Fulgent Genetics, Inc.: Form 10-Q for the period ended Sep 30, 2023

The following discussion and analysis of our financial condition and results of operations should be read together with our condensed consolidated financial statements and related notes included in this report. Additionally, pursuant to Instruction 2 to paragraph (b) of Item 303 of Regulation S-K promulgated by the U.S. Securities and Exchange Commission, or SEC, in preparing this discussion and analysis, we presume that readers have access to and have read the discussion and analysis of our financial condition and results of operations included in our annual report on Form 10-K for our fiscal year ended December 31, 2022, filed with the SEC on February 28, 2023, or the 2022 Annual Report. As used in this discussion and analysis and elsewhere in this report, unless the context otherwise requires, the terms “Fulgent,” the “Company,” “we,” “us” and “our” refer to Fulgent Genetics, Inc. and its consolidated subsidiaries.

Forward-Looking Statements

The following discussion and analysis contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, or the Securities Act, and Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act. Forward-looking statements are statements other than historical facts and relate to future events or circumstances or our future performance, and they are based on our current assumptions, expectations and beliefs concerning future developments and their potential effect on our business. The forward-looking statements in this discussion and analysis include statements about, among other things, our future financial and operating performance, our future cash flows and liquidity and our growth strategies, as well as anticipated trends in our business and industry. These forward-looking statements are subject to a number of risks and uncertainties, including, among others, those described under “Item 1A. Risk Factors” in Part I of the 2022 Annual Report. Moreover, we operate in a competitive and rapidly evolving industry and new risks emerge from time to time. It is not possible for us to predict all of the risks we may face, nor can we assess the impact of all factors on our business or the extent to which any factor or combination of factors could cause actual results to differ from our expectations. In light of these risks and uncertainties, the forward-looking events and circumstances described in this discussion and analysis may not occur, and actual results could differ materially and adversely from those described in or implied by any forward-looking statements we make. Although we have based our forward-looking statements on assumptions and expectations we believe are reasonable, we cannot guarantee future results, levels of activity, performance or achievements or other future events. As a result, forward-looking statements should not be relied on or viewed as predictions of future events, and this discussion and analysis should be read with the understanding that actual future results, levels of activity, performance and achievements may be materially different than our current expectations. The forward-looking statements in this discussion and analysis speak only as of the date of this report, and except as required by law, we undertake no obligation to update publicly any forward-looking statements for any reason after the date of this report to conform these statements to actual results or to changes in our expectations.

Overview

We are a technology-based company with a well-established clinical diagnostic business and a therapeutic development business. Our clinical diagnostic business offers molecular diagnostic testing services, comprehensive genetic testing, and high-quality anatomic pathology laboratory services designed to provide physicians and patients with clinically actionable diagnostic information to improve the quality of patient care. Our therapeutic development business is focused on developing drug candidates for treating a broad range of cancers using a novel nanoencapsulation and targeted therapy platform designed to improve the therapeutic window and pharmacokinetic profile of new and existing cancer drugs. We aim to transform from a genomic diagnostic business into a fully integrated precision medicine company.

Business Risks and Uncertainties and Other Factors Affecting Our Performance

Our business and prospects are exposed to numerous risks and uncertainties. For more information, see “Item 1A. Risk Factors” in Part I of the 2022 Annual Report. In addition, our performance in any period is affected by a number of other factors. See the description of some of the material factors affecting our performance in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” of the 2022 Annual Report.

Results of Operations

The table below summarizes our results of our continuing operations for each of the periods presented. For a financial overview relating to our results of operations, including general descriptions of the make-up of material line items of our statement of operation data, see “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” of the 2022 Annual Report.

(in thousands)

21

Revenue

Revenue decreased $21.0 million, or 20%, from $105.7 million in the three months ended September 30, 2022 to $84.7 million in the three months ended September 30, 2023, and decreased $332.6 million, or 60%, from $551.3 million in the nine months ended September 30, 2022 to $218.7 million in the nine months ended September 30, 2023. The decreases in revenue between periods were primarily due to decreased orders for our COVID-19 tests.

Revenue from non-U.S. sources increased $1.6 million, or 38%, from $4.1 million in the three months ended September 30, 2022 to $5.7 million in the three months ended September 30, 2023, and increased $4.2 million, or 40%, from $10.5 million in nine months ended September 30, 2022 to $14.6 million in the nine months ended September 30, 2023. The increase in revenue from non-U.S. sources between periods were primarily due to increased sales of our traditional genetic testing services to customers in China through our joint venture in China.

After aggregating customers that are under common control or affiliation, one customer contributed 14% and 11% of the Company’s revenue in the three and nine months ended September 30, 2023, respectively. A different customer contributed 13% and 21%, of the Company’s revenue in the three and nine months ended September 30, 2022, respectively.

Cost of Revenue

Cost of revenue decreased $14.7 million, or 25%, from $59.6 million in the three months ended September 30, 2022 to $44.8 million in the three months ended September 30, 2023. The decrease was primarily due to decreases of $4.3 million in depreciation expenses, $3.4 million in reagent and supply expenses, $3.3 million in consulting and outside labor costs, $726,000 in payroll expenses, $553,000 in shipping expenses, and $420,000 in external customer engagement platform expense related to the decreased tests delivered and orders for our COVID-19 tests, and $1.1 million in allocated facility expense.

Cost of revenue decreased $57.9 million, or 29%, from $197.4 million in the nine months ended September 30, 2022 to $139.5 million in the nine months ended September 30, 2023. The decrease was primarily due to decreases of $30.8 million in consulting and outside labor costs for production, $23.9 million in reagent and supply expenses, $9.3 million in depreciation expenses, $2.2 million in shipping expenses, $1.1 million in meals provided to production teams during pandemic and other travel expense, and $856,000 in external customer engagement platform expense related to the decreased tests delivered and orders for our COVID-19 tests, $1.6 million in allocated facility expense, $750,000 in change in gain or loss on disposal of fixed assets, $663,000 in office and computer expenses, and $334,000 in other state tax, and partially offset by an increase of $13.8 million in personnel costs including equity-based compensation expense related to an entity acquired in the second quarter of 2022.

Our gross profit decreased $6.3 million, from $46.1 million in the three months ended September 30, 2022 to $39.8 million in the three months ended September 30, 2023. The decrease in gross profit was primarily due to the decrease in revenue from our COVID-19 tests. Our gross profit as a percentage of revenue, or gross margin, increased from 43.6% to 47.0% due to changes in product mix and revenue recognized for COVID-19 tests completed in prior periods.

Our gross profit decreased $274.7 million, from $353.9 million in the nine months ended September 30, 2022 to $79.2 million in the nine months ended September 30, 2023. The decrease in gross profit was primarily due to the decrease in revenue from our COVID-19 tests. Our gross profit as a percentage of revenue, or gross margin, decreased from 64.2% to 36.2% due to changes in product mix.

Research and Development

Research and development expenses increased $2.5 million, or 33%, from $7.5 million in the three months ended September 30, 2022 to $10.0 million in the three months ended September 30, 2023. The increase was primarily due to increases of $1.6 million in personnel costs including equity-based compensation expense related to increased headcount and equity awards granted post the second quarter of 2022, and $584,000 in reagent and supply expenses related to increased reagent usage for research.

Research and development expenses increased $9.1 million, or 45%, from $20.4 million in the nine months ended September 30, 2022 to $29.5 million in the nine months ended September 30, 2023. The increase was primarily due to increases of $7.2 million in personnel costs including equity-based compensation expense related to increased headcount and equity awards granted post the second quarter of 2022, $681,000 in consulting and outside labor costs, and $611,000 in reagent and supply expenses related to increased reagent usage for research.

Selling and Marketing

Selling and marketing expenses were relatively consistent between periods at $10.2 million and $9.9 million in the three months ended September 30, 2023 and 2022, respectively.

Selling and marketing expenses increased $2.3 million, or 8% from $28.7 million in the nine months ended September 30, 2022 to $31.0 million in the nine months ended September 30, 2023. The increase was primarily due to increases of $2.1 million in software expense, and $1.2 million related to allocated facility expenses, and partially offset by a decrease of $2.0 million in consulting and outside labor costs.

General and Administrative

General and administrative expenses decreased $8.8 million, or 33%, from $26.3 million in the three months ended September 30, 2022 to $17.5 million in the three months ended September 30, 2023. The decrease was primarily due to a decrease of $8.9 million in provisions for credit losses.

General and administrative expenses decreased $25.0 million, or 30%, from $82.3 million in the nine months ended September 30, 2022 to $57.3 million in the nine months ended September 30, 2023. The decrease was primarily due to decreases of $29.6 million in provision for credit losses, $5.2 million in acquisition related costs incurred in the prior period, $2.3 million in legal and professional fees, and $1.7 million in licenses and permits, partially offset by increases of $5.4 million in personnel costs including equity-based compensation expense related to entity acquired in the second quarter of 2022 and equity awards granted post the second quarter of 2022, $4.5 million related to allocated facility expense, and $3.5 million in depreciation expense.

Amortization of Intangible Assets

Amortization of intangible assets represents amortization expenses on the intangible assets arose from the business combinations in 2022 and 2021 and a patent purchased in 2021. Amortization expenses were $2.0 million in the three months ended September 30, 2023 and 2022, respectively, and $5.9 million and $4.5 million in the nine months ended September 30, 2023 and 2022, respectively.

Restructuring Costs

Restructuring expenses represent one-time employee termination benefits provided to employees associated with an entity acquired by the Company who were involuntarily terminated in the prior period.

Interest and Other Income, net

Interest and other income, net, is primarily comprised of net interest income (expenses), which was $6.4 million and $1.5 million in the three months ended September 30, 2023 and 2022, respectively, and $15.2 million and $2.3 million in the nine months ended September 30, 2023 and 2022, respectively. This interest income (expense) related to interest earned on various investments in marketable securities including realized and holding gain (loss) on marketable equity securities, net of interest expenses incurred for our notes payable and margin loan. The increase is primarily due to increases in interest rates on investments relative to the prior comparative periods.

Provision for Income Taxes

Provision for income taxes was $20.3 million and $12.0 million for the three and nine months ended September 30, 2023, respectively, and $414,000 and $51.5 million for the three and nine months ended September 30, 2022, respectively. The effective tax rate was 296% and 24% for the three months ended September 30, 2023 and 2022, respectively. The effective tax rate was (42%) and 24% for the nine months ended September 30, 2023 and 2022, respectively. The change in the effective tax rate for the three and nine months ended September 30, 2023, relative to 2022, was due to the establishment, in the three months ended September 30, 2023, of a valuation allowance on the Company's net deferred tax assets. FASB ASC 740 requires that deferred income tax assets be reduced by a valuation allowance if it is more likely than not that some or all of the deferred income tax assets will not be realized. The Company has evaluated the realizability of any of its deferred tax assets and has concluded that it is more likely than not that the Company may not realize benefit of its deferred tax assets, primarily as a result of operating losses in the nine months ended September 30, 2023, and, accordingly, has provided a full valuation allowance at September 30, 2023.

Net Loss Attributable to Noncontrolling Interest

Net loss attributable to noncontrolling interest represents net loss attributable to the minority shareholders from entities not wholly owned.

Liquidity and Capital Resources

Liquidity and Sources of Cash

We had $851.5 million and $852.9 million in cash, cash equivalents, and marketable securities as of September 30, 2023 and December 31, 2022, respectively. Our marketable securities primarily consist of U.S. government and U.S. agency debt securities, U.S. treasury bills, corporate bonds, municipal bonds, and Yankee debt securities as of September 30, 2023 and December 31, 2022.

Our primary uses of cash are to fund our operations and to fund strategic acquisitions as we continue to invest in and seek to grow our business. Cash used to fund operating expenses is impacted by the timing of our expense payments, as reflected in the changes in our outstanding accounts payable and accrued expenses.

We believe our existing cash, cash equivalent, and short-term marketable securities will be sufficient to meet our anticipated cash requirements for at least the next 12 months. Cash provided by operations significantly contributed to our ability to meet our liquidity needs, including paying for capital expenditures. However, cash provided by our operations fluctuates from period to period, which we expect may continue in the future. These fluctuations can occur because of a variety of factors, including, among others, factors relating to the demand for our tests, the amount and timing of sales, the prices we charge for our tests due to changes in product mix, customer mix, general price degradation for tests, or other factors, the rate and timing of our billing and collections cycles and the timing and amount of our commitments and other payments. Moreover, even if our liquidity expectations are correct, we may still seek to raise additional capital through securities offerings, credit facilities or other debt financings, asset sales or collaborations or licensing arrangements.

If we raise additional funds by issuing equity securities, our existing stockholders could experience substantial dilution. Additionally, any preferred stock we issue could provide for rights, preferences or privileges senior to those of our common stock, and our issuance of any additional equity securities, or the possibility of such an issuance, could cause the market price of our common stock to decline. The terms of any debt securities we issue or borrowings we incur, if available, could impose significant restrictions on our operations, such as limitations on our ability to incur additional debt or issue additional equity or other restrictions that could adversely affect our ability to conduct our business, and would result in increased fixed payment obligations. If we seek to sell assets or enter into collaborations or licensing arrangements to raise capital, we may be required to accept unfavorable terms or relinquish or license to a third party our rights to important or valuable technologies or tests we may otherwise seek to develop ourselves. Moreover, we may incur substantial costs in pursuing future capital, including investment banking, legal and accounting fees, printing and distribution expenses, and other similar costs. Additional funding may not be available to us when needed, on acceptable terms or at all. If we are not able to secure funding if and when needed and on reasonable terms, we may be forced to delay, reduce the scope of, or eliminate one or more sales and marketing initiatives, research and development programs, or other growth plans or strategies. In addition, we may be forced to work with a partner on one or more aspects of our tests or market development programs, or initiatives, which could lower the economic value to us of these tests, programs or initiatives. Any such outcome could significantly harm our business, performance, and prospects.

Cash Flows

The following table summarizes our cash flows for each of the periods indicated:

(in thousands)

Operating Activities

Cash provided by operating activities in the nine months ended September 30, 2023 was $12.1 million. The difference between net loss and cash provided in operating activities for the period was primarily due to the effects of $31.5 million in equity-based compensation expenses, $19.6 million in depreciation and amortization, $11.0 million in deferred taxes, and $4.9 million in noncash lease expense, partially offset by negative impact of $4.3 million in provisions for credit loss and $2.4 million in amortization of discount on marketable securities. Changes in operating assets and liabilities primarily consisted of decreases of $7.0 million in accounts payable related to the timing of payments, $4.8 million in operating lease liabilities, and an increase of $2.9 million in other current and long-term assets, partially offset by a decrease of $7.6 million in trade accounts receivable due to the timing of collections.

Cash provided by operating activities in the nine months ended September 30, 2022 was $220.3 million. The difference between net income and cash provided by operating activities for the period was primarily due to the effects of $25.3 million in provision for credit losses, $22.9 million in depreciation and amortization, $22.6 million in equity-based compensation expenses, $4.2 million in amortization of premium of marketable securities, $3.3 million in noncash lease expense, $1.1 million in unrecognized tax benefits, and partially offset by a negative impact of $4.9 million increased deferred tax assets. Cash used in operating activities decreased between periods primarily due to decreases of $32.3 million in accounts payable related to timing of payments, $12.9 million in accrued expenses and other liabilities, $3.3 million in operating and finance lease liabilities, and partially offset by decreases of $24.2 million in trade accounts receivable due to timing of collections and $3.7 million in other current and long-term assets primarily reagents and supplies and prepaid expenses.

Investing Activities

Cash provided by investing activities in the nine months ended September 30, 2023 was $14.6 million, which primarily represents proceeds of $376.9 million from maturities of marketable securities, partially offset by $343.6 million for purchases of marketable securities and $19.1 million for purchases of fixed assets, including real estate.

Cash used in investing activities in the nine months ended September 30, 2022 was $168.7 million, which primarily related to $257.3 million purchase of marketable securities and $137.8 million payment related to acquisition of Inform Diagnostics, $15.0 million purchase of preferred stock of a privately held company, purchases of $14.1 million of fixed assets, and $10.0 million contingent consideration payment made in current period related to a business acquisition in 2021, and partially offset by proceeds of $133.4 million from sale of marketable securities and $131.7 million related to maturities of marketable securities.

Financing Activities

Cash used in financing activities in the nine months ended September 30, 2023 was $21.8 million, which primarily related to $15.0 million repayment to the margin loan account, $2.4 million repayment to the notes payable, $2.2 million repurchase of common stock, and $1.6 million common stock withholding for employee tax obligations.

Cash used in financing activities in the nine months ended September 30, 2022 was $47.5 million, which primarily related to $45.3 million repurchase of common stock and $1.5 million related to common stock withholding for employee tax obligations.

Stock Repurchase Program

In March 2022, the Board authorized a $250.0 million stock repurchase program. Under the stock repurchase program, the Company may repurchase shares from time to time in the open market or in privately negotiated transactions. The stock repurchase program has no expiration from the date of authorization.

During the three and nine months ended September 30, 2023, we repurchased 80,000 shares common stock at an aggregate cost of $2.2 million under the stock repurchase program. During the three months ended September 30, 2022, we repurchased 780,000 shares of our common stock at an aggregate cost of $34.7 million, and during the nine months ended September 30, 2022, we repurchased 995,000 shares of our common stock at an aggregate cost of $45.3 million. As of September 30, 2023, a total of approximately $173.5 million remained available for future repurchases of our common stock under our stock repurchase program.

Critical Accounting Policies and Use of Estimates

There have been no material changes to our critical accounting policies or estimates from the information provided in Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” included in the 2022 Annual Report.

Recent Accounting Pronouncements

See Note 2, Summary of Significant Accounting Policies, to our condensed consolidated financial statements included in this report for information about recent accounting pronouncements.

Off-Balance Sheet Arrangements

We did not have during the periods presented, and do not currently have, any off-balance sheet arrangements, as defined in the rules and regulations of the SEC, that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenue or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to investors.

For quantitative and qualitative disclosures about market risk, see Part II, Item 7A, “Quantitative and Qualitative Disclosures About Market Risk,” in our 2022 Annual Report.

Evaluation of Disclosure Controls and Procedures

Disclosure controls and procedures are controls and other procedures of a company that are designed to ensure that information required to be disclosed by the company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure. As required by Rule 13a-15(b) under the Exchange Act, our management, with the participation of our Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures as of September 30, 2023. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of September 30, 2023.

Changes in Internal Control over Financial Reporting

There have not been any changes in our internal control (as required by Rule 13a-15(b) under the Exchange Act) over the financial reporting during the three months ended September 30, 2023 that have materially affected or are reasonably likely to materially affect our internal control over financial reporting.

Inherent Limitations on Disclosure Controls and Procedures and Internal Control over Financial Reporting

Management recognizes that any controls and procedures, no matter how well-designed and operated, can provide only reasonable assurance of achieving their objectives, and management necessarily applies its judgment in evaluating the benefits of possible controls and procedures relative to their costs. Because of these inherent limitations, our disclosure and internal controls may not prevent or detect all instances of fraud, misstatements or other control issues. In addition, projections of any evaluation of the effectiveness of disclosure or internal controls to future periods are subject to risks, including, among others, that controls may become inadequate because of changes in conditions or that the degree of compliance with policies or procedures may deteriorate.

There have been no material changes to the risk factors set forth in Part I, Item 1A, “Risk Factors,” of the 2022 Annual Report.