Fulgent Genetics, Inc. - Quarter Report: 2018 September (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

(Mark One)

For the quarterly period ended September 30, 2018

OR

For the transition period from                              to                             

Commission File Number: 001-37894

FULGENT GENETICS, INC.

(Exact Name of Registrant as Specified in its Charter)

(626) 350-0537

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ☒    No ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    Yes  ☒    No  ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.    ☒

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ☐    No  ☒

As of November 1, 2018, there were 18,069,174 outstanding shares of the registrant’s common stock.

Table of Contents

i

PART I—FINANCIAL INFORMATION

Item 1. Financial Statements.

FULGENT GENETICS, INC.

Condensed Consolidated Balance Sheets

(in thousands, except par value data)

(unaudited)

The accompanying notes are an integral part of these condensed consolidated financial statements.

1

FULGENT GENETICS, INC.

Condensed Consolidated Statements of Operations

(in thousands, except per share data)

(unaudited)

The accompanying notes are an integral part of these condensed consolidated financial statements.

2

FULGENT GENETICS, INC.

Condensed Consolidated Statements of Comprehensive Income (Loss)

(in thousands)

(unaudited)

The accompanying notes are an integral part of these condensed consolidated financial statements.

3

FULGENT GENETICS, INC.

Condensed Consolidated Statements of Stockholders’ Equity

(in thousands)

(unaudited)

The accompanying notes are an integral part of these condensed consolidated financial statements.

4

FULGENT GENETICS, INC.

Condensed Consolidated Statements of Cash Flows

(in thousands)

(unaudited)

The accompanying notes are an integral part of these condensed consolidated financial statements.

5

FULGENT GENETICS, INC.

Notes to the Condensed Consolidated Financial Statements

(unaudited)

Note 1. Overview and Basis of Presentation

The accompanying condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”). These financial statements include the assets, liabilities, revenues and expenses of all wholly-owned subsidiaries and entities in which the Company has a controlling financial interest or is deemed to be the primary beneficiary. In determining whether the Company is the primary beneficiary of an entity, the Company applies a qualitative approach that determines whether it has both (1) the power to direct the economically significant activities of the entity and (2) the obligation to absorb losses of, or the right to receive benefits from, the entity that could potentially be significant to that entity. The Company uses the equity method to account for its investments in entities that it does not control, but in which it has the ability to exercise significant influence over operating and financial policies. All significant intercompany accounts and transactions are eliminated from the accompanying condensed consolidated financial statements.

Nature of the Business

Fulgent Genetics, Inc., together with its subsidiaries (collectively referred to as the “Company,” unless otherwise noted or the context otherwise requires), is a technology company with a focus on offering comprehensive genetic testing to provide physicians with clinically actionable diagnostic information they can use to improve the quality of patient care. The Company has developed a proprietary technology platform that allows it to offer a broad and flexible test menu and continually expand and improve its proprietary genetic reference library. The Company’s current test menu offers single-gene tests and pre-established, multi-gene, disease-specific panels that collectively test for many genetic conditions, including various cancers, cardiovascular diseases, neurological disorders and pediatric conditions. The Company’s existing customer base consists primarily of hospitals and medical institutions, which are frequent and high-volume users of genetic tests and which typically pay the Company directly for its tests.

Unaudited Interim Financial Information

The accompanying unaudited interim condensed consolidated financial statements have been prepared on the same basis as the Company’s audited consolidated financial statements as of and for the fiscal year ended December 31, 2017, which are included in the Company’s annual report on Form 10-K filed with the Securities and Exchange Commission on March 20, 2018 (the “2017 Annual Report”), and, in the opinion of management, include all adjustments, which are normal and recurring in nature, necessary for a fair presentation of the Company’s financial position and results of operations. Operating results for interim periods are not necessarily indicative of the results that may be expected for a full fiscal year or any other period. The accompanying condensed consolidated balance sheet as of December 31, 2017 has been derived from the Company’s audited consolidated financial statements at that date but does not include all of the disclosures required by U.S. GAAP. As such, the information included in this quarterly report on Form 10-Q should be read in conjunction with the Company’s audited consolidated financial statements included in the 2017 Annual Report, including the notes thereto.

Note 2. Summary of Significant Accounting Policies

See the summary of the Company’s significant accounting policies set forth in the notes to its consolidated financial statements included in the 2017 Annual Report.

Use of Estimates

The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make certain estimates, judgments and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported amounts of revenue and expenses during the reporting periods. These estimates, judgments and assumptions are based on historical data and experience available at the date of the accompanying condensed consolidated financial statements, as well as various other factors management believes to be reasonable under the circumstances. Actual results could differ from these estimates.

On an on-going basis, management evaluates its estimates, primarily those related to: (i) revenue recognition criteria, (ii) accounts receivable and allowances for doubtful accounts, (iii) the useful lives of fixed assets, (iv) estimates of tax liabilities and (v) equity method investments.

6

Foreign Currency Translation and Foreign Currency Transactions

The Company translates the assets and liabilities of its non-U.S. dollar functional currency subsidiaries into U.S. dollars using exchange rates in effect at the end of each period. Expenses for these subsidiaries are translated using rates that approximate those in effect during the period. Gains and losses from these translations are recognized in foreign currency translation included in other comprehensive income (loss) in the accompanying condensed consolidated statements of stockholders’ equity. Losses from these translations were $23,000 and $44,000 in the three and nine months ended September 30, 2018, respectively, and gains and losses from these translations were not significant in the comparable periods of 2017.The Company and its subsidiaries that use the U.S. dollar as their functional currency remeasure monetary assets and liabilities at exchange rates in effect at the end of each period, and inventories, property and nonmonetary assets and liabilities at historical rates. Losses from these remeasurements were $7,000 and $74,000 in the three and nine months ended September 30, 2018, respectively, and gains and losses from these remeasurements were not significant in the comparable periods of 2017.

Concentration of Customers

In certain periods, a small number of customers has accounted for a significant portion of the Company’s revenue. In the three and nine months ended September 30, 2018, after aggregating customers that are under common control or are affiliates, one customer contributed 13% of our revenue. In the three months ended September 30, 2017, after aggregating customers that are under common control or are affiliates, one customer contributed 11% of our revenue, and another two customers represent one customer for concentration disclosure purposes as they are managed by the same customer in the PRC, which contributed 12% of our revenue collectively. In the nine months ended September 30, 2017, after aggregating customers that are under common control or are affiliates, three customers each contributed 11% of our revenue, and one of the customers and another customer represent one customer for concentration disclosure purposes as they are managed by the same customer in the PRC and contributed 18% of our revenue collectively.

Revenue Recognition

Effective January 1, 2018, the Company began recognizing revenue in accordance with FASB ASC Topic 606, Revenue from Contracts with Customers (“ASC 606”). The Company adopted ASC 606 utilizing the modified retrospective method, meaning the cumulative effect of applying the standard was recognized to opening retained earnings as of January 1, 2018. To reflect the impact of the adoption, the Company recorded an adjustment of $327,000 to beginning accumulated deficit and accounts receivable and an adjustment of ($74,000) to beginning accumulated deficit and deferred taxes. ASC 606 provides for a five-step model that includes identifying the contract with a customer, identifying the performance obligations in the contract, determining the transaction price, allocating the transaction price to the performance obligations, and recognizing revenue when, or as, an entity satisfies a performance obligation.

Performance Obligations

Genetic Testing Services

Clinical – Institutional and Patient Direct Pay

Our clinical institutional contracts included within genetic testing services typically have a single performance obligation to deliver genetic testing services to the ordering facility or patient. Some arrangements involve the delivery of genetic testing services to research institutions, which we refer to as “sequencing as a service.” In arrangements with hospitals, patients who pay directly, medical or research institutions, the transaction price is stated within the contract and is therefore fixed consideration. For most of our clinical volume, we identified the hospital, patients, medical or research institutions as the customer in Step 1 of the model and have determined a contract exists with those customers in Step 1. As these contracts typically have a single performance obligation, no allocation of the transaction price is required in Step 4 of the model. Control over genetic testing services is transferred to our ordering facility at a point in time. Specifically, we determined the customer obtains control of the promised service upon our delivery of test results.

7

Clinical – Insurance

Our clinical insurance contracts included within genetic testing services typically have a single performance obligation to deliver genetic testing services to the ordering facility or patient. For most of our clinical insurance volume, we identified the patient as the customer in Step 1 of the model and have determined a contract exists with the patient in Step 1. In arrangements with insurance patients, the transaction price is stated within the contract, however, we accept payments from third-party payors that are less than the contractually stated price and is therefore variable consideration. In developing the estimate of variable consideration, we utilize the expected value method under a portfolio approach. Our estimate requires significant judgment and is developed using historical reimbursement data from payors and patients, as well as known current reimbursement trends not reflected in the historical data. As these contracts typically have a single performance obligation, no allocation of the transaction price is required in Step 4 of the model. Control over genetic testing services is transferred to our ordering physicians at a point in time. Specifically, we determined the customer obtains control of the promised service upon our delivery of the test results.

Certain incremental costs pertaining to both clinical insurance and institutional, such as commissions, are incurred in obtaining clinical contracts. Historically contract costs have not been significant to the financial statements. We have elected to utilize the practical expedient to expense incremental costs of obtaining a contract that meet the capitalization criteria, as the amortization period of any contract acquisition asset would be one year or less due to the short-term nature of the customer life.

Significant Judgments and Contract Estimates

Genetic Testing Services

Accounting for clinical insurance contracts includes estimation of the transaction price, defined as the amount we expect to be entitled to receive in exchange for providing the services under the contract. Due to our out-of-network status with the majority of payors, estimation of the transaction price represents variable consideration. In order to estimate variable consideration, we utilize a portfolio approach in which payors with similar reimbursement experience are grouped into portfolios. Our estimates of variable consideration are based primarily on historical reimbursement data. Certain assumptions will also be adjusted based on known and anticipated factors not reflected in the historical reimbursement data. We monitor these accrual estimates at each reporting period based on actual cash collections in order to assess whether a revision to the estimate is required. Both the initial accrual estimate and any subsequent revision to the estimate contain uncertainty and require the use of judgment in the estimation of the transaction price and application of the constraint for variable consideration. If actual results in the future vary from the Company’s estimates, the Company will adjust these estimates, which would affect revenue and earnings in the period such variances become known.

Accounting Pronouncements Recently Adopted

ASU 2014-09

The Company adopted ASU 2014-09 Revenue from Contracts with Customers and all related amendments (collectively codified as ASC 606) on January 1, 2018 utilizing the modified retrospective method, meaning the cumulative effect of applying the standard to all contracts completed as of the date of initial application was recognized to opening retained earnings as of January 1, 2018. Comparative information from prior periods has not been restated and continues to be reported under the accounting standards in effect for those periods.

Financial Statement Impact of Adoption ASC 606

The cumulative effect of changes made to the Condensed Consolidated Balance Sheet at January 1, 2018 for the adoption of ASC 606 were as follows:

8

In accordance with ASC 606 requirements under the modified retrospective method of adoption, the disclosure of the impacts to condensed consolidated financial statements as of and for the three and nine months ended September 30, 2018 were as follows:

There was no impact on the condensed consolidated statements of cash flows for the nine months ended September 30, 2018.

9

Disaggregation of Revenue

The Company classifies its customers into three payor types, Clinical Institutional, Patients who pay directly or Clinical Insurance, as we believe this best depicts how the nature, amount, timing, and uncertainty of our revenue and cash flows are affected by economic factors. The following table summarizes revenue from contracts with customers by payor type for the three and nine months ended September 30, 2018.

There was no material variable consideration recognized in the current period that relates to performance obligations that were completed in the prior period.

Transaction Price Allocated to Future Performance Obligations

ASC 606 requires that the Company disclose the aggregate amount of transaction price that is allocated to performance obligations that have not yet been satisfied as September 30, 2018. ASC 606 provides certain practical expedients that limit the requirement to disclose the aggregate amount of transaction price allocated to unsatisfied performance obligations.

The Company applied the practical expedient to not disclose the amount of transaction price allocated to unsatisfied performance obligations when the performance obligation is part of a contract that has an original expected duration of one year or less. The Company does not have material future obligations associated with Genetic Testing Services that extend beyond one year.

ASU No. 2016-01

In January 2016, the FASB issued ASU No. 2016-01, Financial Instruments Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities, which addresses certain aspects of recognition, measurement, presentation, and disclosure of financial instruments, including a provision that requires equity investments (except for investments accounted for under the equity method of accounting) to be measured at fair value, with changes in fair value recognized in current earnings. The ASU was effective for the Company in the first quarter of 2018, with early adoption permitted. The adoption of this update did not have a material impact on our Consolidated Financial Statements.

ASU No. 2016-15

In August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows (Topic 230). The standard clarifies the way certain cash receipts and cash payments are classified with the objective of reducing the existing diversity in practice. The standard was effective for fiscal years and interim periods beginning after December 15, 2017. The adoption of this update did not have a material impact on our Consolidated Financial Statements.

Recent Accounting Pronouncements

We evaluate all Accounting Standards Updates (ASUs) issued by the Financial Accounting Standards Board (FASB) for consideration of their applicability. ASUs not included in our disclosures were assessed and determined to be either not applicable or are not expected to have a material impact on our Consolidated Financial Statements.

10

ASU No. 2016-02

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842). The update is aimed at making leasing activities more transparent and comparable and requires substantially all leases be recognized by lessees on their balance sheet as a right-of-use asset and corresponding lease liability, including leases currently accounted for as operating leases. This guidance is effective for annual and interim periods beginning on or after December 15, 2018 and early adoption is permitted. The standard requires the use of a modified retrospective transition approach for existing leases. The Company plans to implement ASU 2016-02 on January 1, 2019. using the modified retrospective approach and are still evaluating whether we will elect the practical expedients allowed in the standard. We continue to evaluate the impact of the adoption of ASU 2016-02 on our consolidated financial statements; however, we expect that the adoption of ASU 2016-02 will primarily impact our real-estate leases.

ASU No. 2016-13

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments-Credit Losses: Measurement of Credit Losses on Financial Instruments. ASU No. 2016-13 replaces the incurred loss impairment methodology in current U.S. GAAP with a methodology that reflects expected credit losses. The update is intended to provide financial statement users with more decision-useful information about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date. Entities will apply the standard’s provisions as a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is effective. The standard will be effective for annual reporting periods beginning after December 15, 2019, including interim periods within those reporting periods. Early adoption is permitted. The Company has not yet evaluated the effect this ASU will have on its consolidated financial statements and related disclosures.

ASU No. 2017-08

In March 2017, the FASB issued ASU No. 2017-08, Receivables–Nonrefundable Fees and Other Costs (Subtopic 310-20). Under the ASU, entities must amortize to the earliest call date the premium on certain purchased callable debt securities. The ASU does not require any accounting change for debt securities held at a discount. The guidance calls for a modified retrospective transition approach under which a cumulative-effect adjustment will be made to retained earnings as of the beginning of the first reporting period in which the guidance is adopted. The ASU is effective for public business entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. Early adoption is permitted for all entities, including in an interim period. The Company has not yet evaluated the effect this ASU will have on its consolidated financial statements and related disclosures.

ASU No. 2018-02

In February 2018, the FASB issued ASU No. 2018-02, Income Statement–Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income, which allows a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the Tax Cuts and Jobs Act enacted by the U.S. federal government on December 22, 2017 (the “2017 Tax Act”). Consequently, the amendments eliminate the stranded tax effects resulting from the 2017 Tax Act and will improve the usefulness of information reported to financial statement users. The amendments in this ASU are effective for all entities for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. Early adoption is permitted, including adoption in any interim period, (1) for public business entities for reporting periods for which financial statements have not yet been issued and (2) for all other entities for reporting periods for which financial statements have not yet been made available for issuance. The Company is currently evaluating the effect this ASU will have on its consolidated financial statements and related disclosures.

11

Note 3. Marketable Securities

The Company’s marketable securities consisted of the following:

Management determined that the gross unrealized losses of $123,000 on the Company’s marketable securities as of September 30, 2018 were temporary in nature. Gross unrealized losses on the Company’s marketable securities were $164,000 as of December 31, 2017. The Company currently does not intend to sell these securities prior to maturity and does not consider these investments to be other-than-temporarily impaired as of September 30, 2018.

Note 4. Fair Value Measurements

The authoritative guidance on fair value measurements establishes a framework with respect to measuring assets and liabilities at fair value on a recurring basis and non-recurring basis. Under the framework, fair value is defined as the exit price, or the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants, as of the measurement date. The framework also establishes a three-tier hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available. Observable inputs are inputs market participants would use in valuing the asset or liability and are developed based on market data obtained from sources independent of our Company. Unobservable inputs are inputs that reflect the Company’s assumptions about the factors market participants would use in valuing the asset or liability and are developed based on the best information available in the circumstances. The hierarchy consists of the following three levels:

12

The following table presents information about our financial assets measured at fair value on a recurring basis, based on the three-tier fair value hierarchy:

The Company’s Level 1 assets include money market instruments and are valued based upon observable market prices. Level 2 assets consist of commercial paper and corporate debt securities. Level 2 securities are valued based upon observable inputs that include reported trades, broker/dealer quotes, bids and offers. As of September 30, 2018, the Company had no investments that were measured using unobservable (Level 3) inputs.

There were no transfers between fair value measurement levels during the nine months ended September 30, 2018.

Gross unrealized gains or losses for cash equivalents and marketable securities as of September 30, 2018 were not material. As of September 30, 2018, unrealized losses for securities in an unrealized loss position for more than 12 months were $100,000. During the nine months ended September 30, 2018, the Company did not recognize other-than-temporary impairment losses related to its marketable securities.

Note 5. Fixed Assets

Major classes of fixed assets consisted of the following:

Depreciation expense on fixed assets totaled $547,000 and $438,000 for the three months ended and $1.6 million and $1.3 million for the nine months ended September 30, 2018 and 2017, respectively.

13

Note 6. Other Current Assets

Other current assets consisted of the following:

Reagents are used for DNA sequencing applications in the Company’s DNA sequencing equipment.

Note 7. Reporting Segment and Geographic Information

The Company views its operations and manages its business in one reporting segment. All long-lived assets were located in the United States during the three and nine months ended September 30, 2018 and 2017. Revenue by region was as follows:

Note 8. Commitments and Contingencies

Operating Leases

The Company has commitments under various non-cancelable operating leases with varying terms through August 2023. The Company has options to renew some of these leases for three years after their expiration.

The Company’s headquarters is located in Temple City, California, which is comprised of various corporate offices and a laboratory certified under the Clinical Laboratory Improvement Amendments of 1988 (“CLIA”), accredited by the College of American Pathologists (“CAP”) and licensed by the State of California Department of Public Health. Additional offices are located in El Monte, California and Atlanta, Georgia and are used for certain research and development, customer service, report generation and other administrative functions.

Rent expense was approximately $70,000 and $70,000 for the three months ended and $298,000 and $185,000 for the nine months ended September 30, 2018 and 2017, respectively.

In January 2018, we entered into a lease renewal of our headquarters in Temple City, California, which commenced on February 1, 2018 and expires on January 31, 2021. The total annual rent under the lease is approximately $269,000.

In June 2018, we entered into a lease of office space in El Monte, California, which commenced on August 13, 2018 and expires on August 31, 2023. The total annual rent under the lease is approximately $279,000.

FF Gene Biotech

See Note 14 for a description of the Company’s commitments related to its joint venture, FF Gene Biotech (as defined in Note 14).

14

Purchase Obligations

As of September 30, 2018, the Company had purchase obligations of $1.4 million for reagents, payable within the next twelve months.

Contingencies

From time to time, the Company may be subject to legal proceedings and claims arising in the ordinary course of business. Management does not believe that the outcome of any of these matters will have a material effect on the Company’s consolidated financial position, results of operations or cash flows.

Note 9. Stockholders’ Equity

Components of Comprehensive Income (Loss)

Comprehensive income (loss) consists of two components: net income (loss), and other comprehensive income (loss) (“OCI”). OCI refers to revenue, expenses, gains and losses that, in conformity with U.S. GAAP, are recorded as in the Company’s consolidated statements of stockholders’ equity but are excluded from the Company’s consolidated statements of operations, and as a result, its net income (loss). The Company’s OCI consists of foreign currency translation adjustments from its subsidiaries not using the U.S. dollar as their functional currency and unrealized gains and losses on marketable securities classified as available-for-sale, net of taxes.

The tax effects related to unrealized holding gains (losses) on marketable securities were $15,000 and $10,000 for three and nine months ended September 30, 2018, respectively, and $10,000 and $27,000 for the three and nine months ended September 30, 2017, respectively.

Note 10. Equity-Based Compensation

Equity-based compensation expense for awards granted to employees is measured based on the fair value of the award on the grant date and is recognized in the Company’s consolidated statements of operations over the period during which the employee is required to perform services in exchange for the award (generally, the vesting period of the award). Compensation expense for awards with both a service and performance condition are recognized over the period required to achieve both conditions using the accelerated attribution method. The Company estimates the fair value of stock options using the Black-Scholes option valuation model. The Company measures the fair value of Restricted Stock Units (“RSUs”) and share awards based on the fair value of the underlying shares on the date of grant.

The Company has included equity-based compensation expense as part of cost of revenue and operating expenses in the accompanying condensed consolidated statements of operations as follows:

15

Note 11. Income Taxes

This 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 2017 Tax Act, which was signed into law on December 22, 2017, has resulted in significant changes to the U.S. corporate income tax system. These changes include, among others, a federal statutory rate reduction from 35% to 21%, the elimination or reduction of certain domestic deductions and credits and limitations on the deductibility of interest expenses and executive compensation expenses. The 2017 Tax Act also transitions international taxation from a worldwide system to a modified territorial system and includes base erosion prevention measures on non-U.S. earnings. These changes are effective beginning in 2018.  The Company accounts for changes in tax rates and tax laws in the period of enactment.

On December 22, 2017, SEC Staff Accounting Bulletin No. 118, Income Tax Accounting Implications of the Tax Cuts and Jobs Act ("SAB 118"), was issued to address the application of generally accepted accounting principles in the United States of America in situations when a registrant does not have the necessary information available, prepared, or analyzed (including computations) in reasonable detail to complete the accounting for certain income tax effects of the 2017 Act. In accordance with SAB 118, for 2017, due to the reduction in the corporate income tax rate with the enactment of the 2017 Tax Act, the Company recorded a tax expense of $22,000 related to the revaluation of its net deferred tax assets. The Company has determined that the various other provisions of the 2017 Tax Act are not expected to have a material impact on the Company’s results of operations or financial condition, largely because of the amount of the Company’s net operating loss carryover and the Company has no unrepatriated foreign earnings.

In order to determine the Company’s quarterly provision for income taxes, the Company used an estimated annual effective tax rate for the full fiscal year ending December 31, 2018, which is based on expected annual income and statutory tax rates in the various jurisdictions in which the Company operates, adjusted for discrete items recognized during the period. Certain significant or unusual items are separately recognized in the quarter during which they occur and can cause the effective tax rate to vary from quarter to quarter.

The Company’s effective tax rate was 45% for the three months ended September 30, 2018, compared with 31% for the three months ended September 30, 2017. The effective tax rate was 23% for the nine months ended September 30, 2018, compared with 41% for the nine months ended September 30, 2017. The change in effective tax rate for the three and nine months ended September 30, 2018, was primarily attributable to the reduction of the U.S. federal corporate income tax rate pursuant to the 2017 Tax Act legislation which makes significant changes to the U.S. tax law, including a reduction in the corporate tax rate from 35% to 21% starting in 2018, offset by the net effect of state income taxes and certain expenses or adjustments related to equity-based. The Company has recorded a return to provision benefit during the quarter of approximately $207,000, comprised primarily of U.S. federal and state research credits reflected on the Company’s 2017 tax returns.

The Company will file income tax returns in the U.S. federal jurisdiction, and various states and foreign jurisdictions for the year ending December 31, 2018. As of September 30, 2018, there were no pending tax audits in any jurisdiction.

Note 12. Loss per Share

The following table presents the calculation of basic and diluted loss per share for the three and nine months ended September 30, 2018 and 2017:

16

The following securities have been excluded from the calculation of diluted loss per share because their effect would have been anti-dilutive:

The anti-dilutive shares described above were calculated using the treasury stock method. During the three and nine months ended September 30, 2018 and 2017, the Company had outstanding stock options and RSUs that were excluded from the weighted-average share calculation due to the Company’s net loss position.

Note 13. Related Party

Dr. Yun Yen, who is a member of the Company’s Board of Directors and a stockholder, serves as the President and Chairman of the Board for the Sino-American Cancer Foundation (the “Foundation”) and served as the President for the Taipei Medical University (the “University”), from August 1, 2011 through July 31, 2016 and currently serves as a Chair Professor for the University.    

From time to time, the Company performs research testing services for the Foundation. The Company did not recognize any revenue during the three and nine months ended September 30, 2018 or 2017 as consideration for such services. Additionally, the Company subleases certain of its headquarters facilities to the Foundation. The Company recognized $16,000 and $7,000 in the three months ended and $24,000 and $14,000 for the nine months ended September 30, 2018 and 2017, respectively, as consideration for such sublease. As of September 30, 2018, and December 31, 2017, zero was owed to the Company by the Foundation in connection with these relationships.

From time to time, the Company performs genetic sequencing services for the University. The Company recognized $37,000 and $20,000 as consideration for such services in the three months ended and $53,000 and $55,000 for the nine months ended September 30, 2018 and 2017, respectively. As of September 30, 2018, and December 31, 2017, $39,000 and $40,000, respectively, was owed to the Company by the University in connection with this relationship.

As more fully described in Note 14, in April 2017, the Company, through an affiliated company formed for the purpose of the relationship, entered into a cooperation agreement (the “JV Agreement”) with Xilong Scientific Co., Ltd. (“Xilong Scientific”) and Fuzhou Jinqiang Investment Partnership (LP) (“FJIP”) to form a joint venture under the laws of the People’s Republic of China (“PRC”) called Fujian Fujun Gene Biotech Co., Ltd. (“FF Gene Biotech”). Xilong Scientific is an affiliate of Xi Long USA, Inc., a large stockholder of the Company that, as of September 30, 2018, owned 11% of the outstanding shares of the Company’s common stock, and FJIP is owned by key management of FF Gene Biotech, including Dr. Han Lin Gao, the Chief Scientific Officer and a large stockholder of the Company and the owner of approximately 25% of FJIP.

Fulgent Pharma utilizes space in the facility at which our laboratory and corporate headquarters are located. Since the completion of the Pharma Split-Off, Fulgent Pharma reimburses us for the portion of the rent we pay that is attributable to the space it uses, which amounts are not significant. As of September 30, 2018, and December 31, 2017, $16,000 and $3,000, respectively, was due from Fulgent Pharma as a result of this arrangement, which is recorded in Other receivable in Other current assets in the accompanying condensed consolidated balance sheets.

17

Note 14. Equity Method Investments

In April 2017, the Company, through an affiliated company formed for the purpose of the relationship, entered into the JV Agreement with Xilong Scientific and FJIP to form FF Gene Biotech, a joint venture formed under the laws of the PRC to offer genetic testing services to customers in the PRC. Pursuant to the terms of the JV Agreement, the Company has agreed to contribute to FF Gene Biotech genetic sequencing and other equipment with a total cost of 60,000,000 renminbi (“RMB”) over a three-year period for a 30% ownership interest in FF Gene Biotech, Xilong Scientific has agreed to contribute to FF Gene Biotech 102,000,000 RMB over a three-year period for a 51% ownership interest in the FF Gene Biotech, and FJIP has agreed to contribute to FF Gene Biotech 19,000,000 RMB over a five-year period for a 19% ownership interest in FF Gene Biotech. The Company’s maximum exposure to fund losses of FF Gene Biotech as a result of its minority ownership of this entity is equal to its contribution obligation under the JV Agreement as described above. As of September 30, 2018, 40.3 million RMB (or approximately $5.9 million U.S. dollars) remains to be contributed to the investee under the terms of the JV agreement. To date, the Company has purchased and contributed equipment with an aggregate fair value of $3.0 million pursuant to its contribution commitment under the JV Agreement. The Company accounted for this contribution in accordance with ASC 845, Nonmonetary Transactions, and recorded an investment based on the fair value of the contributed equipment, which is the same as carryover basis.

The Company concluded FF Gene Biotech is a variable interest entity as FF Gene Biotech lacks sufficient capital to operate independently. The Company concluded that it alone does not have the power to direct the most significant activities of FF Gene Biotech and therefore is not the primary beneficiary of the entity. Judgment regarding the level of influence over FF Gene Biotech includes consideration of key factors such as the Company's ownership interest, representation on the board of directors or other management body and participation in policy-making decisions.

The Company accounts for its 30% interest in FF Gene Biotech using the equity method of accounting. The Company recorded its proportionate share of the losses of FF Gene Biotech in the three and nine months ended September 30, 2018 in the accompanying condensed consolidated statements of operations, and recorded its contribution to date, net of its proportionate share in the accumulated losses of FF Gene Biotech, in the accompanying condensed consolidated balance sheet as of September 30, 2018.

The Company entered into a license agreement with FF Gene Biotech, pursuant to which it granted FF Gene Biotech a license to use certain of the Company’s clinical molecular diagnostic gene detection technology and related software and proprietary reference library of genetic information, along with any improvements on this technology that they may develop during the term of the license agreement. Under the license agreement, FF Gene Biotech will pay to the Company, on a quarterly basis, certain royalties based on the revenues of FF Gene Biotech. The Company earned $12,000 and $47,000 for royalties under the license agreement for the three and nine months ended September 30, 2018.

In November 2017, FF Gene Biotech invested and formed a majority-owned subsidiary that focuses on sales and marketing for FF Gene Biotech.

Equity method investments as of September 30, 2018 and December 31, 2017 consisted of the following:

18

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

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 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, 2017 filed with the SEC on March 20, 2018, or the 2017 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, and Section 21E of the Securities Exchange Act of 1934, as amended. 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 II 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 company with a focus on offering comprehensive genetic testing to provide physicians with clinically actionable diagnostic information they can use to improve the quality of patient care. We have developed a proprietary technology platform that allows us to offer a broad and flexible test menu and continually expand and improve our proprietary genetic reference library, while maintaining accessible pricing, high accuracy and competitive turnaround times. We believe our test menu offers more genes for testing than our competitors in today’s market, which enables us to provide expansive options for test customization and clinically actionable results.

Our existing customer base consists primarily of hospitals and medical institutions, which are typically frequent and high-volume users of genetic tests and which often pay us directly for our tests. We believe our relationships with these customers provide a meaningful opportunity for further growth, as we seek to deepen these relationships and drive increased ordering. We also believe our offering could be attractive to other types of customers, including individual physicians and other practitioners, regional medical networks, research institutions and other organizations, and we are building relationships in these new customer markets. Although we have devoted fewer overall resources to sales and marketing efforts than many of our competitors, we made material investments in our sales and marketing team and strategies, the global reach of our business and other aspects of our operations in recent periods, and we believe these investments could help stimulate further demand in the long-term.

19

We offer tests at competitive prices, averaging approximately $987 per billable test delivered in the nine months ended September 30, 2018, and at a lower cost to us than many of our competitors, averaging approximately $499 per billable test delivered in the nine months ended September 30, 2018. Our volume has grown rapidly since our commercial launch, with 5,569 and 15,890 billable tests delivered in the three and nine months ended September 30, 2018, respectively, compared to 4,072 and 12,365 billable tests delivered in the three and nine months ended September 30, 2017, respectively. An aggregate of over 52,793 billable tests were delivered to approximately 970 customers since launching our first commercial genetic tests in 2013 and through September 30, 2018. We have experienced compound quarterly growth of 5% in the number of billable tests delivered in our last eight completed fiscal quarters. We recorded revenue and net loss of $5.6 million and $595,000, respectively, in the three months ended September 30, 2018, compared to revenue and net loss of $4.5 million and $1.1 million, respectively, in the three months ended September 30, 2017. We recorded revenue and net loss of $15.7 million and $3.6 million, respectively, in the nine months ended September 30, 2018, compared to revenue and net loss of $14.4 million and $886,000 in the nine months ended September 30, 2017. We achieved profitability in the first half of 2017, but we have recorded losses in all other periods since our inception.

Following the change to our revenue recognition policy effective as of January 1, 2018, as discussed under “Critical Accounting Policies and Use of Estimates” below, tests delivered to certain customers, namely customers whose tests are paid for by third-party payors, are counted as billable tests at a different time in the delivery and payment process under our new policy as compared to our former policy. Under our former policy, revenue for tests paid for by third-party payors was generally not recognized until we received payment for the tests, due to the inability to satisfy all criteria required to recognize revenue under our former policy before that time; in contrast, under our new policy, some amount of revenue for tests paid for by third-party payors is recognized upon delivery of the test due to our expectation of receiving a cash payment for the tests. As a result, in 2017 under our former policy, these tests were not counted as billable tests delivered until the period in which we received full cash payment for the tests and commencing in 2018 and going forward thereafter under our new policy, these tests are counted as billable tests delivered in the period in which the test is delivered to the customer, which is generally an earlier date and may be in an earlier quarterly or annual period. Accordingly, an increase in the number of billable tests delivered between a period governed by our former policy and a period governed by our new policy, and changes to other operating data metrics that are calculated using the number of billable tests delivered, are attributable in part to this impact of the change to our revenue recognition policy.

In addition, under our new revenue recognition policy, the amount of revenue we recognize upon delivery of one of our tests reflects the consideration to which we expect to be entitled for the test, which we determine in part from the expected collectability of payment based on historical patterns and other relevant factors. For tests paid for by third-party payors, which has represented only a very small portion of our billable tests delivered to date and with which we have little historical experience on which to base collectability determinations, we may recognize in the period in which these tests are delivered only a small portion of the total revenue that we may eventually receive for the tests; however, we will count all of these tests as billable tests delivered in the period (thus impacting our average price per billable test delivered for the period) and we will record all of our costs for these tests in the period, because we expense these costs as they are incurred (thus impacting our cost per billable test delivered for the period). Accordingly, decreases in our average price per billable test delivered or our cost per billable test delivered, as well as our overall collectability rates, between a period governed by our former policy and a period governed by our new policy are attributable in part to the impact of the change to our revenue recognition policy.

As noted above, in all periods to date, we have sold a relatively small number of our tests to customers that pay for tests through third-party payors, and we have received only a small portion of our revenue from these payors. As a result of these factors, we do not estimate the change to our revenue recognition policy, or the resulting changes to the counting or calculation of our operating data metrics as described above, had a material impact on our results of operations in 2017 (governed by our former revenue recognition policy) or 2018 (governed by our new revenue recognition policy), or the comparison of our results or these metrics between these periods; however, if and as tests and revenue from these customers and payors increase, the impact of these changes on our results, including revenue levels and collectability rates, operating data metrics and period-to-period comparisons could become more material.

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 II of this 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 2017 Annual Report.

20

Results of Operations

The table below summarizes our results of operations for the periods indicated. 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 operations data, see “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” of the 2017 Annual Report.