains their focus.
Expenses
Last quarter, I dove into year-over-year and sequential comparisons of Guardant’s operating expenses. Given that Guardant posted a much bigger loss than Wall Street expected despite revenue that was basically in-line with expectations, it seems appropriate to revisit expenses this quarter. In this section, I’ll quickly review “Research and development” and “Sales and marketing”. The “General and administrative” expense line was where the main difference occurred. I’ll treat that in a separate section because there have been some major changes this year. As was the case with year-over-year and sequential comparisons in 2Q20, 3Q20 R&D and S&M expenses are much higher than in 3Q19, but basically flat against 2Q20. As I said last quarter, Guardant has expanded their salesforce and has initiated clinical trials that weren’t in place a year ago.
General and Administrative expense
During his prepared remarks, CFO Bertocci described the year-over-year changes in G&A expenses: “General and administrative expenses for the third quarter were $66.3 million, compared to $16.4 million in the third quarter of 2019. G&A expenses for the third quarter of 2020 included [$50.1] million in stock based compensation or SBC, including expense related to market based restricted stock units [granted to the company’s] founders on May 26 2020, as compared to $1.7 million in SBC in the third quarter of 2019. The remaining increase in G&A expense is $1.5 million, which was primarily due to additional staff to support the growth of the company[, legal] expenses, and the cost of compliance with requirements been a large accelerated public filings with the SEC.” The $1.5 million isn’t very material, but the $50.1 million is quite interesting. My e-mail to Investor Relations also includes a question about this expense. If I get a response, I will follow-up with you, but here is what I understand today (and I apologize for missing this in my 2Q20 analysis; it was disclosed in an SEC Form 8-K that I overlooked). On May 26, 2020, the two co-founders and Guardant’s Board of Directors agreed to significantly change the co-founders’ compensation structure. Their salary would be reduced to $1 annually (from $500,000), but they would each receive a grant of 1,695,574 performance-based restricted stock units (RSUs). These RSUs will expire on 5/26/2027 if they remain unvested, and the co-founders have agreed that they will not receive another equity-based or long-term incentive compensation award prior to calendar year 2027, nor will they be eligible for annual bonus prior to 5/26/27. Talk about going “all-in”! The first third of the RSUs will vest when the GH stock price stays above $120 for 30 consecutive calendar days. When the GH stock price stays above $150 for 30 days, the second third of RSUs will vest. The third set of RSUs vest when $200 per GH share is sustained for 30 days. It should be noted that the co-founders hadn’t received equity compensation awards since July 2017. This is a very interesting compensation structure. Arguably, it aligns management’s interests with shareholders, although I will be very disappointed if GH shares are worth only $200 in 2027. A purist might argue that management has no direct control over the share price, and should instead be compensated based on business performance. Whether you agree or disagree with this compensation scheme, it is what GH shareholders have for the next six-plus years.
My confusion about the $50.1 million in SBC expense in 3Q20 is that – as of 9/30/20 – the all-time high in GH stock was $114.33, shy of the $120 required for shares to vest. Why recognize an expense in 3Q20? I understand that accounting has intricacies and perhaps achieving a sustained $120 price was deemed more likely to occur than not. The $50 million amount also strikes me as a bit odd, since more than 1 million shares will vest when the two co-founders’ shares are combined. My best guess here is that the $50 million includes the number of shares that will vest times the $120/share price MINUS the “baseline” price at the time of the grant ($89.04), which was based on a 180-day volume-weighted average stock price. I’ve tried to reconcile the $50.1 million SBC expense using that calculation, but there is enough discrepancy that it is apparent that I’m missing something. I know that in July, Guardant’s new General Counsel and Corporate Secretary received both GH common stock (12,412 shares) and a ten-year option to buy 24,824 shares at $82.83. I’m sure this affected the $50.1 million SBC expense as well. But I’m still having difficulty making the numbers hit. Hopefully, I’ll get an answer from Investor Relations.
I also raise this issue to alert you that expenses may become elevated as the GH share price approaches $150 and again when it nears $200. For those of you who ignore stock-based compensation, this will be a non-issue.
My last point on stock-based compensation this quarter is that SEC Form 10-Q indicated that there were recent grants to non-executives. This occurred on November 4 and covered 546,572 shares valued at ~$62 million. Some of the grants have a time-based vesting scheme (four years) while others vest based on financial and/or operational metrics. No further details were offered and I couldn’t find additional SEC filings that might provide more detail. Again, this could lead to some expense volatility over the next few years, but it is not as material as the RSUs granted to the co-founders.
Concluding Thoughts
I am tempted to give Guardant Health a pandemic-related “free pass” for this quarter. Their biopharma testing is in the doldrums as enrollment has slowed at clinical trials. Clinical test volume set a record this past quarter, but growth rates are far below the pace exhibited before the pandemic. FDA approval of G360 CDx is still too new to make a difference in the financials, although I’m sure it has accelerated discussions with insurers and oncologists. It seems to me that we are still early in the adoption phase. The pandemic has altered the way medicine is practiced and physicians and patients are cautiously finding new ways to interact. The next few sentences are copied verbatim from my last earnings analysis because they’re still relevant. “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. Please also note that I have no agreement with The Motley Fool to provide ongoing coverage for Guardant Health.
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Thanks and best wishes,
TMFDatabaseBob (long: GH)
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Peace on Earth
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.
And now you get to learn all about it…be careful what you ask for…