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 Itemshttps://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 Comments2017 8.5 10.2 11.1 20.0 = 49.82018 16.7 19.4 21.7 32.9 = 90.6Y-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 publishedY-o-Y 119.6% 178.5% 180.5% 91.3% 136.5%2020 67.5 66.3 74.6 Pandemic hits U.S. late 1Q20Y-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 FY2015 11,8052016 18,643Y-o-Y 57.9%2017 25,754Y-o-Y 38.1%2018 7,027 8,596 29,592Y-o-Y 14% 14.9%2019 9,521 11,875 13,259 15,270 = 49,925Y-o-Y 31% 77% 88.7% 77.6% 68.7%2020 15,257 13,694 16,950Y-o-Y 60.2% 15.3% 27.8%Biopharmaceutical 1Q 2Q 3Q 4Q FY2016 1,8302017 6,286Y-o-Y 243.5%2018 2,505 3,009 10,370Y-o-Y 67% 65.0%2019 3,762 5,285 5,280 6,316 = 20,643Y-o-Y 61% 112% 110.8% 109.9% 99.1%2020 5,266 2,805 3,071Y-o-Y 40.0% -46.9% -41.8%Total 1Q 2Q 3Q 4Q FY2015 11,8052016 20,473Y-o-Y 73.4%2017 31,895Y-o-Y 55.8%2018 9,532 11,605 39,962Y-o-Y 25.3%2019 13,283 17,160 18,539 21,586 = 70,568Y-o-Y 94.5% 86.0% 76.6%2020 20,523 16,499 20,021Y-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 4Q2019 $1800 $1839 $2319 $20492020 2489 2893 2852Y-o-Y 38.3% 57.3% 23.0%Biopharmaceutical 1Q 2Q 3Q 4Q2018 $2966 $3286 $3491 $35712019 3109 3827 4052 4142Y-o-Y 4.8% 16.5% 16.1% 109.9%2020 4230 4054 3919Y-o-Y 36.1% 5.9% -3.3%Total 1Q 2Q 3Q 4Q2018 $1920 $24212019 $2171 $2451 2812 2660Y-o-Y 46.5% 9.9%2020 2936 3090 3016Y-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 4Q2018 $2.5 $1.6 $3.4 $4.82019 7.8 11.9 8.7 5.52020 7.3 15.3 14.23Q20 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 4Q2017 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 4Q2019 -0.30 -0.13 -0.14 -0.842020 -0.29 -0.57 -0.783Q20 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.GuidanceAs 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 TrialsGuardant 360 – CDx and LDTWhy 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.GuardantINFORMAs 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 COBRAThis 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 ECLIPSEECLIPSE 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 MusingsGuardant Has Introduced a COVID-19 TestLast 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.ExpensesLast 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 expenseDuring 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 ThoughtsI 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.Fool on!Thanks and best wishes,TMFDatabaseBob (long: GH)Maintenance Coverage FoolSee what a "Coverage Fool" does here: http://www.fool.com/community/community-team.aspx See my holdings here: http://my.fool.com/profile/TMFDatabasebob/info.aspx Peace on EarthPlease 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.
Revenue in $ millions 1Q 2Q 3Q 4Q FY Comments2017 8.5 10.2 11.1 20.0 = 49.82018 16.7 19.4 21.7 32.9 = 90.6Y-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 publishedY-o-Y 119.6% 178.5% 180.5% 91.3% 136.5%2020 67.5 66.3 74.6 Pandemic hits U.S. late 1Q20Y-o-Y 84.2% 22.8% 22.5%
Clinical 1Q 2Q 3Q 4Q FY2015 11,8052016 18,643Y-o-Y 57.9%2017 25,754Y-o-Y 38.1%2018 7,027 8,596 29,592Y-o-Y 14% 14.9%2019 9,521 11,875 13,259 15,270 = 49,925Y-o-Y 31% 77% 88.7% 77.6% 68.7%2020 15,257 13,694 16,950Y-o-Y 60.2% 15.3% 27.8%Biopharmaceutical 1Q 2Q 3Q 4Q FY2016 1,8302017 6,286Y-o-Y 243.5%2018 2,505 3,009 10,370Y-o-Y 67% 65.0%2019 3,762 5,285 5,280 6,316 = 20,643Y-o-Y 61% 112% 110.8% 109.9% 99.1%2020 5,266 2,805 3,071Y-o-Y 40.0% -46.9% -41.8%Total 1Q 2Q 3Q 4Q FY2015 11,8052016 20,473Y-o-Y 73.4%2017 31,895Y-o-Y 55.8%2018 9,532 11,605 39,962Y-o-Y 25.3%2019 13,283 17,160 18,539 21,586 = 70,568Y-o-Y 94.5% 86.0% 76.6%2020 20,523 16,499 20,021Y-o-Y 54.5% -3.9% 8.0%
Clinical 1Q 2Q 3Q 4Q2019 $1800 $1839 $2319 $20492020 2489 2893 2852Y-o-Y 38.3% 57.3% 23.0%Biopharmaceutical 1Q 2Q 3Q 4Q2018 $2966 $3286 $3491 $35712019 3109 3827 4052 4142Y-o-Y 4.8% 16.5% 16.1% 109.9%2020 4230 4054 3919Y-o-Y 36.1% 5.9% -3.3%Total 1Q 2Q 3Q 4Q2018 $1920 $24212019 $2171 $2451 2812 2660Y-o-Y 46.5% 9.9%2020 2936 3090 3016Y-o-Y 35.2% 26.1% 7.3%
$ millions 1Q 2Q 3Q 4Q2018 $2.5 $1.6 $3.4 $4.82019 7.8 11.9 8.7 5.52020 7.3 15.3 14.2
Gross Margin 1Q 2Q 3Q 4Q2017 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%
Earnings per Share (GAAP) 1Q 2Q 3Q 4Q2019 -0.30 -0.13 -0.14 -0.842020 -0.29 -0.57 -0.78
Thanks for the deep dive - I've decided to not read too much in to GH's performance until next year given COVID's negative impact on diagnostic testing. I'm biding my time for the results of the ECLIPSE/LUNAR2 study results in FY21 but have no intention on selling since it's still had a good return this year.
I kinda scratched my head at this. -why do a covid test? Just seems odd unless they wanted to try to help and can write off some of those costs to keep folks working.-the slowing of biopharma is troubling- they make more per test here. but its only like 20% of the business. This is especially troubling when NVTA added more partners and is accelerating their biopharma companion testing. TBH, clinical trials in Q2 probably werent all that much slower July-Sept, at least judging by the emails I get on the biotechs I follow and since that was a relative lull for COVID. Even labs were open and Q3 sales for research-centric companies like TXG were up YoY. Not buying a covid slow-down here for GH.Overall I agree with the cautious optimism, and think GH may continue to be a winner here, but it demands to be watched more carefully than previous. One nice thing about GH was that they had a multi-pronged approach- well, one of those prongs is dull, the other seems to be pushed further into the future, so they really have their eggs in one basket at the moment, and that basket is lucrative and competitive. On a more macro level, healthcare providers are getting their world turned upside down and just trying to keep their head above water, so progress may be a bit slower than usual around those parts. I think GH can be a winner, but this is recent report raises an eyebrow- will be interesting how the next 12-24 months plays out for GH.
Thanks, Bob! This is really a great post and summary of GH's quarterBelow is the cross post of my explanation for GH's Stock based compensation expense in Q3 2020, and this will also provide an idea of what to expect over the next few quarters (spoiler alert, SBC expense will continue to be very high for a while, but that's probably ok)Since many of the tech companies we follow have relatively high amounts of SBC, especially soon after their IPO, because large amounts of options/restricted stock/etc typically get granted soon after an IPO, some of the below will be general SBC background that gives a broad idea of how many companies value and then expense the options/units granted, and explain why the expense is so high in the initial quarters/years, then typically drops off precipitously.Per Bob's original post: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?Accounting for stock based compensation is something that I know more about than I ever care to admit :) And now you get to learn all about it...be careful what you ask for...So here goesThe general goal is for companies to record stock based compensation expense (the cost related to giving out these options/units) during the period starting from grant date until estimated vesting, because they are recording an expense over the period that the employees/officers are working to earn the awards, in GH's case working to grow the business and make it worth $120, $150, $200 per share. In a way, it's similar to accruing annual bonus expense for employees over the course of the year, as they are working and earning their bonuses, as it would be lumpy to the expense to suddenly record all of the bonus expense at once at the end of each year, or when paid.Years ago, expense wasn't recorded for SBC. It was, at least partially, a push by Warren Buffet, in his annual shareholder letters, to push the powers that be to require expensing of stock based award vesting. Prior to this, it would just show up as dilution in the share count when they vested without ever flowing through the income statement as a cost or expense, which, previously, in a way, rewarded companies that issued loads of options or RSU's, vs. other companies that weren't giving away options like candy.OverviewThe vesting, and related expense for Guardant's SBC, is contingent on what would be called a "market condition" (minimum stock prices of $120-$200 being sustained for 30+ days). The accounting can be somewhat different than for RSU's or stock options that only require a "service condition" (stay with the company for 3 years, 5 years, etc.) or a "performance condition" (revenue must grow to exceed $X million/year, etc.)Per GH's Q2 10-Q:For market-based restricted stock units, the Company derives the requisite service period using the Monte Carlo simulation model and the related compensation expense is recognized over the derived service period using an accelerated attribution model commencing on the grant date. Stock-based compensation expense will be recorded regardless of whether the market conditions are achieved or not. If the related market condition is achieved earlier than its estimated derived service period, the stock-based compensation expense will be accelerated, and a cumulative catch-up expense will be recorded during the period in which the market condition is met.On the day that these RSU's were granted, GH would have had to calculate a value for them (similar to when any company issues stock options, stock appreciation rights, RSU's etc.) using a standard valuation method, which factors in the expected volatility of the stock (based on historical stock price movements, or competitors in similar industry), the stock price on day 1, the likelihood that each vesting target gets reached, etc. Many regular stock options get valued using what's called a Black Scholes model, but Black Scholes isn't designed/recommended for units that have a market based vesting like these, so GH, more appropriately, used another standard technique, called a Monte Carlo model.Basically what you're trying to determine, is "what would an outside person be willing to pay for that grant of these RSU's with these specific vesting conditions?". Although the stock price has never been over $120 yet, (until today actually!) someone might be willing to pay $100, $200, or more each for one of these RSU's, if they think it is likely that the stock price will grow to be well above that (e.g. $400-500) over the next 7 years. Of course, there is a time value component, where a rational person would discount what they think that unit will be worth in the future (e.g. I'm not going to pay $100 today for something that will be worth exactly $100 five years from now, I might pay something less today, e.g. $50, for that future $100).Valuation of the RSUsIn Footnote 11, under "Market-based Restricted Stock Units", they provided more details including:The grant date fair values of the MSUs were determined using a Monte Carlo valuation model for each tranche. The related stock-based compensation expense for each tranche is recognized based on an accelerated attribution method over the estimated derived service period. If the related share price goal is achieved earlier than its expected derived service period, the stock-based compensation expense will be recognized as a cumulative catch-up expense from the grant date to that point in time in achieving the share price goal. The derived service period is the median duration of the successful stock price paths to meet the price goal for each tranche as simulated in the Monte Carlo valuation model. The Monte Carlo valuation model uses assumptions such as volatility, risk-free interest rate, cost of equity and dividend estimated for the performance period of the MSU. The weighted average grant date fair value of the MSUs was $67.00 and the weighted average derived service period was estimated to be in the range of 0.83 – 2.07 years.Stock-based compensation recorded for the MSUs for the three months ended June 30, 2020 was $18.3 million and is recorded in general and administrative expenses in our condensed consolidated statement of operations. Future stock-based compensation for unvested MSUs as of June 30, 2020 was $208.9 million, which is expected to be recognized over a weighted-average period of 1.3 years.There were $1,696,974 RSU's issued to each of the two persons, that's 3,393,948 shares combined. Per the excerpt above, they were valued at $67 each, or (3.4m x $67) $227 million total. That's the amount that will be expensed over the vesting period. Accounting rules require that the expense gets recorded regardless of whether the price targets are achieved, because the original valuation of the units factored in the likelihood of the targets being reached already, in calculating the $67 value per RSU.$67 seems low to me, considering that the stock didn't have to move very far from where it was on the grant date for the $120 target RSU's to vest. I would certainly happily have paid $67 for something that would likely be worth $120 so soon, but could be worth $200, $300, $400, or more depending how high the stock price rises between now and 2027. I assume they were "careful" with their assumptions to not have the RSU's valued too high, since there are so many of them, and even using the $67 value, there's already $50m of expense this past quarter alone, so I guess I'm not totally surprised.Expense Period e.g. Estimated Vesting PeriodsSo next you've got to look at these RSU as three separate sets, or tranches, the ones that vest at $120, at $150, and at $200. So you've got 1.13 million units that vest when the stock achieves the $120, 1.13m at $150, and 1.13m at $200. Let's assume all were valued the same at $67 (although in reality, the $120's were probably valued a little higher, and the $200 target ones a little lower), so each of those three tranches is each valued at about $76 million.The excerpt shows they are using an "accelerated attribution method" to record the expense. And they say the estimated vesting periods range from 0.83 years to 2.07 years. If I'm interpreting that right, and I think I am, it means they expected the first tranche to vest 0.83 years after they were granted in May 2020, or 10 months later in March 2021, meaning they think the stock price will sustain $120 for 30 days around March 2021. It also implies that the last tranche vests 2.07 years after grant, so they are assuming the stock price will sustain $200 for 30 days around June 2022 (not to far away!). We can assume they estimated the $150 target ones would vest somewhere in between, probably sometime in late 2021.The "accelerated" part of the vesting method means that these three tranches are being vested/expensed simultaneously, so in the early months there will be vesting on all three tranches (higher expense initially), then after (let's assume) March 2021, after the 1st tranche has been fully expensed, there will only be two tranches vesting, so the SBC expense will be less, and then after the second tranche has been fully expensed, there will only be a much smaller amount of expense while the final, third tranche vests, and by June 2023, all $227 million will have been recorded as SBC expense.Tranche 1 $76m over 10 months, or $7.6 million per month of expense from late May'20 to Mar'21Tranche 2 $76m over (est) 17 months or $4.5 million per month of exp from late May'20 to Oct'21Tranche 3 $76m over 25 months or $3m per month of exp from late May'20 to Jun'22So starting with June 2020 (there was a little bit of expense in May'20 for the last five days of the month after grant date but let's ignore that for now) they recorded SBC expense relating to these units of $7.6m + $4.5m + $3m = $15.1 million. That's just for these SBC grants and excludes any other employee stock option expense etc. that would have also been recorded as stock based compensation, albeit much much less for those.So in Q3, they had three months like the above at $15.1m per month, or $45.3m for the quarter. Right there is the bulk of your $50m SBC expense last quarter. The next two quarters will probably be similar. Then, starting in April 2021, the first tranche will have been fully expensed (even if it didn't actually vest or hit the $120, there is no expense left to record on that tranche) so then for a while we will just have $4.5m + $3m for tranche's 2+3, or $7.5m per month, or $22.5m per quarter. Then after tranche 2 is fully expensed (I'm estimating that they are using a 17 month period, through Oct 2021 tho we can't be sure) going forward there will only be $3m/month expensed or $9m per quarter until about June 2022.You never extend the estimated vesting period further out once it has been determined at the time of the grant, regardless of how far away the stock price is from the target and how unlikely it is to actually vest, so those expense amounts won't get pushed out further, even if GH's stock doesn't hit the required targets in the timeframe originally estimated. The stock might never hit any of the targets and the RSU's would therefore not actually vest, but it wouldn't change their requirement to record all $227 million of SBC expense over this period (unless, maybe if one of the officers left the company very early on, and forfeited the RSU before they had finished expensing them). The expense also never gets reversed even if they never vest and the officers never get the stock. That's just how the accounting rules work.Early VestingIt does say in their footnote disclosure, however, that they would accelerate the expense if they achieve the target earlier than estimated. So if GH stock goes up to $121 tomorrow and stays there for the next 30 days, then in Q4 2020, they will expense all of the remaining of the $76m from the first tranche in Q4 (about $45m left for tranche 1 alone, in addition to the usual $4.5m/month and $3m/month for tranches 2+3).Theoretically if GH's stock jumped to $201 tomorrow and stayed there for 30 days, they would record all of the remaining expense on all three tranches this quarter in Q4, about $167 million. Now that would make GH's financials look ugly for the end of 2020 with a huge amount of G&A expense relating to SBC...but it would mean the stock price is over $200, which would make me, as a shareholder, that bought my shares below $100/share, very happy, regardless of that big ugly, non-cash, nonrecurring expense on the income statement, and the related dilution of 3.4 million shares that go along with it. Assuming those two officers hold the RSU's or the underlying stock (e.g. they don't sell it right away) once it vests, they have a huge incentive to remain aligned with the rest of us shareholders in striving to drive the business forward so the stock price goes even higher and their stock awards will be worth even more as GH's stock goes above $200/share. Granted they would both already be very rich because their 1.7 million shares each would be worth at least $200/share or about $340 million (in addition to whatever stock they already own).That's it!So I'm sure that was more technical accounting information than you ever wanted to know about restricted stock and stock based compensation :)Let me know if I can further clarify or expand/explain anything or if you have any follow ups questions.-mekong
Hi Fuma.I take management at their word regarding COVID testing. We CAN help, so we should. They chose saliva not because it is best, but because it wouldn't stress existing supply chains for COVID testing. And they wanted to test employees to keep their labs safe. I understand that straying from the core of the business model can lead to problematic distraction -- di-worse-ification, as it is so often called. Management has made it clear that they are happy to exit the COVID business as soon as it makes sense.I wish you would talk more about what you've heard from other companies regarding clinical trial enrollment. You probably get this, but I think that Guardant plays a role as clinical trials enroll patients, not as the trials proceed. I can see from both a patient-worry and a hospital-preoccupation perspective how clinical trial enrollment MIGHT be down but, yes, I find the magnitude concerning and I've heard anecdotal evidence (from sources other than Guardant) that "hospital-preoccupation" might have been less of an issue in Q3. We'll see about Q4. In any case, if you have more concrete information that you're willing to share, I know that some of us here would be "all ears". Invitae is on my watch list, but I could certainly be watching more closely than I have been...Fool on!Thanks and best wishes,TMFDatabaseBob (long: GH; watching NVTA and some other genomic players)Maintenance Coverage FoolSee what a "Coverage Fool" does here: http://www.fool.com/community/community-team.aspx See my holdings here: http://my.fool.com/profile/TMFDatabasebob/info.aspx Peace on EarthPlease 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.
Hi Bob,Let's carry this conversation over to the biotech board as it's starting to wander OT. I have some other thoughts/links that I'd be happy to share as well, but am on shift all day. Definitely alot to unpack, and maybe a chance to find some additional winners in the space.Cheers.
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