Fulgent Genetics, Inc. (FLGT) FY 2023 MD&A
This page reproduces the company's own Item 7 MD&A text from the linked SEC filing. It is filer text, not grepcent analysis, scoring, or investment advice.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Forward-Looking Statements
The following discussion and analysis of our financial condition and results of operations should be read together with our consolidated financial statements and related notes included in this report and contains forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act. We have omitted discussion of 2021 results where it would be redundant to the discussion previously included in Item 7 of our 2022 Annual Report on Form 10-K. 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 this 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 laboratory services business and a therapeutic development business. Our laboratory services business—to which we formerly referred as our clinical diagnostic business, includes technical laboratory services and professional interpretation of laboratory results by licensed physicians. 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, or PK profile, of new and existing cancer drugs.
We recorded revenue and net (loss) from operations of $289.2 million and ($167.8 million), respectively, in 2023, compared to revenue and net income from operations of $619.0 million and $143.4 million, respectively, in 2022.
2023 Developments
In 2023, we launched new Beacon787 expanded carrier screening panel. Beacon787 includes a total of 787 genes associated with autosomal recessive and X-linked conditions. Included in this panel are all of the American College of Medical Genetics and Genomics, or ACMG, tier 3 genes, which ACMG published in their latest practice guideline for carrier screening, recommending that all pregnant patients and those planning a pregnancy be offered this set of genes as an equitable, pan-ethnic screening approach. The ACMG list includes genes with carrier frequency of 1/200 for autosomal recessive conditions and disease prevalence of 1/40,000 for X-linked conditions. Leveraging our proprietary platform and informatics, Beacon787 frequently excels as it relates to analytical detection rates, ability to discern pseudogenes, and reliable copy number calls. This was an important product launch for us and a big step forward in carrier screening. Carrier screening assesses the risk for individuals and couples to pass on certain genetic conditions to their children. This testing is for women or couples who are currently expecting, considering pregnancy, or planning to become pregnant in the future. Most often, carriers for these conditions do not have symptoms or a positive family history of disease. Carrier screening can identify these otherwise unknown risks and allow patients to make informed decisions about family planning. The American College of Obstetricians and Gynecologists, ACOG, recommends offering carrier screening to all women who are considering pregnancy, regardless of ethnicity or family history.
Factors Affecting Our Performance
Mix of Tests Delivered
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We offer our tests at different price points, and we incur different amounts and types of costs, depending on the nature and level of complexity and customization of the test and the specific terms we have negotiated for the tests, which can vary from customer to customer. As a result, the mix of tests delivered in any period, and the customers that order these tests, impacts our financial results for the period.
Mix of Customers
We consider each single billing and paying unit to be an individual customer, even though a unit may represent multiple physicians and healthcare providers ordering tests. The composition and concentration of our customer base can fluctuate from period to period, and in certain prior periods, a small number of customers have accounted for a significant portion of our revenue. Generally, we do not have long-term purchase agreements with any of our customers, including these key customers, and, as result, any or all of them could decide at any time to increase, accelerate, decrease, delay or discontinue their orders from us. Although we believe some of these fluctuations in customer demand may be attributable in part to the nature of our business, in which our customers can experience significant volatility in their testing demand from period to period in the ordinary course of their operations, these demand fluctuations, particularly for our key customers, can have a significant impact on our period-to-period performance regardless of their cause.
We currently classify our customers into three payor types: (i) Insurance, (ii) Institutional, including hospitals, medical institutions, other laboratories, governmental bodies, municipalities and large corporations or (iii) Patients who pay directly. Typically, we bill our Institutional customers for our tests, and they are responsible for paying us directly and billing their patients separately or obtaining reimbursement from third-party payors in connection with a patient’s diagnosis related group. A small percentage of our customers are patients, who elect to pay for tests themselves with out-of-pocket payments after their physicians have ordered our tests.
We are making efforts to diversify our customer market, including building relationships with hospitals and affiliated specialties related to our service offerings. We are also pursuing relationships with payors, including Medicare, some state Medicaid programs, and commercial payors, in an effort to obtain coverage and reimbursement for our tests to make them accessible to more individual physicians. Generally, when we establish these new customer relationships, we agree with the applicable payor, laboratory, or other customer to provide certain of our tests at negotiated rates, but, subject to limited exceptions, most of these relationships do not obligate any party to order our tests at any agreed volume or frequency or at all. Further, any relationships we may develop with any government agencies are subject to unique risks associated with government contracts, including cancellation if adequate appropriations for subsequent performance periods are not made and modification or termination at the government’s convenience without prior notice. These efforts may not lead to meaningful or any increases in our customer base and may not improve our ability to achieve or sustain profitability.
Ability to Maintain Our Broad and Flexible Test Menu
We believe the large number of genes we incorporate into our test menu provides a meaningful competitive advantage. We believe the breadth of genes in our portfolio allows us to provide more comprehensive genetic information and improves our variant detection rate, which can increase the clinical actionability of the data we produce. The breadth of genes in our portfolio also allows us to offer hundreds of pre-established, multi-gene panels that focus on specified genetic conditions, including our Focus and Comprehensive oncology panels and Beacon carrier screening panels and somatic cancer panels. In addition, all of our genetic panel tests can be adjusted up or down to include more or fewer genes, or customers can design their own panels to their exact specifications, resulting in a flexible and customizable test menu. We believe our ability to continue to offer more genes and more ordering flexibility than our competitors could be a key contributor to the long-term growth of our business.
Ability to Maintain Low Internal Costs
We have developed various proprietary technologies that improve our laboratory efficiency and reduce the costs we incur to perform our tests, including our proprietary gene probes, data algorithms, adaptive learning software and genetic reference library. This technology platform enables us to perform each test and deliver its results at a lower cost to us than many of our competitors, and this low cost allows us to maintain affordable and competitive pricing for our customers, which we believe encourages repeat ordering from existing customers and attracts new customers. We believe this low internal cost is a key factor in our ability to grow our business and obtain margins on our sales that allow us to drive toward sustained profitability.
Investments in our operational capabilities could increase our cost of revenue, but these investments could also, on a near-term and/or long-term basis, increase our operating efficiencies and lead to cost of revenue decreases. As a result, the amount, timing, nature and success of these investments, as well as other influences on our cost of revenue from period to period, can impact our costs. Moreover, changes in our other operating expenses, due to investments in these aspects of our business or other factors, are not taken into account but impact our overall results, which can limit the utility of cost as an overall cost measurement tool.
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Ability to Obtain Reimbursement
Much of our revenue depends on receiving reimbursement for our tests from third-party payors, including our Insurance and Institutional customers. These payors have complicated rules and procedures regarding submissions for reimbursement and their reimbursement practices and procedures may vary from period to period. Reimbursed amounts are often subject to audit and, and our ability to collect and retain reimbursement from these payors may vary from period to period. If we are unable to obtain or retain reimbursement during any period, our rate of reimbursement is lower than expected or if reimbursement is delayed, our results of operations may be correspondingly affected and fluctuate significantly from period to period. As part of our business plan for future growth, we intend to pursue coverage and reimbursement from third-party payors at a level adequate for us to again achieve and maintain profitability. However, we cannot predict whether, under what circumstances, or at what payment levels payors will cover and reimburse for our tests, and even if we are successful, we believe it could take several years to achieve coverage and adequate contracted reimbursement with third-party payors. To date, we have contracted directly with national health insurance companies to become an in-network provider and enrolled as a supplier with the Medicare program and some state Medicaid programs, which means that we have agreed with these payors to provide certain of our tests at negotiated rates. Although this does not guarantee that we will receive reimbursement for our tests from these or any other payors at adequate levels, we believe our low cost could enhance our ability to compete effectively in the third-party payor market and our flexibility in establishing relationships with additional third-party payors in the future. Our level of success in obtaining and maintaining adequate coverage and reimbursement from third-party payors for our testing services will, we believe, be a key factor in the rate and level of growth of our business over the long term.
Foreign Currency Exchange Rate Fluctuations
Some of our business to date has been from non-U.S. customers, and we may record increasing revenue levels from non-U.S. sources as we focus on growing our international customer base. These revenue sources expose us to fluctuations in our results associated with changes in foreign currency exchange rates depending on the value of the U.S. dollar compared to the foreign currencies in which we record revenue. During all periods covered by this report, we consider the estimated effect on our revenue of foreign currency exchange rate fluctuations to be immaterial; however, the impact of foreign currency exchange rate fluctuations may increase in future periods as we pursue continued international expansion.
COVID-19 Testing Services
We experienced significant volume growth in 2020, 2021 and 2022 after the launch of our COVID-19 testing services in 2020. Most of this growth in our testing volume resulted from COVID-19 tests that we conducted for certain counties, states and municipalities during the pandemic. However, due to decreased demand of COVID-19 testing following the pandemic and our decision to scale back our COVID-19 testing services, we do not expect material revenue from COVID-19 testing in future periods.
Business Risks and Uncertainties
Our business and prospects are exposed to numerous risks and uncertainties. For more information, see “Item 1A. Risk Factors” in this report.
Financial Overview
Revenue
Our laboratory service segment generates revenue from molecular testing, including precision diagnostics and anatomic pathology, BioPharma services, and COVID-19 testing. We recognize revenue upon delivery of a report to the ordering physician or other customer based on the established billing rate, less contractual and other adjustments, to arrive at the amount we expect to collect. Our therapeutic development segment is still pre-revenue.
Cost of Revenue
Cost of revenue reflects the aggregate costs incurred in delivering test results and consists of: costs of laboratory reagents and supplies; personnel costs, including salaries, employee benefit costs, bonuses and equity-based compensation expenses; depreciation of laboratory equipment; delivery and courier costs relating to the transportation of specimens to be tested; amortization of leasehold improvements; and allocated overhead expenses, including rent and utilities. Costs associated with performing tests are recorded as tests are processed.
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Operating Expenses
Our operating expenses are classified into five categories: research and development; selling and marketing; general and administrative; amortization of intangible assets; and restructuring costs if any. For each category except for amortization of intangible assets, the largest component is personnel costs, which include salaries, employee benefit costs, bonuses and equity-based compensation expenses.
Research and Development Expenses
Research and development expenses represent costs incurred to develop our technology and future tests and treatments. These costs consist of:
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personnel costs, including salaries, benefits, and other employee-related costs, such as bonuses and equity-based compensation expenses;
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consulting costs, including consulting fees and related travel expenses;
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laboratory supplies;
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costs associated with in-process research and conducting clinical studies to develop and support our products;
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costs related to production of clinical materials;
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set up costs, including electronic medical record set up costs, costs associated with setting up and conduct clinical studies at domestic and international sites;
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costs related to compliance with regulatory requirements; and
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allocated overhead expenses, including rent, information technology, equipment depreciation and utilities.
We expense all research and development costs in the periods in which they are incurred. We expect our research and development expenses will continue to increase in absolute dollars, as we expect to continue to invest in research and development activities and continue to innovate and expand the application of our platform. Furthermore, we expect our research and development expenses for our therapeutic development segment to increase as we incur incremental expenses associated with our drug candidates that are currently under development and in clinical trials. Drug candidates in later stages of clinical development generally have higher development costs, primarily due to the increased size and duration of later-stage clinical trials. Accordingly, we expect to incur significant research and development expenses in connection with our initiation of Phase 2 trials for FID-007.
Selling and Marketing Expenses
Selling and marketing expenses consist of personnel costs, customer service expenses, direct marketing expenses, educational and promotional expenses, market research and analysis and allocated overhead expenses, including rent and utilities. We expense all selling and marketing costs as incurred. We expect our selling and marketing expenses will continue to increase in absolute dollars, primarily driven by our increased investment in sales and marketing in recent periods, including developing and expanding our sales team, creating and implementing new sales and marketing strategies and increasing the overall scope of our marketing efforts.
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General and Administrative Expenses
General and administrative expenses include executive, finance, accounting, legal and human resources functions. These expenses consist of personnel costs, audit and legal expenses, consulting costs and allocated overhead expenses, including rent and utilities. We expense all general and administrative costs as incurred. We expect our general and administrative expenses will continue to increase in absolute dollars as we seek to continue to scale our operations. We also expect to continue to incur general and administrative expenses as a result of operating as a public company, including expenses related to compliance with the rules and regulations of the SEC, and the Nasdaq Stock Market, additional insurance expenses, investor relations activities and other administrative and professional services.
Amortization of Intangible Assets
Amortization of intangible assets consist of amortization expense on customer relationships, royalty-free technology, trade name, laboratory information system platform and in-place intangible assets that arose from the business combinations and a patent acquired. We amortize finite lived intangible assets over the period of estimated benefit using the straight-line method. Indefinite lived intangible assets are tested for impairment annually or whenever events or circumstances indicate that the carrying amount of the asset may not be recoverable. If impairment is indicated, we measure the amount of the impairment loss as the amount by which the carrying amount exceeds the fair value of the asset.
Restructuring Costs
Restructuring costs represent one-time employee termination benefits provided to employees associated with a newly acquired entity that were involuntarily terminated. A plan of termination was approved and authorized by management in the second quarter of 2022. The plan identified specific employees to be terminated and established terms of benefits those employees would receive upon termination. No additional costs were incurred under the plan of termination post 2022, and the payable balance has been paid off.
Provision for Income Taxes
Provision for income taxes consists of U.S. federal and state income taxes. A deferred tax liability is recognized for all taxable temporary differences, and a deferred tax asset is recognized for all deductible temporary differences, operating losses and tax credit carryforwards. A valuation allowance is provided when it is more likely than not that some portion or all of a deferred tax asset will not be realized.
The factors that most significantly impact our effective tax rate include the levels of net earnings and certain deductions, including those related to equity-based compensation, the effect of state income taxes, return to provision adjustments, and foreign tax rate differential. We expect that these factors could cause our consolidated effective tax rate to differ significantly from the U.S. federal income tax rate in future periods.
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Results of Operations
The table below summarizes the results of our continuing operations for each of the periods presented. Historical results are not indicative of the results to be expected in the current period or any future period.
| Year Ended December 31, | $ | % | |||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2023 | 2022 | Change | Change | ||||||||||
| Statement of Operations Data: | (dollars in thousands) | ||||||||||||
| Revenue | $ | 289,213 | $ | 618,968 | $ | (329,755 | ) | (53)% | |||||
| Cost of revenue | 184,757 | 252,067 | (67,310 | ) | (27)% | ||||||||
| Gross profit | 104,456 | 366,901 | (262,445 | ) | (72)% | ||||||||
| Operating expenses: | |||||||||||||
| Research and development | 41,440 | 28,910 | 12,530 | 43% | |||||||||
| Selling and marketing | 41,467 | 38,918 | 2,549 | 7% | |||||||||
| General and administrative | 88,999 | 111,074 | (22,075 | ) | (20)% | ||||||||
| Amortization of intangible assets | 7,845 | 6,497 | 1,348 | 21% | |||||||||
| Goodwill impairment loss | 120,234 | — | 120,234 | * | |||||||||
| Restructuring costs | — | 2,975 | (2,975 | ) | * | ||||||||
| Total operating expenses | 299,985 | 188,374 | 111,611 | 59% | |||||||||
| Operating (loss) income | (195,529 | ) | 178,527 | (374,056 | ) | (210)% | |||||||
| Interest and other income, net | 21,444 | 5,498 | 15,946 | 290% | |||||||||
| Income (loss) before income taxes | (174,085 | ) | 184,025 | (358,110 | ) | (195)% | |||||||
| Provision for income taxes | 1,154 | 42,102 | (40,948 | ) | (97)% | ||||||||
| Net (loss) income from consolidated operations | (175,239 | ) | 141,923 | (317,162 | ) | (223)% | |||||||
| Net loss attributable to noncontrolling interests | 7,414 | 1,480 | 5,934 | 401% | |||||||||
| Net (loss) income attributable to Fulgent | $ | (167,825 | ) | $ | 143,403 | $ | (311,228 | ) | (217)% |
Revenue
| Year Ended December 31, | $ | % | |||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2023 | 2022 | Change | Change | ||||||||||
| Revenue Data: | (dollars in thousands) | ||||||||||||
| Precision diagnostics | $ | 131,990 | $ | 93,685 | $ | 38,305 | 41% | ||||||
| Anatomic pathology | 104,655 | 74,799 | 29,856 | 40% | |||||||||
| COVID-19 | 27,152 | 437,507 | (410,355 | ) | (94)% | ||||||||
| BioPharma services | 25,416 | 12,977 | 12,439 | 96% | |||||||||
| Total | $ | 289,213 | $ | 618,968 | $ | (329,755 | ) | (53)% |
Revenue decreased by $329.8 million, or 53%, from $619.0 million in 2022 to $289.2 million in 2023. The decrease in revenue between periods was due to a decrease in COVID-19 testing revenue of 94%, and partially offset by increases in our other revenue streams of 44% for the periods.
We ceased our COVID-19 testing operations at the end of the first quarter of 2023. As a result, we have been focusing our efforts on growing our precision diagnostics, anatomic pathology, and BioPharma services revenue streams. For the year ended December 31, 2023, precision diagnostics, anatomic pathology, and BioPharma services accounted for 46%, 36%, and 9% of our consolidated revenue, respectively, and increased $38.3 million, $29.9 million, and $12.4 million, respectively, compared to 2022. The increase in precision diagnostics revenue and anatomic pathology revenue was due to an additional four months of revenue in 2023 compared to 2022 as Inform Diagnostics was acquired at the end of April 2022. The increase in precision diagnostics was also due to a growth in reproductive health services which included the launch of our expanded Beacon787 testing. The increase in BioPharma services was due to the addition of a few concentrated customers.
We believe the factors that will affect our ability to grow these revenue streams are 1) the average price point we offer and the reimbursement rate from third-party payors; 2) the concentration of our payor base; 3) the competitive advantage we have due to our broad and flexible test menu, detection rate, and turnaround times; and 4) growth in size of an addressable market. Estimated collection amounts from third-party payors are subject to the complexities and ambiguities of billing, reimbursement regulations and claims processing, as well as considerations unique to Medicare and Medicaid programs. Because our proprietary technology platform allows for repaid scaling of a broad, flexible testing menu, we can offer our customers more scalable and affordable testing. In recent years, variation in our revenue has primarily been driven by the volume of tests we deliver, particularly the volume of our COVID-19
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tests that we delivered during these periods. Going forward, we will strive to maintain this competitive advantage and emphasize this in our marketing efforts to grow our testing revenue.
Our customer base includes insurance, institutional, and individual payors. In some periods, our revenue is concentrated on a smaller number of customers. For the laboratory services segment, aggregating customers that are under common control, one customer comprised $35.7 million or 12% of our revenue in 2023, and a different customer comprised $115.6 million or 19% and $260.2 million or 26% of our revenue in 2022 and 2021, respectively. To reduce this revenue risk, we will focus on increasing the number of customers and thereby reducing the concentration.
Revenue from non-U.S. sources increased by $4.4 million, or 28%, from $15.8 million in 2022 to $20.2 million in 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, which contributed $11.4 million in total revenue in 2023.
Cost of Revenue
| Year Ended December 31, | $ | % | |||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2023 | 2022 | Change | Change | ||||||||||
| (dollars in thousands) | |||||||||||||
| Cost of revenue | $ | 184,757 | $ | 252,067 | $ | (67,310 | ) | (27)% | |||||
| Cost of revenue as a % of revenue | 63.9 | % | 40.7 | % | 23.2 | % | 56.9% |
Our consolidated cost of revenue decreased by $67.3 million, or 27%, from $252.1 million in 2022 to $184.8 million in 2023. The decrease was primarily due to decreases of $32.1 million in consulting and outside labor costs for production, $25.9 million in reagent and supply expenses, $12.3 million in depreciation expenses, $5.3 million in shipping expenses, and $1.2 million in travel and meals expense and $2.9 million in facility expense, all related to decreased COVID-19 testing, and partially offset by an increase of $15.4 million in personnel costs, including equity-based compensation expense, due to an additional four months of costs in 2023 compared to 2022 as Inform Diagnostics was acquired at the end of April 2022.
Our consolidated cost of revenues as a percentage of revenue increased from 40.7% to 63.9%. Our gross profit decreased by $262.4 million, or 72%, from $366.9 million in 2022 to $104.5 million in 2023. Our gross profit as a percentage of revenue, or gross margin, decreased from 59.3% to 36.1%. The changes were primarily due to the decrease in revenue from our COVID-19 testing, which had a higher gross margin, and an additional four months of costs in 2023 from Inform Diagnostics.
Research and Development
| Year Ended December 31, | $ | % | |||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2023 | 2022 | Change | Change | ||||||||||
| Research and development | (dollars in thousands) | ||||||||||||
| Laboratory services | $ | 29,748 | $ | 28,164 | $ | 1,584 | 6% | ||||||
| Therapeutic development | 11,692 | 746 | 10,946 | 1467% | |||||||||
| $ | 41,440 | $ | 28,910 | $ | 12,530 | 43% |
Research and development expenses for the laboratory services segment were mainly for developing our technology and future testing and testing services. The expenses of $29.7 million in 2023 primarily consisted of $25.5 million in personnel expenses, including bonuses and equity-based compensation, $1.1 million in reagent and supply expense, $1.1 million in facility expenses, $698,000 in depreciation expense, and $400,000 in software and licensing. The expenses of $28.2 million in 2022 primarily consisted of $23.4 million in personnel expenses, including bonuses and equity-based compensation, $2.2 million in reagent and supply expense, $785,000 in depreciation expense, and $587,000 in consulting and outside labor costs.
Research and development expenses for the therapeutic development segment were $11.7 million and $746,000 in 2023 and 2022, respectively, and were primarily related to the development of FID-007. 2022 was a partial year as the segment was acquired in November of 2022. Research and development expenses in 2023 included $6.4 million of personnel expenses, including equity-based compensation under the equity plan assumed as part of the business combination, and $4.5 million in drug study with various CROs. We anticipate research and development expenditures for this segment will significantly increase in the future, as we expect to begin enrollment for a phase 2 study of FID-007 in the second quarter of 2024.
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Selling and Marketing
Our consolidated selling and marketing expenses increased by $2.5 million, or 7%, from $38.9 million in 2022 to $41.5 million in 2023. The increase was primarily due to increases of $2.2 million in software expense, $1.5 million in facilities expense, $742,000 in personnel costs, including equity-based compensation expense, and $456,000 in advertising and marketing expenses, mainly due to an additional four months of costs in 2023 compared to 2022 as Inform Diagnostics was acquired at the end of April 2022, and partially offset by a decrease of $2.6 million in consulting and outside labor costs related to decreased COVID-19 testing.
General and Administrative
Our consolidated general and administrative expenses decreased by $22.1 million, or 20%, from $111.1 million in 2022 to $89.0 million in 2023. The decrease was primarily due to decreases of $33.5 million in provision for credit losses due to subsequent collections from customers who were previously reserved, $6.2 million in acquisition related to business combinations in 2022, $2.6 million in one-time license and permit expense incurred by Inform Diagnostics, partially offset by increases of $6.6 million in personnel costs including equity-based compensation expense, $6.1 million in facility expense, and $3.6 million in depreciation expense, due to an additional four months of costs in 2023 compared to 2022 as Inform Diagnostics was acquired at the end of April 2022, and $3.0 million in legal and professional fees due to legal liabilities accrued in connection with our voluntary disclosure process as described in Note 8, Debt, Commitments and Contingencies to the Consolidated Financial Statements, and $1.5 million in accounting expense as the entities acquired in 2022 and 2021 were scoped in for financial statement and internal control audit and reviews.
Amortization of Intangible Assets
Our consolidated amortization of intangible assets represents amortization expenses on the intangible assets that arose from the business combinations in 2022 and 2021 and a patent purchased in 2021. The increase in amortization of intangible assets was primarily due to additions in intangible assets from business combinations in 2022.
Goodwill Impairment Loss
| Year Ended December 31, | $ | % | |||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2023 | 2022 | Change | Change | ||||||||||
| Goodwill impairment loss | (dollars in thousands) | ||||||||||||
| Laboratory services | $ | 120,234 | $ | — | $ | 120,234 | * | ||||||
| Therapeutic development | — | — | — | * | |||||||||
| $ | 120,234 | $ | — | $ | 120,234 |
Goodwill impairment loss for 2023 was comprised of a full goodwill impairment loss of $120.2 million for the Laboratory Service reporting unit. There was no goodwill impairment loss for the year ended December 31, 2022. The full impairment was driven by a sustained decline in our stock price and market capitalization. There was no impairment loss for the therapeutic development unit for the years ended December 31, 2023 and 2022. See Note 17, Goodwill and Intangible Assets, for more details.
Restructuring Costs
Restructuring expenses represent one-time employee termination benefits provided to employees that were involuntarily terminated in association with the acquisition of a new entity in 2022.
Interest and Other Income, Net
Interest and other income, net is primarily comprised of net interest income, which was $21.1 million and $5.3 million for 2023 and 2022, respectively. This interest income 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 on our notes payable and a margin loan.
Provision for Income Taxes
Provision for income taxes were $1.2 million and $42.1 million in 2023 and 2022, respectively. The effective income tax rate was (0.69)% and 22.7% of income before income taxes for 2023 and 2022, respectively. The change in the effective tax rate for 2023 relative to 2022 was due to the establishment of a valuation allowance on the Company’s net deferred tax assets. FASB ASC 740
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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, and, accordingly, has provided a full valuation allowance at December 31, 2023.
See Note 11, Income Taxes, to our consolidated financial statements included in this report for more information regarding our income taxes.
Net Loss Attributable to Noncontrolling Interest
Net loss attributable to noncontrolling interest represents net loss attributable to minority shareholders from entities not wholly owned.
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Liquidity and Capital Resources
Liquidity and Sources of Cash
We had $847.7 million and $852.9 million in cash, cash equivalents and marketable securities as of December 31, 2023 and 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 December 31, 2023 and 2022.
Our primary uses of cash are to repurchase our stock, 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 has significantly contributed to our ability to meet our liquidity needs, including paying for capital expenditures, however, cash provided by our operations has in the past 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, 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 cash flows from continuing operations for each of the periods presented:
| Year Ended December 31, | |||||||
|---|---|---|---|---|---|---|---|
| 2023 | 2022 | ||||||
| (in thousands) | |||||||
| Net cash provided by operating activities | $ | 27,003 | $ | 253,520 | |||
| Net cash provided by (used in) investing activities | $ | 38,898 | $ | (261,314 | ) | ||
| Net cash used in financing activities | $ | (47,785 | ) | $ | (77,141 | ) |
Operating Activities
During the year ended December 31, 2023, our operations provided $27.0 million of cash as compared to $253.5 million in 2022. The $226.5 million decrease in cash provided from operating activities in 2023 as compared with the corresponding 2022 period was primarily due to lower cash earnings, cash receipts from customers, and cash payments for operating expenses as COVID-19 revenue dissipated in 2023. We expect to incur more operating expenses and use more cash in operating activities in the coming year as a result of our planned and ongoing clinical trials for FID-007 and as we continue to invest resources to grow our laboratory services business.
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Investing Activities
The cash provided by or used in investing activities are impacted by capital expenditures for operation needs and timing of payments, timing of maturities of marketable securities, and discretionary business combinations and other investment.
Cash provided by investing activities in 2023 was $38.9 million, which primarily related to $508.6 million related to maturities of marketable securities, $44.1 million related to proceeds from sales of marketable securities, and $775,000 related to the sale of fixed assets, and partially offset by $491.9 million in purchase of marketable securities, $22.2 million related to the purchase of fixed assets consisting mainly of medical laboratory equipment and building improvement, $399,000 related to a business acquisition.
Cash used in investing activities in 2022 was $261.3 million, which primarily related to $418.0 million in the purchase of marketable securities, $172.7 million related to business acquisitions, $18.8 million related to the purchase of fixed assets consisting mainly of medical laboratory equipment and building improvement, $15.0 million related to the purchase of redeemable preferred stock and $10.0 million related to contingent consideration payouts related to business acquisitions, and partially offset by $232.5 million related to maturities of marketable securities and $140.2 million related to proceeds from sales of marketable securities.
Financing Activities
Cash used in financing activities in 2023 was $47.8 million, which primarily related to $25.1 million used in the repurchase of common stock $15.0 million used in the repayment for the margin account, $4.3 million used in the repayment of notes payable, and $2.7 million used in common stock withholding for employee tax obligations.
Cash used in financing activities in 2022 was $77.1 million, which primarily related to $74.3 million used in the repurchase of common stock and $1.8 million used in common stock withholding for employee tax obligations.
We did not expect to use any credit facilities due to the strong cash position as of December 31, 2023.
Stock Repurchase Program
In March 2022, our Board authorized a $250.0 million stock repurchase program. The stock repurchase program has no expiration from the date of authorization. Under the stock repurchase program, the Company may repurchase shares from time to time in the open market or in privately negotiated transactions.
During the year ended December 31 2023, we repurchased 953,000 shares of our common stock at an aggregate cost of $25.1 million under the stock repurchase program. During the year ended December 31 2022, we repurchased 1.8 million shares of our common stock at an aggregate cost of $74.3 million under the stock repurchase program. As of December 31, 2023, a total of approximately $150.7 million remained available for future repurchases of our common stock under our stock repurchase programs.
Material Cash Requirements and Contractual Obligations as of December 31, 2023
As of December 31, 2023, we have an outstanding balance of $775,000 in notes payable to Xilong Scientific, which is due in March 2024, and $3.4 million of an installment loan, of which, the current portion is $408,000. See Note 8, Debt, Commitments and Contingencies, of our consolidated financial statements included in this report.
The following summarizes our contractual obligations as of December 31, 2023:
| Payments Due by Period | ||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Total | Less than 1 year | 1-3 years | 3-5 years | More than 5 years | ||||||||||||||
| (in thousands) | ||||||||||||||||||
| Operating lease obligations (1) | $ | 12,242 | $ | 4,309 | $ | 4,140 | $ | 2,243 | $ | 1,550 | ||||||||
| Finance lease obligations(2) | 1,368 | 532 | 836 | — | — | |||||||||||||
| Purchase obligations(3) | 51,934 | 29,669 | 22,265 | — | — | |||||||||||||
| Total contractual obligations | $ | 65,544 | $ | 34,510 | $ | 27,241 | $ | 2,243 | $ | 1,550 |
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(1)
Represents non-cancelable operating leases. For further information, refer to Note 9, Leases, to the Consolidated Financial Statements.
(2)
Represents non-cancelable finance leases. For further information, refer to Note 9, Leases, to the Consolidated Financial Statements.
(3)
Represents non-cancelable purchase obligations for medical lab equipment, reagents and other supplies, see Note 8, Debt, Commitment and Contingencies, to the Consolidated Financial Statements.
Critical Accounting Policies and Use of Estimates
This discussion and analysis is based on our consolidated financial statements included in this report, which have been prepared in accordance with U.S. Generally Accepted Accounting Principles, or U.S. GAAP. The preparation of consolidated financial statements in accordance with U.S. GAAP requires management to make certain estimates, judgments and assumptions and decisions that affect the reported amounts and related disclosures, including the selection of appropriate accounting principles and the assumptions on which to base accounting estimates. In making these estimates and assumptions and reaching these decisions, we apply judgment based on our understanding and analysis of the relevant circumstances, including historical data and experience available at the date of the consolidated financial statements, as well as various other factors management believes to be reasonable under the circumstances, including but not limited to valuation of intangible assets and goodwill in recent business combinations. Actual results could differ from our estimates. We are committed to incorporating accounting principles, assumptions and estimates that promote the representational faithfulness, verifiability, neutrality and transparency of the accounting information included in our consolidated financial statements.
While our significant accounting policies are described in more detail in the notes to the consolidated financial statements included in this report, we believe the accounting policies discussed below used in the preparation of our consolidated financial statements require the most significant estimates, judgments, assumptions and decisions.
Revenue Recognition
We generate revenue from sales of our testing services. We currently receive payments from: insurance, institutional customers, including hospitals, medical institutions, other laboratories, governmental bodies, municipalities and large corporations; and patients who pay directly.
We recognize revenue in an amount that reflects the consideration to which we expect to be entitled in exchange for the transfer of promised goods or services to our customers.
In the absence of Medicare coverage, contractually established reimbursement rates or other coverage, we have concluded that our contracts include variable consideration because the amounts paid by Medicare or commercial health insurance carriers may be paid at less than our standard rates or not paid at all, with such differences considered implicit price concessions. Variable consideration attributable to these price concessions measured at the expected value using the “most likely amount” method under Accounting Standards Codification, or ASC, 606 Revenue from Contracts with Customers, or ASC 606. The amounts are determined by the historical average collection rates by test type and payor category taking into consideration the range of possible outcomes, the predictive value of our past experiences, the time period of when uncertainties expect to be resolved and the amount of consideration that is susceptible to factors outside of our influence, such as the judgement and actions of third parties. Such variable consideration is included in the transaction price only to the extent it is probable that a significant reversal in the amount of cumulative revenue recognized will not occur when the uncertainties with respect to the amount are resolved. Variable consideration may be constrained and excluded form the transaction price in situations where there is no contractually agreed upon reimbursement coverage or in the absence of a predictable pattern and history of collectability with a payor.
We re-assess our estimated transaction price at the end of each reporting period, including our assessment of whether our estimate of variable consideration is constrained to the extent that it is probable that a significant reversal of cumulative revenue will not occur once any uncertainty is resolved. We record any necessary adjustments in the current period’s revenue. $23.0 million variable consideration was recognized as additional revenue in the year ended December 31, 2023 that related to collections for COVID-19 tests completed in the prior period.
Valuation of Goodwill and Indefinite-Lived Intangible Assets
The valuation of assets acquired in a business combination and asset impairment reviews require the use of significant estimates and assumptions. The acquisition method of accounting for business combinations requires us to estimate the fair value of assets acquired, liabilities assumed, and any noncontrolling interest in an acquired business to properly allocate purchase price consideration between assets that are depreciated or amortized and goodwill.
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We assess goodwill and indefinite-lived intangibles for impairment on an annual basis and between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. We may choose to bypass a qualitative assessment of impairment for any reporting unit and proceed directly to performing a quantitative assessment. We would recognize an impairment loss for the amount by which the reporting unit's carrying amount exceeds its fair value.
Our quantitative assessment includes estimating the fair value of each reporting unit and comparing it to its carrying value. We estimate the fair value of reporting units using both income-based and market-based valuation methods. We typically engage a third-party appraisal firm to assist us with the valuation. Based upon the range of estimated values developed from the income and market-based methods, we determine the estimated fair value for each reporting unit. If the estimated fair value of a reporting unit exceeds its carrying value, the goodwill is not impaired, and no further review is required.
The income-based fair value methodology is based on a reporting unit’s forecasted future cash flows that are discounted to the present value using the reporting unit’s weighted average cost of capital, or WACC. Under the income-based approach, it requires management's assumptions and judgments regarding economic conditions in the markets in which we operate and conditions in the capital markets, many of which are outside of management's control. The market-based fair value methodology looks at the guideline public company valuation method to determine the prices of comparable public companies and looks at merger and acquisition methods, similar businesses that were sold recently, to estimate the value of our reporting units. Under the market-based approach, judgment is required in evaluating market multiples and recent transactions.
We performed our annual goodwill and intangible asset impairment test on December 31, 2023, and elected to bypass the optional qualitative test and perform the quantitative assessments for both our laboratory services and therapeutic development reporting units which includes an indefinite-lived intangible asset.
There can be no assurance that the estimates and assumptions management made for the purposes of the goodwill or in-process research & development, or IPR&D, impairment analysis will prove to be accurate predictions of future performance. It is possible that the conclusions regarding impairment or recoverability of goodwill or intangible assets could change in future periods. We will continue to monitor the therapeutic development reporting unit. For all IPR&D projects, there are major risks and uncertainties associated with the timely and successful completion of development and commercialization of these product candidates, including the ability to confirm their efficacy based on data from clinical trials, the ability to obtain necessary regulatory approvals, and the ability to successfully complete these tasks within budgeted costs. We are not able to market a human therapeutic without obtaining regulatory approvals, and such approvals require completing clinical trials that demonstrate a product candidate is safe and effective. In addition, the availability and extent of coverage and reimbursement from third-party payers, including government healthcare programs and private insurance plans, impact the revenues a product can generate. Consequently, the eventual realized value, if any, of these acquired IPR&D projects may vary from their estimated fair values.
Recent Accounting Pronouncements
See Note 2, Summary of Significant Accounting Policies, to our consolidated financial statements included in this report for information about recent accounting pronouncements.
Off-Balance Sheet Arrangements
We did not have, and do not currently have, any off-balance sheet arrangements during the periods presented, 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.