GH 20Q4 Earnings and Analysis

Last quarter, I expressed concern about slowing growth. This quarter, Guardant revealed a statistic that puts the slowing growth in perspective and, to my eye, makes what growth there is impressive. From co-founder and Chief Executive Officer (CEO) Dr. Helmy Eltoukhy’s prepared remarks referring to oncology offices: “… widespread office closures … resulted in a 65% decline in new patient diagnosis this year.” Wow! New oncology patients were down 65% overall but Guardant’s clinical tests grew 27% in that time frame. The stock market found this report lacking, taking GH stock down roughly 8%, and below $150 for the first time in 29 days (more on that point much later). I found this report to be full of promise for the future. Because the “promise” is as yet unfulfilled, those of you on the sidelines might prefer to wait there. But I think Guardant should return to your watch list at least, and I wouldn’t advise selling.

Earnings Report Headline Items…. Motley Fool’s conference call transcript:…. Unless stated otherwise, all italicized quotations are from the Fool 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.]

4Q20 Revenue: $78.3 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 $76.7 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     74.6     78.3     =  286.7   Pandemic hits U.S. late 1Q20
Y-o-Y   84.2%    22.8%    22.5%    24.5%        33.8%

4Q20 Tests: 17,353 clinical; 4,841 biopharmaceutical; 22,194 total The clinical tests and the test total both set new quarterly records, although the growth rates are impacted by COVID-19. The number of oncologists who ordered one or more tests during the quarter was also a record. Biopharmaceutical tests, which are largely for patients in clinical trials, have been especially battered by COVID, but they were bolstered this quarter by what was described as a “yearend rush”.

          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   17,353       =  63,254
Y-o-Y    60.2%    15.3%    27.8%    13.6%           26.7%

          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    4,841       =  15,983
Y-o-Y     40.0%   -46.9%   -41.8%   -23.4%          -22.6%

          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   22,194       =  79,237
Y-o-Y    54.5%    -3.9%     8.0%     2.8%           12.3%

4Q20 Average Selling Price (ASP): $2642 clinical; $3892 biopharmaceutical; $2915 total Clinical’s year-over-year increase was due to improved reimbursement for Medicare non-lung tests under the new Local Coverage Determination (LCD) and also increases in private payer coverage. Biopharmaceutical’s ASP decline was, like last quarter, due to a change in product mix away from GuardantOMNI. Last quarter, I described the sequential clinical ASP decline as “mildly troubling” but “perhaps … a plateau”. New Chief Financial Officer (CFO) Michael Bell suggested that “plateau” might be correct, setting an expectation of roughly unchanged clinical ASP throughout 2021.

          1Q        2Q        3Q        4Q
2019     $1800     $1839     $2319     $2049

2020      2489      2893      2852      2642
Y-o-Y     38.3%     57.3%     23.0%     28.9%

          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      3892
Y-o-Y    36.1%      5.9%     -3.3%     -6.0%

          1Q        2Q        3Q        4Q
2018                        $1920     $2421

2019    $2171     $2451      2812      2660
Y-o-Y                        46.5%      9.9%

2020     2936      3090      3016      2915
Y-o-Y    35.2%     26.1%      7.3%      9.6%

4Q20 Development Services (and other) Revenue: $13.6 million This is typically revenue from partners wanting Guardant 360 (G360) to become a companion diagnostic (CDx) for the partners’ drugs. 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. There wasn’t much discussion of “and other” this quarter; our new CFO seems to keep his cards close to his vest. He did, however, suggest general bullishness for this line item in 2021.

Development Services (and other) Revenue ($ 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      13.6

4Q20 Gross Margin: 63.7%: I wasn’t excited to see the decline in gross margins from the low 70s last quarter. However, management offered a plausible explanation: “We expect our gross margins to continue to be in the mid-60s range for the foreseeable future as we launch new products, such as [GuardantREVEAL], which will take time to gain reimbursement coverage from Medicare and from private payers.” Looking at the current financials, I observe that gross margin for Precision oncology seems to be declining slightly but Development services (and other) gross margin declined much more rapidly, lending credence to the CFO’s commentary.

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%   63.7%

4Q20 GAAP Earnings: $-93.7 million ($-0.94 per diluted share) : Yahoo! Finance indicates that Wall Street expected $-0.57. Various news outlets reported the difference between the GAAP actual loss and the Wall Street estimate as a large “miss”, which can’t have helped the share price. I’m not sure. The other companies I cover offer “adjusted” earnings and Wall Street estimates are based on “adjusted” earnings too. If the only adjustment is the removal of stock-based compensation, Guardant’s loss is reduced to $-0.37/sh. I do not have the tools to verify whether the Wall Street estimates we’re seeing are based on adjusted earnings, or even whether all the analysts take a uniform approach.

Earnings per Share (GAAP)
          1Q       2Q       3Q       4Q
2019    -0.30    -0.13    -0.14    -0.84
2020    -0.29    -0.57    -0.78    -0.94

4Q20 Cash Flow From Operations (CFFO): $-59.2 million; Free Cash Flow (FCF): $-66.5 million Guardant has over $2 billion in cash and securities, and its debt is convertible, so it can easily withstand operating outflows of this magnitude. That said, these are record outflows for Guardant and almost double the prior record, from last year’s fourth quarter. Based on three years of history, there seems to be a seasonality in which the fourth quarter has the strongest outflows. I should note that Guardant has had only one quarter of positive operating cash flow in its history as a public company (3Q19). Increased test volumes could get Guardant closer, but they’re also expecting increased expenses. More later.

CFO Bell offered interesting guidance, which was a mix of positives and negatives. First, he predicts clinical test volumes to exceed 90,000 in 2021, which would set a baseline of 42% growth for that metric. Full-year 2021 revenue is expected to be in a $360-370 million range, implying growth of only 26-29%. The change in billing codes after FDA approval and Guardant’s split of Guardant360 (G360) into G360 CDx and G360 LDT is expected to be a near-term headwind. Furthermore, revenue in recent quarters had been supplemented with successful appeals of prior reimbursement denials. It sounds as if the new CFO doesn’t expect that to continue. CFO Bell guided for a weaker first half of the year, impacted by COVID, and a stronger second half, based on assumptions that COVID fears abate. Although Guardant is rolling out new products (much more later), revenue from them in 2021 is expected to be minimal.

GH earnings day share price: $149.45 -7.88% (vs. S&P 500 -2.45%) The market clearly did not like this earnings report. I’m not sure why. CFO Bell did speak to a $150-180 million increase in operating expenses in 2021 over 2020. For comparison, operating expenses in 2020 were ~$450 million, so that’s a 33-40% jump in expenses. The market tends to view this kind of thing as “expenses are guaranteed, but the returns on those investments are hoped for”. That said, 33-40% operating expense growth, while large, should be compared to 26-29% revenue growth, making it less eye-popping. More on the nature of those expenses later.

Capital Raise
Guardant is debt-free no longer. Guardant offered 0% convertible notes due in November 2027 and entered into a related transaction to hedge conversion risk. This is a complex set of transactions which has the potential to add some volatility to Guardant’s GAAP results. Guardant received $1.13 billion in cash and paid ~$90 million for the hedge. On the asset side of the balance sheet, that shows up as increased cash and marketable securities. On the other side of the balance sheet, in 4Q20, that appears as ~71% debt and ~29% equity. However, in 1Q21, it sounds as if they intend to adopt a new accounting rule that would move the equity portion back into debt. The effective conversion price is $139.82, but there are currently restrictions that prevent conversion. Those restrictions could be lifted as soon as April 2021, depending on the GH market price exceeding and staying above a certain target price (~$182/sh.) for 20 consecutive days, or if the price of the convertible debt drops below a certain threshold. Guardant cannot redeem these notes until after November 2024. If I’m not mistaken, there may be a “mark-to-market” aspect regarding the value of the hedge, which is why I think this set of transactions may introduce some volatility to GAAP quarterly results. What will Guardant do with all this money? An acquisition is a possibility, but the next section offers Guardant’s stated plans. Some of them are reiterations of earlier disclosures, but some are recent or new.

New Products, Pipeline, and Clinical Trials
As you read through all of these, you may wonder why CFO Bell is only predicting a 40% rise in operating expenses!

Guardant360 Updates
This first point was actually announced the same day that FDA approval of Guardant360 (G360) was announced, but I didn’t mention it at the time. The FDA also approved G360 CDx as a companion diagnostic for Tagrisso® (osimertinib), which is an AstraZeneca drug treating EGFR-positive non-small cell lung cancer (NSCLC) with over $3 billion in revenue in 2019. [EGFR is epidermal growth factor receptor.] This quarter’s news is that – pursuant to their partnerships with Janssen (a division of Johnson & Johnson) and Amgen – Guardant has submitted supplemental PMAs (Pre-Market Approvals) to the FDA for amivantamab and sotorasib. Janssen’s amivantamab targets NSCLC where the EGFR mutation has Exon 20 insertions. Amivantamab is not on the market yet, but Johnson & Johnson filed a biologic application with the FDA for new drug approval on Dec 20, 2020; it had received Breakthrough Drug designation from the FDA earlier in 2020, which could speed the FDA’s review process. Sotorasib is in Phase 3 trials for advanced NSCLC and targets KRAS G12C mutations. On January 28, 2021, Amgen presented positive Phase 2 data for sotorasib, indicating that it is the first drug to show progression-free survival against this mutation. Sotorasib is also currently in Phase 2 trials for advanced colorectal cancer (CRC) and for other tumors. KRAS G12C occurs in 13% of NSCLC patients and 1-3% of CRC patients. Sotorasib has also been granted Breakthrough Drug designation by the FDA, and data is being reviewed under the FDA’s Real Time Oncology Review pilot program. These seem like good partners to have and good drugs to be associated with. Radius Health has also partnered with Guardant for companion diagnostic assistance, but no PMA has been filed yet.

As mentioned earlier, the bifurcation of medical codes between G360 CDx and G360 LDT could create some headwinds in 2021. I see the reasoning, though. FDA-approved CDx will be slower to change, since new approvals would be required. LDT will be more nimble, adding detection of new mutations as the treatment landscape evolves.

We’re familiar with the argument for using G360’s liquid biopsy (blood draw) testing to choose a treatment regimen, but co-founder, Board Chairman, President and Chief Operating Officer (COO) Dr. AmirAli Talasaz points out the reasoning for a G360 test after a treatment regimen has been chosen: “We have over 40 publications that demonstrate that a second liquid biopsy test a few weeks after treatment initiation, can segment responders versus nonresponders across multiple tumor types and multiple classes of therapies.” More tests with actionable utility sounds good to me. As does ensuring patients are on drugs that are helping them.

There was no update for GuardantINFORM this quarter.

GuardantREVEAL was announced on February 16 and is Guardant’s initial foray into the minimal residual disease (MRD) detection and recurrence monitoring market; Guardant estimates the Total Addressable Market (TAM) at $15 billion in the U.S. For now, the test is specifically targeted to CRC survivors and is based on liquid biopsy. An estimated 10-30% of early-stage CRC patients recur, according to the American Cancer Society. The assay that Guardant is using is identical to the one being tested in the COBRA trial. The current standard of care is CEA (carcinoembryonic antigen) testing, which has sensitivity of 69% and specificity of 64%. [Sensitivity is the ability to correctly identify a person as having a disease. Specificity is the ability to correctly identify a person as disease-free.] GuardantREVEAL claims 91% sensitivity and 100% specificity, so it is a strong improvement over the standard of care, in terms of accuracy. COO Dr. Talasaz states, “Besides CRC, we have exciting feasibility data in other cancer types like lung and [bladder], which gives us confidence that our blood-only MRD test will continue to have market-leading performance as we expand [GuardantREVEAL] in multi-cancer types in the near future.” This is a huge TAM expansion for Guardant – the estimated U.S. TAM for G360 is only $6 billion. In his prepared remarks, CEO Dr. Eltoukhy noted that Guardant had initiated multiple studies related to recurrence monitoring in CRC patients, but no further details were offered.

Progress of the COBRA trial was not updated this quarter. The only mention was in comparison to GuardantREVEAL.

ECLIPSE is the clinical trial pitting the LUNAR-2 assay against colonoscopy in patients with average-risk of colorectal cancer. Guardant now has more than 150 clinical trial sites up and running, and they continue to believe they will complete trial enrollment (~10,000 patients) by November 2021. Asked about the timeline for submission to the FDA, CEO Dr. Eltoukhy noted that it will take some time to run the tests, collate the data, and prepare the forms for filing. As a reminder, LUNAR-2 is Guardant’s initial offering in the “early cancer detection” market, and the current focus is on colorectal cancer. The U.S. “early cancer detection” market is estimated at a $30 billion TAM. CEO Dr. Eltoukhy mentioned a $50 billion TAM, which probably is not a U.S.-only figure. Assuming that the ECLIPSE results pass FDA muster, I think we are less than two years away from a commercial product here, for those who felt that GRAIL had a two-year head start on Guardant in the early cancer detection space.

With the large expansion of TAM comes a large expansion of expense. When addressing an average-risk population, Guardant will no longer be marketing solely to oncologists; now their target audience will be primary care physicians – a less-focused group that is roughly an order of magnitude larger. This will require a very different sales team, and that is something Guardant is just beginning to address. CEO Dr. Eltoukhy indicated he wants to be “ready to go” when the data is released. I think this will imply one or two quarters of a large sales force learning their product, but not yet able to sell it.

Tissue Product
This disclosure is new to this quarter’s conference call, I believe. CEO Dr. Eltoukhy said, “We are also very excited for the upcoming launch of our first tissue product, which we believe will address the unmet need that persists in the therapy selection market due to the challenges with many of the existing tissue offerings.” This came as a bit of a surprise to me, but CEO Dr. Eltoukhy (misattributed in the transcript) indicated that it was more a question of “when” than “if”. From Guardant’s perspective, the two most critical failings with existing tissue biopsy testing are: slow results turnaround; and incomplete genomic profiling. Guardant believes they have the automation and operational excellence to improve the situation on both those fronts, as well as provide better customer service. They think it is important to expand beyond being a “liquid biopsy” company to become a “cancer testing” company. While CEO Dr. Eltoukhy indicated that no timeline for commercialization has been announced, the earnings press release did say, “later in 2021”.

Future Clinical Trials
COO Dr. Talasaz ended his prepared remarks with this gem: “We are starting to plan our next screening clinical trial in other cancer types and expect to share more updates about this in the latter part of 2021.” Pressed for more details during the Q&A, he reminded the analyst that prior discussions had mentioned lung, breast, and ovarian cancers in addition to the CRC focus that was ultimately chosen for ECLIPSE. On the one hand, broadening screening toward multicancer is extremely exciting. On the other hand, clinical trials are expensive.

While successful early cancer screening has the potential to radically change the world’s healthcare spending profile, making that transition will be extremely disruptive for companies that charge large amounts for extending a late-stage patient’s lifespan by months or a few years.

Geographic Expansion
Guardant has partnered with Vall d’Hebron Institute of Oncology in Spain and expects to create a lab there for processing European samples. Certain important European accreditations and certifications have already been achieved. Guardant has filed for regulatory approval of G360 in Japan and hopes to build another lab there to process Asian samples. Working with the SoftBank joint venture, testing is now available in over 40 countries.

Other Random Musings
Covered Lives
A September 15, 2020 company presentation indicated that Guardant had relationships with insurers covering 170 million people. During the earnings conference call, CEO Dr. Eltoukhy updated that number to over 200 million people for NSCLC and more than 100 million for multi-cancer testing. This increase probably reflects last year’s FDA approval of G360, paving the way for broader adoption. Prior to FDA approval, this number might increase by 10 million lives in a quarter, so this is a big jump.

Investigator Sponsored Trials
Guardant was asked about presenting data at upcoming oncology conferences. What Guardant has done is make their tests available to independent investigators who devise and run their own clinical trials. Often these investigators are KOLs, or Key Opinion Leaders – some of the best oncologists around. It is results of these trials that are getting published. This is probably the source of selectivity and specificity data regarding the assay used for both the COBRA trial and for GuardantREVEAL. Guardant is aware of one completed trial where a publication of trial results is under review and will hopefully be published before too long.

Revenue Growth, Expense Growth, and Stock-Based Compensation
We are seeing widening GAAP losses at Guardant. Management has told us that operating expenses will be considerably higher in 2021 than in 2020. The TMF analyst who recommended Guardant Health listed several red flags to watch for, and one of them was expenses that were out of control. He seemed most concerned with Sales and Marketing. Therefore, I want to take some time to compare 2020’s operating expenses with 2019’s, both with stock-based compensation (SBC) included and excluded.

Assuming a relatively steady gross margin, the path to profitability at a young company is to grow revenue faster than expenses. This was probably easier in pre-pandemic times – the two year compound annual growth rate (CAGR) for revenue was over 100% between 2017 and 2019. Revenue grew 33.8% in 2020 and guidance for 2021 is 26-29% revenue growth.

Research & Development Expense: This line item was $86.292 million in 2019, or $80.385 million excluding SBC. The corresponding numbers for 2020 are $149.862 million and $139.838 million. R&D expanded by 74% in 2020, with or without SBC. Management listed several factors in the SEC Form 10-K filing, but the largest factor was increased headcount. They note that R&D expenses will continue to increase due to new product initiatives and a focus on the LUNAR programs.

Sales & Marketing Expense: This line item was $78.335 million in 2019, or $73.619 million excluding SBC. The corresponding numbers for 2020 are $106.513 million and $97.234 million. S&M expanded at 36% in 2020, or 32% without SBC. As with R&D, management cited several factors, but the largest factor was increased headcount. Unsurprisingly, they also predict growth in S&M expenses. For now, at least, the growth in this line item is at a similar pace to growth in revenue.

General & Administrative Expense: This line item was $61.399 million in 2019, or $55.931 million excluding SBC. The corresponding numbers for 2020 are $192.770 million and $69.799 million. GAAP G&A expanded at 214%(!!!) in 2020, but only rose 25% without SBC. As you can see, SBC is the real culprit here and growth in G&A without SBC is lower than revenue growth.

To be fair, management hasn’t stressed making profitability a goal and – with two billion in cash and marketable securities on the balance sheet – they can easily afford to grow unprofitably for many years. That said, I personally would like to see profitability, but I’ll need some patience. It appears that the primary factor will be the pace of R&D growth versus the pace of revenue growth. Given the co-founders’ ambitions for the company, outsized R&D spending could persist for a while.

The second factor, which only affects GAAP profitability, is the accrual of the expenses related to the May 2020 SBC grant to the co-founders, which could persist through the 2Q22 quarter, but would largely disappear afterwards, since they are not eligible for another grant until 2027. You may recall from last quarter that expenses associated with each of the three tranches of this SBC accrue on a schedule based on Monte Carlo analysis, but unaccrued expenses within each tranche will accelerate to the period when the tranche actually vests, if earlier than expected. The first tranche of this SBC grant vested during 1Q21, which was a little earlier than expected, so SBC will be a little elevated that quarter. The second tranche came close to vesting in 1Q21, but the GH stock price fell below $150 the day after earnings were reported. It is still possible for this tranche to vest in 1Q21, but unlikely; the GH share price would have to close above $150 virtually every day in March. If that were to happen, 1Q21 SBC expense would be quite elevated, as there is probably a fair amount of unaccrued expense; I’d probably rather see some volatility in March and vesting occur in a later quarter, after more expense has accrued. The final tranche will vest with the occurrence of 30 consecutive calendar days with the GH share price above $200, with the Monte Carlo analysis predicting that to occur during 2Q22.

Concluding Thoughts
Guardant Health raised cash twice during 2020: a secondary offering of common shares in June; and a convertible debt offering in November. With $2 billion in cash and marketable securities, and debt that can be paid with shares, management has put its foot on the accelerator toward achieving its ambitions for the company. Shareholders will need to watch how well management executes against the wide range of initiatives already in place and/or newly initiated. Another critical question, of course, is whether 2020’s revenue growth slowdown was truly a COVID issue, or one of market saturation. Given the aforementioned statistic that new cancer patient diagnoses declined by 65% in 2020, but that Guardant clinical test volume increased 27% anyway, I’m less inclined to worry about saturation than I was last quarter. A bevy of new products, if well accepted, will fuel growth for years to come. Despite the market’s reaction to this quarterly report, I’m pretty excited about Guardant’s future.

I hope this was useful for you. If you have any questions or comments, please post them. I may not be 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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TMFDatabaseBob (long: GH, AMGN; 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.