Fulgent Genetics, Inc. — Q2 2018 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2018. Unaudited results; amounts below are in U.S. dollars unless noted.
Business context
Fulgent provides genetic testing services, primarily to hospitals and medical institutions, and offers a broad, customizable test menu. It reported one operating segment. Management cited investment in sales and marketing, research and development, and laboratory capacity as part of its growth efforts.
Financial performance and liquidity
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Revenue | $5.40m | $4.64m | $10.05m | $9.95m |
| Gross profit | $2.86m | $2.76m | $4.74m | $6.21m |
| Gross margin | 52.9% | 59.5% | 47.1% | 62.4% |
| Operating income (loss) | $(1.00)m | $(0.15)m | $(3.20)m | $0.07m |
| Net income (loss) | $(1.05)m | $(0.03)m | $(2.96)m | $0.21m |
| Diluted loss per share | $(0.06) | $(0.00) | $(0.17) | — |
- Q2 revenue rose 16%, but first-half revenue was nearly flat, up 1%. Test volume increased 47% in Q2 and 24% in the first half; average revenue per billable test fell 21% and 19%, respectively.
- Cost of revenue rose 35% in Q2 and 42% in the first half, outpacing revenue. First-half operating expenses increased 29%, including higher R&D and selling and marketing costs. Management attributed lower average test prices to test and customer mix, lower-price research sequencing work, and competitive price pressure.
- At June 30, cash and cash equivalents were $3.65m and marketable securities were $34.41m, for $38.06m combined. Current assets were $38.20m and current liabilities $2.98m. Total liabilities were $2.99m; the filing reports no borrowings.
- First-half operating cash flow was a use of $1.35m, versus $2.07m provided in the prior-year period. Investing activities used $1.48m; financing provided $0.01m. Cash fell $2.84m from year-end 2017.
- Trade receivables were $5.06m, net of a $0.52m allowance for doubtful accounts, versus $4.01m and $0.29m, respectively, at year-end. Fixed assets, net, were $7.33m. Marketable securities had $185,000 of gross unrealized losses, which management considered temporary.
Material changes and accounting
- Profitability deteriorated: the company moved from first-half 2017 net income of $207,000 to a first-half 2018 net loss of $2.96m. The filing says it had recorded losses in all periods since inception except the first half of 2017.
- Revenue from the PRC declined substantially. Two customers that together represented 21% of first-half 2017 revenue ordered no tests in the first half of 2018; management did not expect meaningful revenue from them going forward. One affiliated customer group accounted for 13% of revenue in both Q2 and the first half of 2018.
- Fulgent adopted ASC 606 on January 1, 2018 using the modified retrospective method. It now recognizes estimated revenue for third-party-payor tests upon delivery rather than generally waiting for payment. Adoption increased opening accounts receivable by $327,000 and reduced deferred tax assets by $74,000. Compared with the former method, reported revenue was lower by $6,000 in Q2 and $183,000 in the first half; estimates depend on collections and reimbursement assumptions.
- The 30%-owned FF Gene Biotech joint venture generated an equity-method loss of $491,000 in the first half. Fulgent had contributed equipment with an aggregate fair value of $3.0m and had a remaining contribution obligation of RMB 40.3m, approximately $6.1m, at June 30.
Outlook, risks and contingencies
- Management stated that existing cash, operating cash flow and equity-financing proceeds should meet anticipated cash requirements for at least the next 12 months. It cautioned that cash flow and collections may fluctuate, and that additional financing might be needed; no future financing commitments were in place.
- Management identified ongoing investment in growth, sales and marketing, R&D, and operating infrastructure. No numerical revenue or earnings guidance was provided in the filing text.
- Key risks include continued losses, price competition and declining test prices, customer concentration and payment collection, limited third-party-payor coverage, regulatory uncertainty for laboratory-developed tests, international-market exposure, and reliance on a single laboratory and certain suppliers.
- Fulgent had $2.3m of reagent purchase obligations payable within 12 months. It also had operating leases, including a renewed headquarters lease and a new El Monte office lease. Management said ordinary-course legal matters were not expected to have a material effect; it reported no material pending legal proceedings.
- Management concluded disclosure controls were effective as of June 30, 2018. Controls and processes were modified to support ASC 606 revenue estimates and monitoring.
Important facts for investors to verify
- Whether rising test volumes translate into improved revenue per test, gross margins, and sustainable profitability.
- Receivable aging, allowance adequacy, collection rates, and the reliability of ASC 606 estimates for third-party-payor revenue.
- Customer concentration and the effect of lost PRC customers on future revenue and geographic mix.
- The timing, funding, and potential returns of the remaining FF Gene Biotech contribution commitment, including risks from the joint venture’s losses and Fulgent’s minority ownership.
- Cash usage, marketable-security liquidity, and the assumptions behind management’s stated 12-month liquidity outlook.
- Share dilution and equity compensation: the 2016 incentive plan’s authorized share reserve was increased by 2.0 million shares in May 2018; 18,019,499 common shares were outstanding as of August 1, 2018.