Fulgent Genetics Has Further Upside

Fulgent Genetics (FLGT) is a genetic testing contractor with proprietary technology enabling a host of different genetic tests. The share price has been on a roll lately, but we think after some consolidation, this could resume as the shares still aren’t all that expensive.

The evolution hasn’t gone in a straight line, although revenues are generally rising, but that can vary a bit quarter to quarter as the mix influences ASPs and the incidence of contracts.

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Data by YCharts

The company provides a series of low-cost tests (see the company website), and it’s still expanding into new areas (Q4CC):

Our focus this year was on stabilizing our business by expanding into new areas, such as reproductive health, cancer as well as sequencing-as-a-service… With the new initiative, our sequencing service packaged with data analysis are driving the strongest volume growth as we have seen momentum with our existing customers, while adding new pharma companies and the research organizations to our client base.

The company also advances through partnerships (Q4CC):

One particular exciting partnership for our carrier screen test is with Columbia University Irving Medical Center, which we announced in early January. This partnership in Columbia University was able to offer their patients — expand the carrier screening test, which provides more accurate view on patients’ genetic condition.

This partnership was outcome of highly competitive situation, where Columbia selected Fulgent due to our superior technology and comprehensive screening capability. This partnership will give us opportunity to business in New York State, which is a new market for the Fulgent. This partnership would also give us the opportunity to leverage Columbia’s expertise in genetical medicine to co-develop additional tests in future.

There were other contract wins like a research initiative agreement with a permanent medical foundation, where the company will provide a full service of genetic testing service, a multi-year, multi-million-dollar contract. And management argues more is in store as it is in talks with other parties and it had several wins in the exome sequencing business, for instance.

Q4 and 2018 results

From the 10-K:

A steady increase in tests delivered (+35% y/y), but ASPs are declining by 15% while cost per test declined only 7%.

For Q4, the main results (from the earnings PR):

  • Revenue totaled $5.7 million, growing 33% year over year
  • Billable tests delivered totaled 6,408, growing 52% year over year
  • GAAP loss was $935,000, or $0.05 per share
  • Non-GAAP loss was $193,000, or $0.01 per share
  • Adjusted EBITDA was $50,000

That is, the company is pretty close to being non-GAAP break-even. Another thing that has to be realized is that the company has a joint venture in China which generates revenue ($1.3M in 2018), but this isn’t counted in the revenue above but appears on the balance sheet. Management is pretty optimistic here (Q4CC):

Long term, we remain confident that the JV uniquely positions us to capture the large China market.

Guidance

Here is the guidance provided on the Q4CC:

We expect revenue for the full year 2019 to be at least $26 million, which represents year-over-year growth of at least 22%. And we expect the year to be back-end weighted as it will take time to ramp on a number of these agreements that Ming has discussed. We also remain focused on improving leverage, while investing for growth. As we continue to scale, we expect to return to GAAP profitability in the latter part of 2019.

Margins

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Data by YCharts

Non-GAAP margins are considerably better as they improved 979 basis points y/y. An important question is whether there will be operational leverage:

  • S&M was $1.1M (GAAP), flat on Q3
  • R&D was $1.4M, flat on Q3
  • G&A was $1.4M, up from $1.3 in Q3
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Data by YCharts

Not yet a great deal of operational leverage, although non-GAAP operating expense was $3.5M versus $3.9M for the GAAP version.

Cash

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Data by YCharts

Cash flows are only recently improving and are still negative on a TTM basis, although cash from operations was a positive $778K in Q4, but much of that was driven by changes in working capital. The following is more important (Q4CC):

We’ve continued to manage our business around cash flow breakeven with the goal of achieving sustainable cash flow generation next year. We ended the fourth quarter with $37.4 million in cash, cash equivalents and marketable securities with no debt. This equates to over $2 in cash, cash equivalents and marketable securities per share.

So the company still has plenty of cash and intends to be cash flow positive next year.

Risks

  • Competition
  • Contracts
  • ASP

These risks are considerably related as more competition tends to reduce ASPs and margins and makes it more complicated to win new contracts. This is not the place for a competitive overview of the market, which is still in the very early innings, but the 10-K had this to say:

Our competitors include dozens of companies focused on molecular genetic testing services, including specialty and reference laboratories that offer traditional single-gene and multi-gene tests. Principal competitors include companies such as Ambry Genetics, Inc.; Roche; GeneDx, a subsidiary of OPKO Health, Inc.; Invitae Corporation; Myriad Genetics, Inc.; and Pathway Genomics Corporation, as well as other commercial and academic laboratories. In addition, other established and emerging healthcare, information technology and service companies may develop and sell competitive tests, which may include informatics, analysis, integrated genetic tools and services for health and wellness.

Perhaps a bigger risk is that technology is a fast-moving target and a new entrant into the market (or existing player) might come up with something better.

A growing market brings big opportunities, with the market set to expand. It was a $5B market in 2017 (Market Watch):

Global Genetic Testing Market is set to exceed USD 22 billion by 2024; according to a new research report by Global Market Insights. Innovation in genetic testing leading to enhanced efficiency, high sensitivity and safety will serve to be a high impact rendering factor. Technological advancement in scientific research as well as research instrument is increasing the importance of genetic testing.

But with such growth, it’s likely that a host of new players will enter, and some of these might offer better and/or cheaper testing. Still, we think that the benefits of market growth far outweigh potential competition at the moment, so we’re not too worried here.

While the company has long-standing customers, revenues cannot generally be called recurring, so it has to keep fighting to gain new contracts, and as a result revenue and earnings might display considerable variability (10-K):

Our results of operations have experienced fluctuations 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, the amount and timing of sales of billable tests; the prices we charge for our tests due to changes in product, customer or payor mix, general price degradation for genetic tests or other competitive factors; the rate and timing of our billings and collections; and the timing and amount of our commitments and other payments, as well as the other risk factors discussed in this report. In addition, in certain prior periods, our results have been impacted by events that may not recur regularly, in the same amounts or at all in the future.

Valuation

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Data by YCharts

The company isn’t yet profitable (although it’s not far off, as we saw above) and 3.5x sales is a fairly reasonable valuation. The one analyst giving estimates has the EPS at $0.02 this year rising to $0.24 the next.

Shares have almost doubled this year already, but we still don’t find them terribly expensive.

Conclusion

We are a little late to this party, but we nevertheless see a solid company that is about to return to profitability this year. The market in which it operates is fast growing and still in the early innings, which provides a tremendous opportunity, but also a bit of a risk as technology is still in some flux.

We would not be big buyers at these levels, but we can recommend a small position that can be added on weakness, which has occurred plenty of times in the past (even if that’s no guarantee for the future).

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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