Transforming Genetic Data into
Actionable Patient Care
2017 Annual Report
4978 Santa Anita Avenue, Temple City, California 91780
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
(cid:3) ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2017
OR
(cid:4) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number 001-37894
FULGENT GENETICS, INC.
(Exact name of registrant as specified in its charter)
Delaware
(State or other jurisdiction of
incorporation or organization)
4978 Santa Anita Avenue
Temple City, CA
(Address of principal executive offices)
81-2621304
(I.R.S. Employer
Identification No.)
91780
(Zip Code)
Registrant’s telephone number, including area code: (626) 350-0537
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Common Stock, par value $0.0001 per share
Name of each exchange on which registered
The Nasdaq Stock Market
(Nasdaq Global Market)
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. YES (cid:4) NO (cid:3)
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. YES (cid:4) NO (cid:3)
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 (cid:3) NO (cid:4)
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File
required to be submitted and posted 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 and post such files). YES (cid:3) NO (cid:4)
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405) is not contained herein, and will not be
contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K. (cid:4)
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.
(cid:4)
Large accelerated filer
(cid:4)(cid:2)(Do not check if a smaller reporting company)
Non-accelerated filer
(cid:4)
(cid:3)
(cid:3)
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 Act). YES (cid:4) NO (cid:3)
The aggregate market value of the registrant’s voting and non-voting common equity held by non-affiliates as of June 30, 2017 (computed by
reference to the price at which the registrant’s common stock was last sold on such date, the last business day of the registrant’s most recently
completed second fiscal quarter, as reported by the Nasdaq Global Market) was approximately $33.7 million. For purposes of this calculation, it has
been assumed that all shares of the registrant’s common stock held by directors, executive officers and persons beneficially owning 10% or more of
the registrant’s common stock are held by affiliates; however, the treatment of these persons as affiliates for purposes of this calculation is not, and
shall not be considered, a determination as to whether such persons are affiliates of the registrant for any other purpose.
As of March 1, 2018, there were 17,866,870 outstanding shares of the registrant’s common stock.
Portions of the registrant’s definitive proxy statement for its 2018 annual meeting of stockholders are incorporated by reference in Part III of this
report.
Accelerated filer
Smaller reporting company
Emerging growth company
TABLE OF CONTENTS
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(cid:3) (cid:56)(cid:81)(cid:85)(cid:72)(cid:86)(cid:82)(cid:79)(cid:89)(cid:72)(cid:71)(cid:3)(cid:54)(cid:87)(cid:68)(cid:73)(cid:73)(cid:3)(cid:38)(cid:82)(cid:80)(cid:80)(cid:72)(cid:81)(cid:87)(cid:86)(cid:3)
(cid:3) (cid:51)(cid:85)(cid:82)(cid:83)(cid:72)(cid:85)(cid:87)(cid:76)(cid:72)(cid:86)(cid:3)
(cid:3) (cid:47)(cid:72)(cid:74)(cid:68)(cid:79)(cid:3)(cid:51)(cid:85)(cid:82)(cid:70)(cid:72)(cid:72)(cid:71)(cid:76)(cid:81)(cid:74)(cid:86)(cid:3)
(cid:3) (cid:48)(cid:76)(cid:81)(cid:72)(cid:3)(cid:54)(cid:68)(cid:73)(cid:72)(cid:87)(cid:92)(cid:3)(cid:39)(cid:76)(cid:86)(cid:70)(cid:79)(cid:82)(cid:86)(cid:88)(cid:85)(cid:72)(cid:86)(cid:3)
(cid:3)
(cid:3) (cid:48)(cid:68)(cid:85)(cid:78)(cid:72)(cid:87)(cid:3)(cid:73)(cid:82)(cid:85)(cid:3)(cid:53)(cid:72)(cid:74)(cid:76)(cid:86)(cid:87)(cid:85)(cid:68)(cid:81)(cid:87)(cid:182)(cid:86)(cid:3)(cid:38)(cid:82)(cid:80)(cid:80)(cid:82)(cid:81)(cid:3)(cid:40)(cid:84)(cid:88)(cid:76)(cid:87)(cid:92)(cid:15)(cid:3)(cid:53)(cid:72)(cid:79)(cid:68)(cid:87)(cid:72)(cid:71)(cid:3)(cid:54)(cid:87)(cid:82)(cid:70)(cid:78)(cid:75)(cid:82)(cid:79)(cid:71)(cid:72)(cid:85)(cid:3)(cid:48)(cid:68)(cid:87)(cid:87)(cid:72)(cid:85)(cid:86)(cid:3)(cid:68)(cid:81)(cid:71)(cid:3)(cid:44)(cid:86)(cid:86)(cid:88)(cid:72)(cid:85)(cid:3)(cid:51)(cid:88)(cid:85)(cid:70)(cid:75)(cid:68)(cid:86)(cid:72)(cid:86)(cid:3)(cid:82)(cid:73)(cid:3)(cid:40)(cid:84)(cid:88)(cid:76)(cid:87)(cid:92)(cid:3)(cid:54)(cid:72)(cid:70)(cid:88)(cid:85)(cid:76)(cid:87)(cid:76)(cid:72)(cid:86)
(cid:3) (cid:54)(cid:72)(cid:79)(cid:72)(cid:70)(cid:87)(cid:72)(cid:71)(cid:3)(cid:41)(cid:76)(cid:81)(cid:68)(cid:81)(cid:70)(cid:76)(cid:68)(cid:79)(cid:3)(cid:39)(cid:68)(cid:87)(cid:68)(cid:3)
(cid:3) (cid:48)(cid:68)(cid:81)(cid:68)(cid:74)(cid:72)(cid:80)(cid:72)(cid:81)(cid:87)(cid:182)(cid:86)(cid:3)(cid:39)(cid:76)(cid:86)(cid:70)(cid:88)(cid:86)(cid:86)(cid:76)(cid:82)(cid:81)(cid:3)(cid:68)(cid:81)(cid:71)(cid:3)(cid:36)(cid:81)(cid:68)(cid:79)(cid:92)(cid:86)(cid:76)(cid:86)(cid:3)(cid:82)(cid:73)(cid:3)(cid:41)(cid:76)(cid:81)(cid:68)(cid:81)(cid:70)(cid:76)(cid:68)(cid:79)(cid:3)(cid:38)(cid:82)(cid:81)(cid:71)(cid:76)(cid:87)(cid:76)(cid:82)(cid:81)(cid:3)(cid:68)(cid:81)(cid:71)(cid:3)(cid:53)(cid:72)(cid:86)(cid:88)(cid:79)(cid:87)(cid:86)(cid:3)(cid:82)(cid:73)(cid:3)(cid:50)(cid:83)(cid:72)(cid:85)(cid:68)(cid:87)(cid:76)(cid:82)(cid:81)(cid:86)(cid:3)
(cid:3) (cid:52)(cid:88)(cid:68)(cid:81)(cid:87)(cid:76)(cid:87)(cid:68)(cid:87)(cid:76)(cid:89)(cid:72)(cid:3)(cid:68)(cid:81)(cid:71)(cid:3)(cid:52)(cid:88)(cid:68)(cid:79)(cid:76)(cid:87)(cid:68)(cid:87)(cid:76)(cid:89)(cid:72)(cid:3)(cid:39)(cid:76)(cid:86)(cid:70)(cid:79)(cid:82)(cid:86)(cid:88)(cid:85)(cid:72)(cid:86)(cid:3)(cid:36)(cid:69)(cid:82)(cid:88)(cid:87)(cid:3)(cid:48)(cid:68)(cid:85)(cid:78)(cid:72)(cid:87)(cid:3)(cid:53)(cid:76)(cid:86)(cid:78)(cid:3)
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(cid:3) (cid:38)(cid:75)(cid:68)(cid:81)(cid:74)(cid:72)(cid:86)(cid:3)(cid:76)(cid:81)(cid:3)(cid:68)(cid:81)(cid:71)(cid:3)(cid:39)(cid:76)(cid:86)(cid:68)(cid:74)(cid:85)(cid:72)(cid:72)(cid:80)(cid:72)(cid:81)(cid:87)(cid:86)(cid:3)(cid:58)(cid:76)(cid:87)(cid:75)(cid:3)(cid:36)(cid:70)(cid:70)(cid:82)(cid:88)(cid:81)(cid:87)(cid:68)(cid:81)(cid:87)(cid:86)(cid:3)(cid:82)(cid:81)(cid:3)(cid:36)(cid:70)(cid:70)(cid:82)(cid:88)(cid:81)(cid:87)(cid:76)(cid:81)(cid:74)(cid:3)(cid:68)(cid:81)(cid:71)(cid:3)(cid:41)(cid:76)(cid:81)(cid:68)(cid:81)(cid:70)(cid:76)(cid:68)(cid:79)(cid:3)(cid:39)(cid:76)(cid:86)(cid:70)(cid:79)(cid:82)(cid:86)(cid:88)(cid:85)(cid:72)(cid:3)
(cid:3) (cid:38)(cid:82)(cid:81)(cid:87)(cid:85)(cid:82)(cid:79)(cid:86)(cid:3)(cid:68)(cid:81)(cid:71)(cid:3)(cid:51)(cid:85)(cid:82)(cid:70)(cid:72)(cid:71)(cid:88)(cid:85)(cid:72)(cid:86)(cid:3)
(cid:3) (cid:50)(cid:87)(cid:75)(cid:72)(cid:85)(cid:3)(cid:44)(cid:81)(cid:73)(cid:82)(cid:85)(cid:80)(cid:68)(cid:87)(cid:76)(cid:82)(cid:81)(cid:3)
(cid:38)(cid:68)(cid:88)(cid:87)(cid:76)(cid:82)(cid:81)(cid:68)(cid:85)(cid:92)(cid:3)(cid:49)(cid:82)(cid:87)(cid:72)(cid:3)(cid:53)(cid:72)(cid:74)(cid:68)(cid:85)(cid:71)(cid:76)(cid:81)(cid:74)(cid:3)(cid:41)(cid:82)(cid:85)(cid:90)(cid:68)(cid:85)(cid:71)(cid:16)(cid:47)(cid:82)(cid:82)(cid:78)(cid:76)(cid:81)(cid:74)(cid:3)(cid:54)(cid:87)(cid:68)(cid:87)(cid:72)(cid:80)(cid:72)(cid:81)(cid:87)(cid:86)(cid:3)
PART I
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(cid:44)(cid:87)(cid:72)(cid:80)(cid:3)(cid:23)(cid:17)(cid:3)
PART II
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(cid:44)(cid:87)(cid:72)(cid:80)(cid:3)(cid:28)(cid:37)(cid:17)(cid:3)
PART III (cid:3)
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PART IV
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CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
This report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended,
or Securities Act, and Section 21E of the Securities Exchange Act of 1934, as amended, or Exchange Act. Forward-looking statements
are statements other than historical facts and relate to future events or circumstances or our future performance, and they are based on
our current assumptions, expectations and beliefs concerning future developments and their potential effect on our business. The
words “believe,” “may,” “will,” “potentially,” “estimate,” “continue,” “anticipate,” “intend,” “could,” “would,” “project,” “plan,”
“expect” and similar expressions that convey uncertainty of future events or outcomes identify forward-looking statements.
The forward-looking statements in this report include statements about, among other things:
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developments, projections and trends relating to us, our competitors and our industry;
our strategic plans for our business;
our operating performance, including our ability to achieve equal or higher levels of revenue, stabilize the historical
fluctuations in our performance and achieve or grow profitability;
the rate and degree of market acceptance and adoption of our tests and genetic testing generally and other anticipated
trends in our industry;
our ability to remain competitive, particularly if the genetic testing market continues to expand and competition becomes
more acute;
our ability to continue to expand the number of genes covered by our tests and introduce other improvements to our tests;
our continued ability to offer affordable pricing for our tests, in spite of recent price degradation in our industry, and our
ability to maintain the low internal costs of our business model and record acceptable margins on our sales;
our ability to strengthen our existing base of hospital and medical institution customers by maintaining or increasing
demand from these customers;
our ability to grow and diversify our customer base, including our plans to target new institutional and individual
customer groups;
the level of success of our efforts to increase our global presence, including strengthening relationships with existing and
new international customers and establishing other types of arrangements, including our joint venture in the People’s
Republic of China, or PRC, or other international joint venture or distributor relationships we may pursue;
the impact on our business of our recent investments in building and restructuring our sales and marketing strategies and
teams, and our plans for future sales and marketing efforts;
advancements in technology by us and our competitors;
our ability to effectively manage any growth we may experience, including expanding our infrastructure, developing
increased efficiencies in our operations and hiring additional skilled personnel in order to support any such growth;
developments with respect to U.S. and foreign regulations applicable to our business, and our ability to comply with these
regulations;
our ability to obtain and maintain coverage and adequate reimbursement for our tests;
the state of the U.S. and foreign healthcare markets, including the role of governments in the healthcare industry generally
and pressures or incentives to reduce healthcare costs while expanding individual benefits, as well as the impact of general
uncertainty in the U.S. healthcare regulatory environment following the results of the 2016 U.S. presidential election;
our ability to attract, retain and motivate key scientific and management personnel;
our expectations regarding our ability to obtain and maintain protection of our trade secrets and other intellectual property
rights and not infringe the rights of others;
our expectations regarding our future expense levels and our ability to appropriately forecast and plan our expenses;
our expectations regarding our future capital requirements and our ability to obtain additional capital if and when needed;
and
the impact of the above factors and other future events on the market price of our common stock.
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These forward-looking statements are subject to a number of risks and uncertainties, including, among others, those described
under Item1A. “Risk Factors” and elsewhere in 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 report 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 report should be read with the understanding that our actual future results, levels of
activity, performance and achievements or other future events may be materially different than what we currently expect.
The forward-looking statements in this report speak only as of the date of this document, 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.
We qualify all of our forward-looking statements by this cautionary note.
* * * * * * *
This report reflects the completion of the Reorganization, as defined and described below, on September 30, 2016. Pursuant to
the Reorganization, Fulgent Therapeutics LLC became a wholly owned subsidiary of the registrant, Fulgent Genetics, Inc. As used in
this report, unless the context otherwise requires, (i) the term “Fulgent LLC” refers to Fulgent Therapeutics LLC, (ii) the term
“Fulgent Inc.” refers to Fulgent Genetics, Inc. and (iii) the terms “Fulgent,” the “company,” “we,” “us” and “our” refer, for
periods prior to completion of the Reorganization, to Fulgent LLC and, for periods after completion of the Reorganization, to Fulgent
Inc. and its consolidated subsidiaries after giving effect to the Reorganization. Following the Reorganization, Fulgent Inc. is a holding
company with no material assets other than 100% of the equity interests in its subsidiaries, including Fulgent LLC, and Fulgent LLC
is considered Fulgent Inc.’s predecessor for accounting purposes and Fulgent LLC’s financial statements for all periods prior to
completion of the Reorganization constitute Fulgent Inc.’s historical financial statements. In this report, Fulgent LLC’s equity
interests are referred to as “units” and Fulgent LLC’s equity holders are referred to as “members.”
We own registered or unregistered trademark rights to Fulgent® and our company name and logo. Any other service marks,
trademarks and trade names appearing in this report are the property of their respective owners. We do not use the ® or ™ symbol in
each instance in which one of our trademarks appears in this report, but this should not be construed as any indication that we will
not assert our rights thereto to the fullest extent under applicable law.
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Item 1. Business.
PART I
Overview
We are a growing technology company with an initial 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. Combining next generation
sequencing, or NGS, with our technology platform, we perform full-gene sequencing with deletion/duplication analysis in single-gene
tests; pre-established, multi-gene, disease-specific panels; and customized panels that can be tailored to meet specific customer needs.
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. After launching our first commercial genetic tests in 2013, we have
expanded our test menu to include approximately 18,000 single-gene tests and more than 850 panels that collectively test for
approximately 7,700 genetic conditions, including various cancers, cardiovascular diseases, neurological disorders and pediatric
conditions.
Genetic testing offers the possibility of early identification of a disease or a genetic predisposition to a disease and enhanced
disease treatment and prognosis. As a result, we believe widespread genetic testing could enable significant health improvements and
healthcare cost reductions. Due to these and other potential benefits, genetic testing has experienced significant growth in recent years.
If this growth trend continues, we believe genetic testing could become a more accepted part of standard medical care and the
knowledge of a person’s unique genetic makeup could begin to play a more important role in the practice of medicine. We believe this
growth has been tempered, however, because many tests are prohibitively expensive, are produced through inefficient processes and
often do not result in clinically actionable data. Through our technology platform, we have developed an offering that we believe
addresses these industry challenges and provides a sustainable competitive advantage, both in today’s genetic testing market and if we
seek to implement new diagnostic tools in the future.
Our technology platform, which integrates sophisticated data comparison and suppression algorithms, adaptive learning
software, advanced genetic diagnostics tools and integrated laboratory processes, allows us to offer a test menu with expansive genetic
coverage. We believe the comprehensive data output and high detection rates of our tests, both made possible by this expansive
genetic coverage, provide physicians with information they can readily incorporate into treatment decisions for their patients, which
we refer to as clinical actionability. In addition, our technology platform facilitates our ability to perform customized genetic tests
using our expansive library of genes, and we believe this flexibility increases the utility of the genetic data we produce. Further, our
technology platform provides us with operating efficiencies that help lower our internal costs, which allows us to offer our tests at
accessible price points. As a result, our efforts to build and continually enhance our technology platform allow us to deliver
comprehensive, adaptable, clinically actionable and affordable genetic analysis while maintaining a low cost per billable test, enabling
us to efficiently meet the needs of our growing base of customers. These features of our offering have resulted in rapid volume growth
since our commercial launch, with 16,578 billable tests delivered in 2017, 12,507 billable tests delivered in 2016, and an aggregate of
over 36,903 billable tests delivered to approximately 750 customers from inception through December 31, 2017.
Genetic Testing Industry
Genetic testing identifies mutations in genes or chromosomal abnormalities. The results of genetic tests can be used to confirm
or rule out a diagnosis of a suspected genetic condition, to predict a person’s likelihood of developing a genetic condition, and to
improve the selection and implementation of drug treatment programs targeting specific diseases.
The availability and accessibility of genetic testing has grown significantly in recent years, due in large part to improvements in
testing technologies, particularly next generation sequencing. NGS technology, a relatively new genetic testing technique that enables
millions of DNA fragments to be sequenced in parallel, has dramatically lowered the cost and improved the quality of genetic testing.
As technology advances continue to drive costs down and improve testing quality, the availability and accessibility of genetic tests is
expected to continue to accelerate. This expansion of testing availability and accessibility, as well as a growing and aging population,
increasing overall incidence of disease, innovations in genomic medicine that enable the selection and implementation of drug
treatment programs based on genetic information, or pharmacogenomics, indications of possible relaxations and increased flexibility
in the regulatory landscape and other factors, all contribute to expectations of continued growth in the global market for genetic
testing.
While adoption of genetic testing has increased in recent years, we believe widespread utilization has been
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tempered because of certain challenges and barriers to adoption that exist in today’s market. These industry challenges include: the
continued high prices of some genetic tests, in spite of declining prices in recent periods; largely inadequate reimbursement options,
due to third-party payors’ restrictions on reimbursement to only a narrow subset of genetic tests and certain patients who meet specific
criteria; the limited scope of some genetic analysis, which may test only a small portion of the genes in the human genome and thus
may fail to diagnose or identify a predisposition to a condition that is linked to mutations in untested genes; inefficient testing
processes, which often involve sequential retesting from multiple different laboratories in order to obtain comprehensive results; and
the cumbersome and time-consuming nature of test results interpretation, which requires significant expertise and time to review
proprietary and publicly available information about individual genetic disorders, genes and variants and understand the implications
of genetic mutations that are identified in a genetic test. In addition, the increased competition in our industry in recent years, due in
large part to the growth of genetic testing, as well as the cost-saving initiatives on the part of government entities and other third-party
payors, have resulted in downward pressure on the price for genetic analysis and interpretation, which have posed challenges to
genetic testing laboratories as they seek to maintain both competitive pricing and acceptable revenue levels and margins on test sales.
We have approached these competitive and operational industry challenges by building and continually advancing a multi-faceted
technology platform that we believe will facilitate our ability to address many of these challenges.
Our technology-driven approach to the challenges facing our industry has resulted in our development of an integrated
technology platform featuring the following proprietary tools and processes:
Our Technology Platform
Proprietary Gene Probes
Many genetic testing providers use gene probes in the sequencing process to extract and target specific genomic regions. A gene
probe is a single strand of DNA or RNA that has a base sequence complementary to the base sequence of a targeted gene and that
binds to this complementary base sequence when introduced during the sequencing process, thereby identifying the presence and
location of the targeted gene. Many companies obtain these gene probes from third-party suppliers. We have developed technologies
to design and formulate our own proprietary gene probes, which, when combined with our proprietary genetic reference library and
publicly available genetic databases, support our ability to sequence DNA regions we believe laboratories using commercial probes
cannot sequence and improve the detection rate of our test data. In turn, we believe this enables us to produce clinically actionable
results physicians can use to improve care for their patients. In addition, our proprietary gene probes are specifically engineered to
generate genetic data optimized for our software, which enables us to rapidly incorporate new genes into our test menu, develop new
panels of disease-specific tests and customize tests for our customers. Moreover, once we develop a probe for a new gene, we can
efficiently reproduce, validate and assure the quality of that probe under applicable guidelines and standards, which allows us to
continuously and rapidly expand our library of genetic content while increasing the breadth of our test menu. Additionally, we believe
our probes more effectively enrich the targeted genes to improve the quality of the sequenced data we produce.
Advanced Database Algorithms
After DNA is sequenced using all appropriate equipment and tools, the fully sequenced genes are analyzed in a process known
as curation, in which every DNA sequence is aligned with a known reference sequence and differences between the DNA sequence
and the reference sequence are identified. These differences, which represent potential genomic alterations, are then compared to
publicly available genetic databases and proprietary genetic libraries to identify pathogenic alterations associated with disease or
disease risk. We have developed proprietary data comparison and data suppression algorithms to improve and simplify this curation
process by highlighting identified pathogenic mutations. Our advanced data comparison algorithms measure DNA sequences from
patient specimens against genetic data available from the broader scientific community and our own proprietary reference library of
genetic information, which enables us to rapidly and effectively detect pathogenic mutations. Our advanced data suppression
algorithms reduce irrelevant noise in the genetic data we analyze, which improves the efficiency and speed of our data analysis and
reduces the reliance upon manual review and comparison in the curation process.
Adaptive Learning Software
We have developed software that automatically incorporates the data from each completed test into our expansive genetic
reference library, enabling it to continuously evolve with each set of genes we analyze. This adaptive learning software supports the
continuous improvement of our proprietary gene probes and leverages the capabilities of these gene probes to improve the speed and
effectiveness of curation and reporting. Our adaptive learning software also communicates with our integrated laboratory systems,
which leads to increasing automation processes and other operating efficiencies.
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Proprietary Laboratory Information Management Systems
We have developed proprietary laboratory information management systems that are highly integrated with our laboratory
processes and adaptive learning software. These systems provide the backbone by which we efficiently manage workflow, monitor
quality and ensure the fidelity of information generation and analytics for reporting to our customers. The result is a highly connected
platform that allows us to process tests and information in an efficient manner. Our talented team of software engineers continuously
iterates with our laboratory and customer-facing personnel to improve the efficiencies of these systems.
The benefits provided by our technology platform include:
Our Solution
Low Internal Cost per Billable Test
We have developed various proprietary technologies that improve our laboratory efficiency and reduce the costs we incur to
perform our tests. This technology platform enables us to perform each test and deliver its results at a lower internal cost than many of
our competitors, averaging approximately $516 per billable test delivered in 2017. This low cost per billable test allows us to maintain
affordable pricing for our customers, averaging approximately $1,130 per billable test delivered in 2017, which we believe encourages
repeat ordering from existing customers and attracts new customers. We believe our low cost per billable test could also facilitate the
process for establishing coverage and reimbursement from third-party payors at a level adequate for us to achieve profitability with
this payor group.
Broad and Flexible Test Menu
We currently offer single-gene tests on approximately 18,000 genes, which, to our knowledge, is thousands more than most of
our competitors’ portfolios. Based on the results of a retrospective study of individuals with a personal or family history of cancer,
described below, 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 provide a flexible and customizable test menu for our customers, which can reduce the need for sequential
retesting. We offer single-gene tests on all of the genes in our portfolio, as well as deletion/duplication analysis and site-specific tests.
If customers desire a broader test, we offer more than 850 pre-established, multi-gene panels that focus on specified genetic
conditions. These panels can be adjusted up or down to include more or fewer genes, or customers can design their own panels to their
exact specifications. We also offer clinical and full gene exome testing options. We offer our tests at different price points and
turnaround times depending on the size and complexity of the test, which increases optionality for our customers. We believe the
flexibility of our offering improves the efficiency and utility of the data output by our tests and decreases overall customer costs. We
also offer our customers access to our highly qualified genetic counselors and laboratory experts to assist in interpreting the data we
provide, which further increases the utility of our test results for ordering physicians.
The benefit of including multiple genes on a single panel was discussed in a study published in 2016 by the University of
Southern California, or USC, Norris Comprehensive Cancer Center in Cancer Genetics. The study retrospectively evaluated 475
individuals with a personal or family history of cancer who had undergone a clinically indicated multi-gene panel test of six to 110
genes from one of the following six commercial laboratories: Myriad Genetics (n=354), Ambry Genetics (n=100), Fulgent (n=17),
University of Washington Genetics Laboratory (n=2), City of Hope Molecular Diagnostics (n=1) and Baylor Genetics Laboratory
(n=1). The study concluded that multi-gene panel testing increases the yield of mutations detected and adds to the capability of
providing individualized cancer risk assessment. More specifically, the study reported that deleterious mutations were identified in
15.6% of patients tested on a variety of multi-gene panels, which included 8.6% of patients who would not have a mutation detected if
a targeted gene-by-gene-approach had been used. The study also presented evidence that, as the number of genes on a panel increased,
a higher proportion of panels identified a mutation. The Fulgent panels evaluated in the study contained over 100 genes compared to
less than 30 genes in the next largest panel. Additionally, approximately 35% of our panels identified a genetic mutation, and in
comparison, the test with the next highest percentage of detected mutations identified mutations in approximately 17% of its tests.
Expansive and Growing Genetic Library
Using our proprietary gene probes and testing processes, we are able to capture large amounts of genetic information from each
test we perform—oftentimes more than is ordered for the test—without an incremental increase in our costs. Through this data
collection process, we have developed a proprietary reference library of expansive genetic information. This reference library is
automatically curated by our adaptive learning software and supplemented with manual curation by our team of highly trained
professionals, which adds to and improves upon the information available in public genetic databases. As a result, our integrated
technology systems allow us to leverage publicly available information from the broader scientific community with our internally
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developed reference library to develop what we believe is a more reliable catalog of genetic information and to accelerate, standardize
and improve our curation and reporting process.
Our Genetic Tests
Our offering consists of a wide variety of tests and test types, and our customers have a high degree of choice when selecting a
test from our menu. A customer may select a single-gene test of any of the genes in our portfolio or a customer may select one of
our pre-established panel tests, which are designed to test particular genes and mutations within these genes that relate to a wide
range of specified conditions and diseases. For example, our Focus and Comprehensive oncology panels test 29 genes and 123 genes,
respectively, that relate to various cancers and our Beacon carrier screening panels test up to 336 genes covering over 320 inherited
conditions. We can perform full-gene sequencing with deletion/duplication analysis in all of these tests. In addition, we continually
seek to expand our test menu with new genes and panel tests, including our plans to expand our oncology test options by launching
somatic cancer panels and leverage our expertise in pediatrics by launching newborn genetic panel tests, both in the first half of 2018.
We also offer certain research service tests, which we refer to as “sequencing as a service” and which are primarily ordered by
our research institution and other similar institutional customers. In addition, we offer whole exome and clinical exome panel tests,
which test all genes included in our portfolio and up to 4,809 genes located in the exome, respectively, and produce results that we
combine with the individual’s unique clinical presentation and family history to enhance the clinical relevance of the results. Our
whole exome and clinical exome tests also include the option for Trio testing, which involves sequencing the genes of a patient’s
parents and is thought to enhance the utility of the test results. In addition, we offer whole genome testing, which determines and tests
the complete DNA sequence of a genome at a single time. We also provide known mutation testing, which can be used to target
familial specific or other desired mutations, as well as repeat expansion testing, which tests for a particular type of mutation known as
“copy choice” DNA replication. Importantly, all of our pre-established panels are customizable, offering customers the ability to add
or remove genes at their election.
Our Customers
Since inception, we have sold our tests to approximately 750 total 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. In 2017, two
of our customers contributed 12% and 10% of our total revenue, respectively, and in 2016, two of our customers each contributed 15%
of our total revenue.
We have primarily sold our tests to hospitals and medical institutions. We have approached the genetic testing market with a
focus on these customers in part because they are frequent and high-volume users of genetic tests. We believe this customer base
provides a meaningful opportunity for further growth by acquiring additional hospital and medical institution customers and by
deepening our relationships with existing customers to drive increased ordering. Additionally, collection of billings from these
institutional customers is generally more attainable than from other types of customers in today’s reimbursement environment, as
approximately 86% of our test billings that were generated and due in 2017 were paid during that period. In addition, we believe
hospitals and medical institutions are early adopters of NGS technology and could influence broader clinical acceptance of genetic
testing.
We are also seeking to expand our customer base to include new customer groups. To this end, we have contracted directly with
a regional physician services organization and a national health insurance company to become an in-network provider and enrolled as
a supplier with the Medicare program and some state Medicaid programs, in an effort to obtain coverage and reimbursement for our
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tests to make them accessible to more individual physicians. In addition, we are building relationships with research institutions and
other similar institutional customers, a national clinical laboratory, regional medical networks and various other organizations to
facilitate access to physicians, practitioners and other new customer groups, including certain U.S. military and other government
agencies. 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, these relationships do not obligate any
party to order our tests.
Much of our business to date has been from non-U.S. customers, with approximately $9.7 million and $10.0 million of our
revenue coming from non-U.S. sources in 2017 and 2016, respectively. These customers are located in a variety of geographic
markets, including Canada, where we have historically focused much of our international efforts, the PRC, where we started selling
tests directly to customers in the third quarter of 2016, and other regions, such as Australia, Europe and the Middle East. In addition,
we have worked with one of our large stockholders to establish a joint venture to offer genetic testing to customers in the PRC, which
was formed in April 2017 and which we refer to as FF Gene Biotech. We believe FF Gene Biotech could expand our long-term
opportunities to address the genetic testing market in Asia.
Our customers can generally be divided into three categories based on the party from which we receive payment for our tests:
hospitals, medical and other institutions; patients and third-party payors. Hospitals, medical and other institutions are responsible for
paying for the vast majority of the tests we have delivered since our inception. We bill these organizations for our tests and they are
responsible for paying us directly and either billing their patients separately or obtaining reimbursement from third-party payors in
connection with a patient’s diagnosis related group, or DRG. 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. Third-party payors, which consist of
private health insurers and the Centers for Medicare and Medicaid Services, or CMS, have been responsible for paying for a small
number of the tests we have delivered to date; however, as we seek to expand our customer base to include more individual
practitioners, we expect this category of payors would be responsible for many of the tests we deliver to these customers.
Third-party payors require us to identify the test for which we are seeking reimbursement using a Current Procedural
Terminology, or CPT, code set maintained by the American Medical Association, or AMA. Where we offer a multi-gene panel and
there is no CPT code for the full panel but the panel includes a gene for which the AMA has an established CPT code, we identify the
test provided under that CPT code when billing a third-party payor for that test. In cases where there is not a specific CPT code, our
test may be billed under a miscellaneous code for an unlisted molecular pathology procedure. Because this miscellaneous code does
not describe a specific service, the insurance claim must be examined to determine what service was provided, whether the service
was appropriate and medically necessary, and whether payment should be rendered, which may require a letter of medical necessity
from the ordering physician. Given the changing CPT coding environment and our development of relationships with third-party
payors, we expect that our practices regarding billing these payors will evolve in the future.
Sales and Marketing
Our sales force currently consists of a lean internal team of sales and marketing experts with deep experience in our industry, as
well as a network of independent sales representatives who are knowledgeable about our tests. Historically, we have significantly
relied on organic growth and word-of-mouth among our customers to generate interest in our tests, which we believe demonstrates the
value of our offering. In recent periods, we have invested significant time and capital to strengthen our sales and marketing efforts,
including increasing the size and restructuring the organization of our internal team, re-focusing our initiatives and strategies, and
increasing the overall scope of our marketing activities.
Our sales and marketing strategy is designed to expand our brand awareness, grow our customer base and further penetrate our
relationships with existing customers. We aim to achieve these objectives by providing education about the benefits and full scale of
our offering, both to the medical community in general and to our targeted customer and geographic markets. We plan to expand our
presence and test volume in international markets through our own direct sales team, which includes one sales person dedicated to
international markets, a number of independent contractor sales representatives, and, if opportunities arise, by engaging distributors or
establishing other types of arrangements, such as joint ventures or other relationships, to manage or assist with sales, logistics,
education and customer support in certain territories.
Our marketing activities also include targeted initiatives, including working with medical professional societies to promote
awareness of the benefits of our tests and genetic testing in general, presenting at medical, scientific or industry exhibitions and
conferences and pursuing or supporting scientific studies of our tests and publication of results in medical or scientific journals, such
as the USC Norris Comprehensive Cancer Center study published in 2016 and discussed above and another study being conducted by
the same entity and expected to publish results in 2018 or 2019. In addition, we conduct email advertising campaigns to existing and
potential future customers when we want to send a specific message about our company and our brand, including, for instance, when
we launch new tests or new test options and when we add new genes to our test menu.
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Our sales and marketing strategy is also focused on offering differentiated and highly available customer service resources,
which we believe is an important factor in maintaining and deepening our customer relationships. Genetic tests are highly complex by
nature and we recognize that our customers may want to discuss with us available testing options, specimen collection requirements,
expected turnaround times, the cost of our tests and the clinical reports we produce. As a result, we offer comprehensive customer
service designed to enable efficient ordering and increase the accessibility of our clinical reports, including customer access to our
licensed and qualified laboratory directors who review and approve each report we produce.
Our Suppliers
We rely on a limited number of suppliers for certain laboratory substances used in the chemical reactions incorporated into our
processes, which we refer to as reagents, as well as for the sequencers and various other equipment and materials we use in our
laboratory operations. In particular, we rely on Illumina, Inc. as the sole supplier of the next generation sequencers and associated
reagents we use to perform our genetic tests and as the sole provider of maintenance and repair services for these sequencers. Our
laboratory operations would be interrupted if we encounter delays or difficulties securing these reagents, sequencers, other equipment
or materials or maintenance and repair services, which could occur for a variety of reasons, including if we need a replacement or
temporary substitute for any of our limited or sole suppliers and are not able to locate and make arrangements with an acceptable
replacement or temporary substitute.
Competition
Our competitors include dozens of companies focused on molecular genetic testing services, including specialty and reference
laboratories that offer traditional single-gene and multi-gene tests. Principal competitors include companies such as Ambry Genetics,
Inc.; Counsyl; Foundation Medicine, Inc.; GeneDx, a subsidiary of OPKO Health, Inc.; Invitae Corporation; Myriad Genetics, Inc.;
and Pathway Genomics Corporation, as well as other commercial and academic laboratories. In addition, other established and
emerging healthcare, information technology and service companies may develop and sell competitive tests, which may include
informatics, analysis, integrated genetic tools and services for health and wellness.
Additionally, participants in closely related markets, such as prenatal testing and clinical trial or companion diagnostic testing,
could converge on offerings that are competitive with the type of tests we perform. Instances where potential competitors are aligned
with key suppliers or are themselves suppliers could provide these potential competitors with significant advantages. Further,
hospitals, research institutions and eventually individual physicians and other practitioners may also seek to perform at their own
facilities the type of genetic testing we would otherwise perform for them. In this regard, continued development of, and associated
decreases in the cost of, equipment, reagents and other materials and databases and genetic data interpretation services may enable
broader direct participation in genetic testing and analysis and drive down the use of third-party testing companies such as ours.
Additionally, cost decreases and increased direct participation, as well as cost-saving initiatives on the part of government entities and
other third-party payors, could intensify the downward pressure on the price for genetic analysis and interpretation generally.
Moreover, the biotechnology and genetic testing fields continue to undergo significant consolidation, permitting larger clinical
laboratory service providers to increase cost efficiencies and service levels, resulting in more intense competition.
We believe the principal competitive factors in our market are:
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breadth and depth of genetic content;
flexibility of test customization;
price of tests;
quality of results, including their reliability, accuracy and clinical actionability;
accessibility of results;
coverage and reimbursement arrangements with third-party payors;
turnaround time;
customer service;
convenience of testing; and
brand recognition.
We believe we compare favorably with our competitors on the basis of these factors. However, many of our existing and
potential future competitors have longer operating histories, larger customer bases, more expansive brand recognition and deeper
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market penetration, substantially greater financial, technological and research and development resources and selling and marketing
capabilities and considerably more experience dealing with third-party payors. As a result, they may be able to respond more quickly
to changes in customer requirements or preferences, develop faster and better advancements for their technologies and tests, create and
implement more successful strategies for the promotion and sale of their tests, obtain more favorable results from third-party payors
regarding coverage and reimbursement for their offerings, adopt more aggressive pricing policies for their tests, secure supplies from
vendors on more favorable terms or devote substantially more resources to infrastructure and systems development. In addition,
competitors may be acquired by, receive investments from or enter into other commercial relationships with larger, well-established
and well-financed companies as use of NGS for clinical diagnosis and preventative care increases. Further, companies or governments
that effectively control access to genetic testing through umbrella contracts or regional preferences could promote our competitors or
prevent us from performing certain tests in certain territories. We may not be able to compete effectively against these organizations.
Research and Development
We have assembled a highly-qualified team with expertise in a number of fields important to our business, such as
bioinformatics, genetics, software engineering, laboratory management and sales and marketing, and as of March 1, 2018,
approximately half of our employees have a PhD or other advanced degree. We rely on this team to conduct all of our research and
development activities, including efforts to develop and curate our expansive library of genetic information and further expand our
technology platform. Our research and development expenses were $4.2 million and $3.6 million in 2017 and 2016, respectively.
Intellectual Property
We rely on a combination of registered and unregistered intellectual property rights, including trade secrets, trademarks and
customary contractual protections, to protect our core technology and intellectual property.
Trade Secrets
We rely on trade secrets, including unpatented know-how, technology and other proprietary information, to maintain and
develop the competitive position afforded by many of our laboratory, analytic and business practices. For example, significant
elements of our genetic tests and our testing procedures, including aspects of specimen preparation, our bioinformatics algorithms and
related processes and our adaptive learning software, are based on unpatented trade secrets and know-how. We try to protect trade
secrets and know-how by taking reasonable steps to keep them confidential, including entering into nondisclosure and confidentiality
agreements with parties who have access to them, such as our employees and certain third parties, and entering into invention
assignment agreements with our employees and consultants that obligate them to assign to us any inventions developed in the course
of their work for us.
Trademarks
We own registered and unregistered trademark and service mark rights under applicable U.S. and foreign law to distinguish
and/or protect our brand, including our company name and logo.
CLIA
Regulation
As a clinical laboratory, we are required to hold certain federal licenses, certifications and permits to conduct our business. In
1988, Congress passed the Clinical Laboratory Improvement Amendments of 1988, or CLIA, which establishes quality standards for
all laboratory testing designed to ensure the accuracy, reliability and timeliness of patient test results. Our laboratory is CLIA-certified
and accredited by the College of American Pathologists, or CAP, a CLIA-approved accrediting organization.
Under CLIA, a laboratory is any facility that performs laboratory testing on specimens derived from humans for the purpose of
providing information for the diagnosis, prevention or treatment of disease or the impairment or assessment of health. CLIA requires
that we hold a certificate applicable to the type of laboratory examinations we perform and that we comply with various standards
with respect to personnel qualifications, facility administration, proficiency testing, quality control and assurance and inspections.
Laboratories must register and list their tests with CMS, the agency that oversees CLIA, and CLIA compliance and certification is a
prerequisite to be eligible to bill government payors and many private payors for our tests. CLIA is user-fee funded, such that all costs
of administering the program must be covered by the regulated facilities, including certification and survey costs.
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We are subject to survey and inspection every two years to assess compliance with CLIA’s program standards, and we may be
subject to additional unannounced inspections. Our CLIA certification was last renewed October 23, 2017. If our clinical reference
laboratory is found to be out of compliance with CLIA requirements at any of these inspections, we may be subject to sanctions such
as suspension, limitation or revocation of our CLIA certificate, a directed plan of correction, on-site monitoring, civil monetary
penalties, civil injunctive suits, criminal penalties, exclusion from the Medicare and Medicaid programs and significant adverse
publicity.
In addition to CLIA requirements, we elect to participate in the accreditation program of CAP. CMS has deemed CAP standards
to be equally or more stringent than CLIA regulations and has approved CAP as a recognized accrediting organization. Inspection by
CAP is performed in lieu of inspection by CMS for CAP-accredited laboratories. Because we are accredited by the CAP Laboratory
Accreditation Program, we are deemed to also comply with CLIA.
State and Foreign Laboratory Licensure
Under CLIA, states may adopt laboratory regulations that are more stringent than those under federal law, and a number of
states have implemented their own more stringent laboratory regulatory requirements. State laws may require that laboratory
personnel meet certain qualifications, specify certain quality control procedures or facility requirements or prescribe record
maintenance requirements.
Our genetic testing laboratory is located in Temple City, California. As a result, we are required to maintain a license to conduct
testing in the State of California. California laws establish standards for day-to-day operations of our laboratory, including with
respect to the training and skills required of personnel, quality control and proficiency testing requirements. If our clinical reference
laboratory is out of compliance with California standards, the State of California Department of Public Health, or CA DPH, may
suspend, restrict or revoke our license to operate our clinical reference laboratory, assess substantial civil money penalties or impose
specific corrective action plans. Any such actions could materially affect our business. We maintain a current license in good standing
with CA DPH.
Additionally, several states require the licensure of out-of-state laboratories that accept specimens from those states and/or
receive specimens from laboratories in those states. Our laboratory holds the required out-of-state laboratory licenses to perform
testing on specimens from Florida, Maryland and Pennsylvania. In addition to having a laboratory license in New York, our laboratory
is required to obtain approval on a test-specific basis by the New York State Department of Health before specific testing is performed
on specimens from New York. Because our licensure application is currently pending in New York, we are currently prohibited from
performing tests on specimens from New York until our license is approved.
Other states may adopt similar licensure requirements in the future, which could require us to modify, delay or discontinue our
operations in such jurisdictions. If we identify any other state with such requirements or if we are contacted by any other state advising
us of such requirements, we intend to follow instructions from the state regulators as to how to comply with such requirements.
We are also subject to regulation in foreign jurisdictions, which we expect will increase as we seek to expand international
utilization of our tests or if jurisdictions in which we pursue operations adopt new or modified licensure requirements. Foreign
licensure requirements could require review and modification of our tests in order to offer them in certain jurisdictions or could
impose other limitations, such as restrictions on the transport of human blood or other tissue necessary for us to perform our tests that
may limit our ability to make our tests available outside of the United States on a broad scale.
FDA
Pursuant to its authority under the federal Food, Drug, and Cosmetic Act, or FDC Act, the U.S. Food and Drug Administration,
or FDA, has jurisdiction over medical devices, which are defined to include, among other things, in vitro diagnostic products, or IVDs,
used for clinical purposes. The tests that we offer may be considered IVDs and as such, medical devices. The laws and regulations
governing the marketing of IVDs are evolving, extremely complex, and in many instances there are no significant regulatory or
judicial interpretations of these laws and regulations. The FDA regulates, among other things, the research, testing, manufacturing,
safety, labeling, storage, recordkeeping, premarket clearance or approval, marketing and promotion and sales and distribution of
medical devices in the United States to ensure that medical products distributed domestically are safe and effective for their intended
uses. In addition, the FDA regulates the import and export of medical devices.
The FDC Act classifies medical devices into one of three categories based on the risks associated with the device and the level
of control necessary to provide reasonable assurance of safety and effectiveness. Devices deemed by the FDA to pose the greatest risk,
such as life-sustaining, life-supporting or implantable devices or devices deemed not substantially equivalent to a previously 510(k)
cleared device, are categorized as Class III. These devices typically require submission and approval of a premarket approval
application, or PMA. Devices deemed to pose lower risk are categorized as either Class I or II, which requires the manufacturer to
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submit to the FDA a 510(k) premarket notification submission requesting clearance of the device for commercial distribution in the
United States. Some low-risk devices are exempted from this requirement. When a 510(k) premarket notification submission is
required, the manufacturer must submit to the FDA a premarket notification submission demonstrating that the device is “substantially
equivalent” to: (i) a device that was legally marketed prior to May 28, 1976, for which PMA approval is not required, (ii) a legally
marketed device that has been reclassified from Class III to Class II or Class I, or (iii) another legally marketed, similar device that has
been cleared through the 510(k) clearance process.
After the FDA permits a device to enter commercial distribution, numerous regulatory requirements apply. These include: the
Quality System Regulation, which requires manufacturers to follow elaborate design, testing, control, documentation and other quality
assurance procedures during the manufacturing process; labeling regulations; the FDA’s general prohibition against promoting
products for unapproved or “off-label” uses; and the Medical Device Reporting regulation, which requires that manufacturers report to
the FDA if their device may have caused or contributed to a death or serious injury or malfunctioned in a way that would likely cause
or contribute to a death or serious injury if it were to recur. The FDA has broad post-market and regulatory and enforcement powers.
Failure to comply with the applicable U.S. medical device regulatory requirements could result in, among other things, warning
letters, fines, injunctions, consent decrees, civil penalties, repairs, replacements, refunds, recalls or seizures of products, total or partial
suspension of production, the FDA’s refusal to grant future premarket clearances or approvals, withdrawals or suspensions of current
product applications, and criminal prosecution.
Although the FDA has statutory authority to assure that medical devices, including IVDs, are safe and effective for their
intended uses, the FDA has historically exercised its enforcement discretion and not enforced applicable provisions of the FDC Act
and regulations with respect to laboratory developed tests, or LDTs, which are a subset of IVDs that are intended for clinical use and
designed, manufactured and used within a single laboratory. We believe our tests fall within the definition of an LDT. As a result, we
believe our diagnostic tests are not currently subject to the FDA’s enforcement of its medical device regulations and the applicable
FDC Act provisions.
Even though we commercialize our tests as LDTs, our tests may in the future become subject to more onerous regulation by the
FDA. Pursuant to the Food and Drug Administration Safety and Innovation Act of 2012, the FDA notified Congress on July 31, 2014
that the FDA intended to issue in 60 days the draft Framework Guidance and the Notification Guidance. On October 3, 2014, the FDA
issued the draft Framework Guidance and Notification Guidance for comment. The Framework Guidance stated that the FDA intends
to modify its policy of enforcement discretion with respect to LDTs in a risk-based manner consistent with the existing classification
of medical devices. The draft guidances resulted in a large number of public comments from interested parties. The FDA
subsequently announced in November 2016 that it would not issue a final guidance to allow for further public discussion on an
appropriate LDT oversight approach and to give congressional committees the opportunity to develop a legislative solution. In
January 2017, the FDA published a Discussion Paper on Laboratory Developed Tests, which provided a synthesis of the feedback the
agency had received and which outlined, as part of the synthesis, a new possible approach to LDT oversight. The Discussion Paper
noted that the synthesis does not represent the formal position of the FDA, nor is it enforceable.
If and when the FDA finalizes its position on regulation of LDTs through formal guidance, or new legislation is passed, or if the
FDA disagrees with our assessment that our tests fall within the definition of an LDT, we could for the first time be subject to
enforcement of regulatory requirements such as registration and listing requirements, medical device reporting requirements and
quality control requirements (although the possible approach outlined in the Discussion Paper would exempt previously marketed
LDTs from many requirements, in other words, it would “grandfather” existing LDTs). Any new FDA enforcement policies affecting
LDTs may result in increased regulatory burdens on our ability to continue marketing our tests and to develop and introduce new tests
in the future. Additionally, if and when the FDA begins to actively enforce its premarket submission regulations with respect to LDTs
generally or our tests in particular, we may be required to obtain premarket clearance for our tests under Section 510(k) of the FDC
Act or approval of a PMA. The process for submitting a 510(k) premarket notification and receiving FDA clearance usually takes
from three to 12 months, but it can take significantly longer and clearance is never guaranteed. The process for submitting and
obtaining FDA approval of a PMA generally takes from one to three years or even longer and approval is not guaranteed. PMA
approval typically requires extensive clinical data and can be significantly longer, more expensive and more uncertain than the 510(k)
clearance process. If premarket review is required for some or all of our tests, the FDA could require that we stop selling our products
pending clearance or approval and conduct clinical testing prior to making submissions to FDA to obtain premarket clearance or
approval. The FDA could also require that we label our tests as investigational or limit the labeling claims we are permitted to make.
While there is also the risk that the FDA does not consider our tests to be LDTs, the draft Framework Guidance stated that, in
the interest of ensuring continuity in the testing market and avoiding disruption of access to tests marketed as LDTs that do not meet
the FDA’s definition of LDTs, the FDA intends to apply the same risk-based framework described in the Framework Guidance to any
IVD that is offered as an LDT by a CLIA-certified laboratory. We would expect the FDA to take the same or similar approach in any
new program for the regulation of LDTs.
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Additionally, the FDA has recently solicited public input and published two draft guidance documents relating to FDA oversight
of NGS-based tests. The two draft guidance documents on NGS-based tests describe the FDA’s current thinking and proposed
approach regarding the possible use of FDA-recognized standards to support analytical validity, and public human genetic variant
databases to support clinical validity, of these tests. While it appears that the FDA is striving to provide a flexible pathway to device
clearance or approval for manufacturers seeking to market NGS-based tests, it is unknown how the FDA may regulate such tests in the
future and what testing and data may be required to support such clearance or approval. If premarket review is required for some or all
of our tests and the FDA requires more extensive testing such as clinical trials, for example, we could experience significantly
increased development costs and delay.
The FDA enforces its medical device requirements by various means, including inspection and market surveillance. If the FDA
finds a violation, it can institute a wide variety of enforcement actions, ranging from an Untitled Letter or Warning Letter to more
severe sanctions, such as: fines, injunctions and civil penalties; recall or seizure of products; operating restrictions, partial suspension
or total shutdown of production; and criminal prosecution.
Legislative proposals addressing the FDA’s oversight of LDTs have been introduced by Congress in the past and we expect that
new legislative proposals may be introduced from time to time in the future. The likelihood that Congress will pass such legislation
and the extent to which such legislation may affect the FDA’s plans to enforce its medical device requirements with respect to certain
LDTs is difficult to predict at this time. If the FDA ultimately lifts its policy of enforcement discretion over LDTs and begins to
enforce its medical device requirements with respect to LDTs, our tests may be subject to additional regulatory requirements imposed
by the FDA, the nature and extent of which would depend upon applicable final guidance or regulation by the FDA or instruction by
Congress. Failure to comply with any applicable FDA requirements could trigger a range of enforcement actions by the FDA,
including warning letters, civil monetary penalties, injunctions, criminal prosecution, recall or seizure, operating restrictions, partial
suspension or total shutdown of operations and denial of or challenges to applications for clearance or approval, as well as significant
adverse publicity.
Reimbursement
CPT Codes
Third-party payors, including private insurers and CMS, require genetic testing companies to identify each test for which
reimbursement is sought using a CPT code set maintained by the AMA. These CPT codes in their current form are not readily applied
to many of the genetic tests we conduct. For example, for many of our multi-gene panels, there may not be an appropriate CPT code
for any genes in a panel, in which case our test would be billed under a miscellaneous code for an unlisted molecular pathology
procedure. Because these miscellaneous codes do not describe a specific service, the insurance claim would need to be examined to
determine the service that was provided, whether the service was appropriate and medically necessary and whether payment should be
rendered. This process can require a letter of medical necessity from the ordering physician and it can result in a delay in processing
the claim, a lower reimbursement amount or denial of the claim.
In September 2014, the AMA published new CPT codes for genomic sequencing procedures that are effective for dates of
service on or after January 1, 2015. These include genomic sequencing procedure codes for certain multi-gene panel tests. In a final
determination under the Medicare Clinical Laboratory Fee Schedule, or CLFS, published in November 2014, CMS set the 2015
payment rate for these codes using the gap-fill process. Under the gap-fill process, local Medicare Administrative Contractors, or
MACs, establish rates for the codes that each MAC believes meet the criteria for Medicare coverage and considering laboratory
charges and discounts to charges, resources, amounts paid by other payors for the tests and amounts paid by the MAC for similar tests.
In 2015, gap-filled payment rates were established for some, but not all, of the published codes for genomic sequencing procedures.
For the codes for which local gap-filled rates were established in 2015, a national limitation amount for Medicare was established for
2016. For the codes for which local gap-filled rates were not established in 2015, associated procedures are priced by the local MACs
in 2016 if an individual MAC determines that such codes should be covered. Where available, the national limitation amount serves as
a cap on the Medicare and Medicaid payment rates for a test procedure, which may not be adequate for all of the procedures covered
by the applicable codes, including our tests to the extent we are required to report them under these codes.
PAMA
In April 2014, Congress passed the Protecting Access to Medicare Act of 2014, or PAMA, which included substantial changes
to the way in which clinical laboratory services will be paid under Medicare. Under PAMA, laboratories that receive the majority of
their Medicare revenue from payments made under the CLFS or the Physician Fee Schedule are required to report to CMS, beginning
in 2017 and every three years thereafter (or annually for “advanced diagnostic laboratory tests”), private payor payment rates and
volumes for their tests. Laboratories that fail to report the required payment information may be subject to substantial civil monetary
penalties. We do not believe that our tests meet the current definition of advanced diagnostic laboratory tests, and therefore we believe
we will be required to report private payor rates for our tests every three years. As required under PAMA, CMS will use the rates and
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volumes reported by laboratories to develop Medicare payment rates for laboratory tests equal to the volume-weighted median of the
private payor payment rates for the tests. On June 23, 2016, CMS published the final rule implementing the reporting and rate-setting
requirements under PAMA.
As set forth under PAMA, for tests furnished on or after January 1, 2018, Medicare payments for clinical diagnostic laboratory
tests will be paid based upon these reported private payor rates. For clinical diagnostic laboratory tests that are assigned a new or
substantially revised CPT code, initial payment rates will be assigned by the gap-fill methodology, as under prior law. Initial payment
rates for new advanced diagnostic laboratory tests will be based on the actual list charge for the laboratory test.
The payment rates calculated under PAMA became effective starting January 1, 2018. Any reductions to payment rates resulting
from the new methodology are limited to 10% per test per year in each of the years 2018 through 2020 and to 15% per test per year in
each of the years 2021 through 2023. In late 2017, CMS published the final payment rates and supporting documentation for the new
private payor rate-based payment system.
PAMA codifies Medicare coverage rules for laboratory tests by requiring any local coverage determination to be made
following the local coverage determination process. PAMA also authorizes CMS to consolidate coverage policies for clinical
laboratory tests among one to four laboratory-specific MACs. These same contractors may also be designated to process claims if
CMS determines that such a model is appropriate. It is unclear whether CMS will proceed with contractor consolidation under this
authorization.
PAMA also authorizes the adoption of new, temporary billing codes and/or unique test identifiers for FDA-cleared or approved
tests as well as advanced diagnostic laboratory tests. The AMA’s CPT Editorial Panel has approved a proposal to create a new section
of billing codes to facilitate implementation of this section of PAMA. At this time, it is unclear whether or when the new section of
billing codes will be implemented, nor is it clear if or how these codes would apply to our tests.
Privacy and Security Laws
HIPAA and HITECH
Under the administrative simplification provisions of the federal Health Insurance Portability and Accountability Act of 1996, or
HIPAA, as amended by the federal Health Information Technology for Economic and Clinical Health Act, or HITECH, the U.S.
Department of Health and Human Services, or HHS, has issued regulations that establish uniform standards governing the conduct of
certain electronic healthcare transactions and requirements for protecting the privacy and security of protected health information, or
PHI, used or disclosed by most healthcare providers and other covered entities and their respective business associates, including
subcontractors of business associates. The following four principal regulations with which we are required to comply have been issued
in final form under HIPAA and HITECH: privacy regulations, security regulations, the breach notification rule and standards for
electronic transactions, which establish standards for common healthcare transactions.
The privacy regulations of HIPAA and HITECH cover the use and disclosure of PHI by covered entities and business
associates, which include subcontractors that create, receive, maintain or transmit PHI on behalf of a business associate. A
subcontractor means any person to whom a business associate delegates a function, activity or service, other than in the capacity of the
business associate’s workforce. As a general rule, a covered entity or business associate may not use or disclose PHI except as
permitted under the privacy regulations of HIPAA and HITECH. The privacy regulations also set forth certain rights of an individual
with respect to his or her PHI maintained by a covered entity or business associate, including the right to access or amend certain
records containing his or her PHI or to request restrictions on the use or disclosure of his or her PHI.
Covered entities and business associates must also comply with the security regulations of HIPAA and HITECH, which
establish requirements for safeguarding the confidentiality, integrity and availability of electronic PHI. In addition, HITECH
established, among other things, certain breach notification requirements with which covered entities and business associates must
comply. In particular, a covered entity must notify any individual whose unsecured PHI is breached according to the specifications set
forth in the breach notification rule. A covered entity must also notify the Secretary of HHS and, under certain circumstances, the
media.
There are significant civil and criminal fines and other penalties that may be imposed for violating HIPAA. A covered entity or
business associate is also liable for civil monetary penalties for a violation that is based on an act or omission of any of its agents,
including a downstream business associate, as determined according to the federal common law of agency. Penalties for failure to
comply with a requirement of HIPAA and HITECH vary significantly depending on the failure and include civil monetary penalties of
up to $1.5 million per violation of the same requirement per calendar year. A single breach incident can result in violations of multiple
requirements, resulting in potential penalties in excess of $1.5 million. Additionally, a person who knowingly obtains or discloses
individually identifiable health information in violation of HIPAA may face a criminal penalty of up to $50,000 and up to one year of
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imprisonment. These criminal penalties increase if the wrongful conduct involves false pretenses or the intent to sell, transfer or use
identifiable health information for commercial advantage, personal gain or malicious harm. Further, to the extent that we submit
electronic healthcare claims and payment transactions that do not comply with the electronic data transmission standards established
under HIPAA and HITECH, payments to us may be delayed or denied.
The HIPAA privacy, security, and breach notification regulations establish a uniform federal “floor,” but do not supersede state
laws that are more stringent or provide individuals with greater rights with respect to the privacy or security of, and access to, their
records containing PHI or insofar as such state laws apply to personal information that is broader in scope than PHI as defined under
HIPAA. Massachusetts, for example, has a state law that protects the privacy and security of personal information of Massachusetts
residents.
Numerous other federal, state and foreign laws, including consumer protection laws and regulations, govern the collection,
dissemination, use, access to, confidentiality and security of patient health information. In addition, Congress and some states are
considering new laws and regulations that further protect the privacy and security of medical records or medical information. With the
recent increase in publicity regarding data breaches resulting in improper dissemination of consumer information, many states have
passed laws regulating the actions that a business must take if it experiences a data breach, such as prompt disclosure to affected
customers. Generally, these laws are limited to electronic data and make some exemptions for smaller breaches. Congress has also
been considering similar federal legislation relating to data breaches. The Federal Trade Commission and states’ Attorneys General
have also brought enforcement actions and prosecuted some data breach cases as unfair and/or deceptive acts or practices under the
Federal Trade Commission Act. In addition to data breach notification laws, some states have enacted statutes and rules requiring
businesses to reasonably protect certain types of personal information they hold or to otherwise comply with certain specified data
security requirements for personal information. We intend to continue to comprehensively protect all personal information and to
comply with all applicable laws regarding the protection of such information.
Foreign Laws
We are also subject to foreign privacy laws in the jurisdictions in which we sell our tests. The interpretation, application and
interplay of consumer and health-related data protection laws in the United States, Europe and elsewhere are often uncertain,
contradictory and in flux. For example, a new General Data Protection Regulation, or GDPR, and Cybersecurity Directive have been
enacted in the European Union and will come into full effect in May 2018. These texts will introduce many changes to privacy and
security in the European Union, including stricter rules on consent and security duties for critical industries, including for the health
sector. The interpretation of some rules is still unclear, and some requirements may be completed by national legislation. This makes it
difficult to assess the impact of these new data protection laws on our business at this time. More generally, foreign laws and
interpretations governing data privacy and security are constantly evolving and it is possible that laws may be interpreted and applied
in a manner that is inconsistent with our current practices, in which case we could be subject to government-imposed fines or orders
requiring that we change our practices. These fines can be very high. For instance, the GDPR introduces fines of up to approximately
$22 million or 4% of a group’s worldwide annual turnover for certain infringements. In addition, privacy regulations differ widely
from country to country.
Fraud and Abuse Laws
In the United States, we must comply with various fraud and abuse laws and we are potentially subject to regulation by various
federal, state and local authorities, including CMS, other divisions of HHS (such as the Office of Inspector General), the U.S.
Department of Justice, individual U.S. Attorney offices within the Department of Justice and state and local governments. We also
may be subject to foreign fraud and abuse laws.
Anti-Kickback and Fraud Statutes
In the United States, the federal Anti-Kickback Statute prohibits, among other things, knowingly and willfully offering, paying,
soliciting or receiving remuneration, directly or indirectly, overtly or covertly, in cash or in kind, in order to induce or in return for the
referral of an individual for the furnishing of or arranging for the furnishing of, purchasing, leasing, ordering or arranging for or
recommending purchasing, leasing or ordering of any good, facility, service or item for which payment may be made in whole or in
part by a federal healthcare program. Courts have stated that a financial arrangement may violate the Anti-Kickback Statute if any one
purpose of the arrangement is to encourage patient referrals or other federal healthcare program business, regardless of whether there
are other legitimate purposes for the arrangement. The definition of “remuneration” has been broadly interpreted to include anything
of value, including gifts, discounts, credit arrangements, payments of cash, consulting fees, waivers of co-payments, ownership
interests and providing anything at less than its fair market value. The Anti-Kickback Statute is broad and may technically prohibit
many innocuous or beneficial arrangements within the healthcare industry, although it does contain several exceptions. HHS has
issued a series of regulatory “safe harbors,” which set forth certain provisions that, if met, will assure healthcare providers and other
parties that they will not be prosecuted under the Anti-Kickback Statute. Although full compliance with the statutory exceptions or
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regulatory safe harbors ensures against prosecution under the federal Anti-Kickback Statute, the failure of a transaction or
arrangement to fit within a specific statutory exception or regulatory safe harbor does not necessarily mean that the transaction or
arrangement is illegal or that prosecution under the Anti-Kickback Statute will be pursued. Furthermore, a person or entity does not
need to have actual knowledge of the statute or specific intent to violate it in order to have committed a violation. Penalties for
violations of the Anti-Kickback Statute are severe and include imprisonment, criminal fines, civil monetary penalties and exclusion
from participation in federal healthcare programs. In addition, a violation of the federal Anti-Kickback Statute can serve as a basis of
liability under the federal False Claims Act (described below). Many states also have anti-kickback statutes, some of which may apply
to items or services reimbursed by any third-party payor, including commercial insurers.
There are also U.S. federal laws related to healthcare fraud and false statements relating to healthcare matters. The healthcare
fraud statute prohibits, among other things, knowingly and willfully executing a scheme to defraud any healthcare benefit program,
including private payors. A violation of this statute is a felony and may result in fines, imprisonment or exclusion from government
payor programs such as the Medicare and Medicaid programs. The false statements statute prohibits knowingly and willfully
falsifying, concealing or covering up a material fact or making any materially false, fictitious or fraudulent statement in connection
with the delivery of or payment for healthcare benefits, items or services. Similar to the federal Anti-Kickback Statute, a person or
entity does not need to have actual knowledge of the statute or specific intent to violate it in order to have committed a violation. A
violation of this statute is also a felony and may result in fines, imprisonment or exclusion from government payor programs.
False Claims Act
Another development affecting the healthcare industry is the increased enforcement of the federal False Claims Act and, in
particular, actions brought pursuant to the False Claims Act’s “whistleblower” or “qui tam” provisions. The False Claims Act imposes
liability on any person or entity that, among other things, knowingly presents, or causes to be presented, a false or fraudulent claim for
payment by a federal government payor program. The qui tam provisions of the False Claims Act allow a private individual to bring
actions on behalf of the federal government alleging that the defendant has defrauded the federal government by submitting a false
claim to the federal government and permit such individuals to share in any amounts paid by the entity to the government in fines or
settlement. In addition, the Patient Protection and Affordable Care Act, as amended by the Health Care and Education Reconciliation
Act, which we collectively refer to as the Affordable Care Act, establishes a requirement for providers and suppliers to report and
return any overpayments received from government payors under the Medicare and Medicaid programs within 60 days of
identification. Failure to identify and return such overpayments exposes the provider or supplier to False Claims Act liability. When
an entity is determined to have violated the False Claims Act, it may be required to pay up to three times the actual damages sustained
by the government, plus civil penalties ranging from $5,500 to $11,000 for each false claim.
In addition, various states have enacted false claim laws analogous to the federal False Claims Act, although many of these state
laws apply where a claim is submitted to any third-party payor and not merely a government payor program.
Civil Monetary Penalties Law
The federal Civil Monetary Penalties Law imposes penalties against any person or entity that, among other things, is determined
to have presented or caused to be presented a claim to a federal health program that the person knows or should know is for an item or
service that was not provided as claimed or for a claim that is false or fraudulent. This law also prohibits the offering or transfer of
remuneration to a Medicare or state healthcare program beneficiary if the person knows or should know it is likely to influence the
beneficiary’s selection of a particular provider, practitioner, or supplier of items or services reimbursable by Medicare or a state
healthcare program, unless an exception applies.
Physician Referral Prohibitions
The U.S. federal law directed at “self-referrals,” commonly known as the “Stark Law,” prohibits a physician from making
referrals for certain designated health services, including laboratory services, that are covered by the Medicare program, to an entity
with which the physician or an immediate family member has a direct or indirect financial relationship, unless an exception applies.
The prohibition also extends to payment for any services referred in violation of the Stark Law. A physician or entity that engages in a
scheme to circumvent the Stark Law’s referral prohibition may be fined up to $100,000 for each such arrangement or scheme. In
addition, any person who presents or causes to be presented a claim to the Medicare program in violation of the Stark Law is subject
to civil monetary penalties of up to $15,000 per service, an assessment of up to three times the amount claimed and possible exclusion
from participation in federal healthcare programs. The Stark Law is a strict liability statute, meaning that a physician’s financial
relationship with a laboratory must meet an exception under the Stark Law or the referrals are prohibited. Thus, unlike the Anti-
Kickback Statute’s safe harbors, if a laboratory’s financial relationship with a referring physician does not meet the requirements of a
Stark Law exception, then the physician is prohibited from making Medicare and Medicaid referrals to the laboratory and any such
referrals will result in overpayments to the laboratory and subject the laboratory to the Stark Law’s penalties.
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Many states have comparable laws that are not limited to Medicare referrals. The Stark Law also prohibits state receipt of
federal Medicaid matching funds for services furnished pursuant to a prohibited referral, but this provision of the Stark Law has not
been implemented by regulations. In addition, some courts have held that the submission of claims to Medicaid that would be
prohibited as self-referrals under the Stark Law for Medicare could implicate the False Claims Act.
Physician Sunshine Laws
The Affordable Care Act, among other things, imposed new reporting requirements on manufacturers of certain devices, drugs
and biologics for certain payments and transfers of value by them and in some cases their distributors to physicians and teaching
hospitals, as well as ownership and investment interests held by physicians and their immediate family members. The reporting
program (Open Payments program) is administered by CMS under regulations issued for the program. Because we manufacture our
own LDTs solely for use by or within our own laboratory, we believe we are exempt from these reporting requirements. We may
become subject to such reporting requirements under the terms of current CMS regulations, however, if the FDA requires us to obtain
premarket clearance or approval for our tests.
Anti-Bribery Laws
FCPA
We are subject to U.S. Foreign Corrupt Practices Act, or FCPA, which prohibits companies and their intermediaries from
making payments in violation of law to non-U.S. government officials for the purpose of obtaining or retaining business or securing
any other improper advantage. The sale of our tests internationally demands a high degree of vigilance in maintaining, implementing
and enforcing a policy against participation in corrupt activity. Other U.S. companies in the medical device and pharmaceutical fields
have faced substantial monetary fines and criminal penalties under the FCPA for allowing their agents to deviate from appropriate
practices in doing business with non-U.S. government officials.
Foreign Laws
We are also subject to similar anti-bribery laws in the foreign jurisdictions in which we operate. In Europe, various countries
have adopted anti-bribery laws providing for severe consequences, in the form of criminal penalties and/or significant fines for
individuals and/or companies committing a bribery offence. For instance, in the United Kingdom, under the Bribery Act of 2010,
which became effective in July 2011, a bribery occurs when a person offers, gives or promises to give a financial or other advantage to
induce or reward another individual to improperly perform certain functions or activities, including any function of a public or private
nature. Bribery of foreign public officials also falls within the scope of the Bribery Act of 2010. Under the new regime, an individual
found in violation of the Bribery Act of 2010 faces imprisonment of up to 10 years and could be subject to an unlimited fine, as could
commercial organizations for failure to prevent bribery.
Healthcare Policy Laws
In March 2010, the Affordable Care Act was enacted in the United States. The Affordable Care Act made a number of
substantial changes to the way healthcare is financed both by governmental and private insurers. For example, the Affordable Care
Act requires each medical device manufacturer to pay a sales tax equal to 2.3% of the price for which such manufacturer sells its
medical devices. The medical device tax has been suspended for 2016 and 2017, and under recent legislation is again suspended for
2018 and 2019. It is unclear at this time when, or if, the provision of our LDTs will trigger the medical device tax, and it is possible
that this tax will apply to some or all of our existing tests or tests we may develop in the future. Additionally, the Affordable Care Act
establishes an Independent Payment Advisory Board, or IPAB, to propose reductions to payments in order to reduce the per capita rate
of growth in Medicare spending if expenditures exceed certain targets. The expenditure targets for IPAB proposals have not been
exceeded at this time, and it is unclear when such targets may be exceeded in the future, when any IPAB-proposed reductions to
payments could take effect and how any such reductions would affect reimbursement payments for our tests. The Affordable Care Act
also contains a number of other provisions, including provisions governing enrollment in federal and state healthcare programs,
reimbursement matters and fraud and abuse, which we expect will impact our industry and our operations in ways that we cannot
currently predict. Following the results of the 2016 U.S. presidential election and in light of the policies of the current administration,
which has threatened to repeal the Affordable Care Act, there is uncertainty regarding the continued effect or the Affordable Care Act
in its current form.
Corporate Practice of Medicine
Numerous states have enacted laws prohibiting business corporations, such as us, from practicing medicine and employing or
engaging physicians to practice medicine, generally referred to as the prohibition against the corporate practice of medicine. These
laws are designed to prevent interference in the medical decision-making process by anyone who is not a licensed physician. For
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example, California’s Medical Board has indicated that determining the appropriate diagnostic tests for a particular condition and
taking responsibility for the ultimate overall care of a patient, including providing treatment options available to the patient, would
constitute the unlicensed practice of medicine if performed by an unlicensed person. Violation of these corporate practice of medicine
laws may result in civil or criminal fines, as well as sanctions imposed against the business corporation and/or the professional
through licensure proceedings. Typically, such laws are only applicable to entities with a physical presence in the applicable state.
Environmental and Other Regulatory Requirements
Our laboratory is subject on an ongoing basis to federal, state and local laws and regulations governing the use, storage,
handling and disposal of regulated medical waste, hazardous waste and biohazardous waste, including chemicals, biological agents
and compounds and blood and other tissue specimens. Typically, we use licensed or otherwise qualified outside vendors to dispose of
this waste. However, many of these laws and regulations provide for strict liability, holding a party potentially liable without regard to
fault or negligence. As a result, we could be held liable for damages and fines if our, or others’, business operations or other actions
result in contamination of the environment or personal injury due to exposure to hazardous materials. Our costs for complying with
these laws and regulations cannot be estimated or predicted and depends on a number of factors, including the amount and nature of
waste we produce (which depends in part on the number of tests we perform) and the terms we negotiate with our waste disposal
vendors.
Our operations are also subject to extensive requirements established by the U.S. Occupational Safety and Health
Administration relating to workplace safety for healthcare employees, including requirements to develop and implement programs to
protect workers from exposure to blood-borne pathogens by preventing or minimizing any exposure through needle stick or similar
penetrating injuries.
Employees
We believe growing and retaining a strong team is crucial to our success. As of March 1, 2018, we had 98 employees, all
of which are full-time, engaged in bioinformatics, genetics, software engineering, laboratory management, sales and marketing and
corporate and administrative activities. None of our employees are represented by a labor union or covered by collective bargaining
agreements and we believe our relationship with our employees is good.
Corporate Information
We were incorporated in Delaware on May 13, 2016. We are the holding company of our subsidiaries, including primarily
Fulgent LLC, which was initially formed in June 2011. On September 30, 2016, Fulgent LLC became our wholly owned subsidiary in
a transaction we refer to as the Reorganization, in which the holders of all equity interests in Fulgent LLC immediately prior to the
Reorganization became all of our stockholders immediately following the Reorganization.
Our initial operations focused on Fulgent LLC’s former pharmaceutical business, or the Pharma Business, and in 2013 we
commenced the genetic testing business we are currently pursuing. In October 2015, we recapitalized Fulgent LLC to establish two
series of units, with the Class D units having economic rights based on the genetic testing business we are currently pursuing and the
Class P units having economic rights based on the Pharma Business. On April 4, 2016, Fulgent LLC separated the Pharma Business
from the genetic testing business we are currently pursuing in a transaction we refer to as the Pharma Split-Off. The operating results
of the Pharma Business have been reported as discontinued operations for all periods in our consolidated financial statements included
in this report.
Our headquarters and laboratory are located at 4978 Santa Anita Avenue, Temple City, California 91780, and our telephone
number is (626) 350-0537. Our website address is www.fulgentgenetics.com. The information contained on or that can be accessed
through our website is not part of and is not incorporated into this report by this reference.
We qualify as an emerging growth company as defined in the Jumpstart Our Business Startups Act of 2012, as amended, or
JOBS Act. As an emerging growth company, we may take advantage of specified reduced disclosure and other requirements that are
applicable generally to other public companies. We will remain an emerging growth company until December 31, 2021, unless our
gross revenue exceeds $1.07 billion in any fiscal year before that date, we issue more than $1.0 billion of non-convertible debt in any
three-year period before that date or the market value of our common stock held by non-affiliates exceeds $700.0 million as of the last
business day of the second fiscal quarter of any fiscal year before that date.
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Available Information
We file reports with the Securities and Exchange Commission, or the SEC, and make available, free of charge, on or through
our website, our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, proxy and information
statements and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act as soon as
reasonably practicable after we electronically file such material with, or furnish it to, the SEC.
Item 1A. Risk Factors.
Investing in our common stock involves a high degree of risk. Before making any investment decision with respect to our
common stock, you should carefully consider the risks described below and all of the other information included in this report and the
other filings we make with the SEC. We believe the risks and uncertainties described below are the most significant we face and the
occurrence of any of these risks could harm our business, financial condition, results of operations, prospects and reputation and
could cause the trading price of our common stock to decline. Additional risks and uncertainties not presently known to us or that we
currently deem immaterial may also impair our business.
Business and Strategy Risks
Our results of operations may fluctuate significantly from period to period and can be difficult to predict.
Our results of operations have 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, the amount and timing of sales of billable
tests, the prices we charge for our tests due to changes in product mix, customer mix, general price degradation for genetic 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, as well as the other risk factors discussed in this report. In addition, in certain prior periods, our results have been impacted
by events that may not recur regularly, in the same amounts or at all in the future. Moreover, our limited operating history makes it
difficult to determine if fluctuations in our performance reflect seasonality or other trends or are the result of other factors or events.
These fluctuations in our operating results may render period-to-period comparisons less meaningful, and investors should not rely on
the results of any one period as an indicator of future performance. Additionally, these fluctuations in our operating results could cause
our performance in any particular period to fall below the expectations of securities analysts or investors or guidance we have
provided to the public, which could negatively affect the price of our common stock.
We have a history of losses, and we may not be able to achieve or sustain profitability.
We have a history of losses. Although we achieved profitability in the first three months and the first half of 2017, we have
recorded losses in all other periods since our inception, including in the 2017 fiscal year. As a result, we may not be able to achieve
profitability in any future period, and even if we can achieve profitability, we may not be able to sustain it. Further, we have generated
limited revenue to date, and our historical revenue levels may not grow or even continue. We may incur additional losses in the future,
particularly as we focus on investing in and growing our business and operations and experience related increases in expenses. Our
prior losses and any future losses have had and will continue to have an adverse effect on our stockholders’ equity and working
capital, which could negatively impact our operations and your investment in our company. Any failure to sustain or grow our revenue
levels and achieve or maintain profitability would negatively affect our business, financial condition, results of operations and cash
flows, and could cause the market price of our common stock to decline.
We are an early-stage company with a limited operating history, which could expose us to enhanced risks and increase the
difficulty of evaluating our business and prospects.
We began operations in May 2012 and commercially launched our first genetic tests in 2013. As a result, we have only a limited
operating history upon which you can evaluate our business and prospects. Our revenue levels may not continue to grow at historical
rates or at all, and we may not be able to achieve or sustain profitability. Our limited operating history makes it difficult to evaluate
our current business and hinders our ability to reliably forecast our future operating results, including revenue, cash flows and
movement toward sustained profitability. We have encountered and will continue to encounter risks and uncertainties frequently
experienced by growing companies in the life sciences and technology industries, such as risks related to an evolving and
unpredictable industry and business model, management of growth and the other uncertainties described in this report. If our
assumptions regarding these risks and uncertainties are incorrect or these risks and uncertainties change due to fluctuations in our
markets, or if we do not address these risks successfully, our operating and financial results could differ materially from our
expectations and our business could suffer.
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Our industry is subject to rapidly changing technology and new and increasing amounts of scientific data, and if we fail to
keep pace with these technological advances, we may be unable to compete effectively and our business and prospects could
suffer.
In recent years, there have been numerous advances in the ability to analyze large amounts of genomic information and the role
of genetics and gene variants in disease diagnosis and treatment. Our industry has been, and we believe will continue to be,
characterized by rapid technological change, increasing amounts of data, frequent introductions of new genetic tests and evolving
industry standards, all of which could make our tests obsolete if we are not able to enhance our technologies and tests faster and better
than our competitors. Our future success will depend on our ability to keep pace with the evolving needs of our customers in a timely
and cost-effective manner and to pursue new market opportunities that develop as a result of technological and scientific advances. If
we are not able to keep pace with these advances and increased customer expectations that develop as a result of these advances, we
may be unable to sustain or grow our business and our future operations and prospects could suffer.
Our mix of customers can fluctuate from period to period, and the loss of or a reduction in sales to any of our customers could
materially harm our business.
The composition and concentration of our customer base can fluctuate from period to period, and in certain prior periods, a
small number of customers has 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 a result, any or all of them could decide at any time to
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 genetic 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. In addition, the failure of any one of our
customers to pay on a timely basis would negatively impact our results and cash flows. Our ability to maintain or increase sales to our
existing customers depends on a variety of factors, including the other risk factors discussed in this report, many of which are beyond
our control. Because of these and other factors, sales to any of our customers, including our key customers, may not continue in the
amounts or at the rates as they have in the past, and such sales may never reach or exceed historical levels in any future period. The
loss of any of our customers, or a reduction in orders or difficulties collecting payments from any of them, could significantly reduce
our revenue and adversely affect our operating results.
If we are not able to grow and diversify our customer base and increase demand for our tests from existing and new
customers, our potential for growth could be limited.
To achieve our desired revenue growth, we must increase test volume by further penetrating our existing hospital and medical
institution customers. In addition, we must grow our customer base beyond hospitals and medical institutions and into additional
customer groups, such as individual physicians, other practitioners and research institutions. To this end, we are making efforts to
diversify our customer market, including building relationships with research institutions and other similar institutional customers, a
national clinical laboratory, regional medical networks and various other organizations to facilitate access to physicians, practitioners
and other new customer groups, including certain U.S. military and other government agencies. 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, none of these relationships obligate any party to order our tests at any agreed volume or frequency or at
all. Further, any relationships we may develop with the U.S. military or any other U.S. 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 and without prior notice. As a result, our efforts to pursue
these or other new customer markets could fail, and even if we are able to develop relationships with new customers in these or any
other new customer groups, these relationships may not lead to meaningful or any increases in our customer base, the number of
billable tests we deliver or our revenue, and may not improve our ability to achieve or sustain profitability.
We may fail to obtain the customer growth needed to grow volumes and revenue levels as desired or anticipated or at all, which
could occur for a variety of reasons, including, among others:
•
•
•
•
the genetic testing market generally, and particularly the market for NGS genetic tests, is relatively new and may not grow as
predicted or may decline;
our efforts to improve our existing tests and develop and launch new tests may be unsuccessful;
we may not be able to convince additional hospitals and medical institutions or additional customer groups of the utility of our
tests and their potential advantages over existing and new alternatives;
our investments in our sales and marketing functions, including our recent efforts to increase and restructure our sales force and
re-focus and expand our marketing initiatives and strategies, may fail;
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•
•
•
•
•
we may be unsuccessful in convincing customers of the benefits of our broad and customizable test menu;
genetic testing is expensive and many existing and potential new customers may be sensitive to pricing, particularly if we are
not able to maintain low prices relative to our competitors;
potential new customers, particularly individual physicians and other practitioners, may not adopt our tests if coverage and
adequate reimbursement are not available;
negative publicity or regulatory investigations into the actions of companies in our industry could raise doubts about the
legitimacy of diagnostic technologies generally, and could result in scrutiny of diagnostic activities by the FDA or other
applicable government agencies; and
our competitors could introduce new tests that cover more genes or that provide more accurate or reliable results.
If we are unable to address these and other risks associated with growing our customer base and deepening our relationships
with existing customers, we may not achieve our desired growth in billable tests and our results of operations could be adversely
impacted.
We face intense competition, which could intensify further in the future, and we may fail to maintain or increase our revenue
levels or achieve or sustain profitability if we cannot compete successfully.
With the development of NGS, the clinical genetic testing market has become increasingly competitive, and we expect this
competition to intensify further in the future. We face competition from a variety of sources, including, among others, dozens of
companies focused on molecular genetic testing services, such as specialty and reference laboratories that offer traditional single-gene
and multi-gene tests, as well as established and emerging healthcare, information technology and service companies that may develop
and sell competitive tests, which may include informatics, analysis, integrated genetic tools and services for health and wellness.
Additionally, participants in closely related markets, such as prenatal testing and clinical trial or companion diagnostic testing,
could converge on offerings that are competitive with the type of tests we perform. Instances where potential competitors are aligned
with key suppliers or are themselves suppliers could provide these potential competitors with significant advantages. Further,
hospitals, research institutions and eventually individual physicians and other practitioners may also seek to perform at their own
facilities the type of genetic testing we would otherwise perform for them. In this regard, continued development of, and associated
decreases in the cost of, equipment, reagents and other materials and databases and genetic data interpretation services may enable
broader direct participation in genetic testing and analysis and drive down the use of third-party testing companies such as ours.
Moreover, the biotechnology and genetic testing fields continue to undergo significant consolidation, permitting larger clinical
laboratory service providers to increase cost efficiencies and service levels, resulting in more intense competition.
Many of our existing and potential future competitors have longer operating histories, larger customer bases, more expansive
brand recognition and deeper market penetration, substantially greater financial, technological and research and development
resources and selling and marketing capabilities, and considerably more experience dealing with third-party payors. As a result, they
may be able to respond more quickly to changes in customer requirements or preferences, develop faster and better advancements for
their technologies and tests, create and implement more successful strategies for the promotion and sale of their tests, obtain more
favorable results from third-party payors regarding coverage and reimbursement for their offerings, adopt more aggressive pricing
policies for their tests, secure supplies from vendors on more favorable terms or devote substantially more resources to infrastructure
and systems development. We may not be able to compete effectively against these organizations.
Additionally, increased competition and cost-saving initiatives on the part of government entities and other third-party payors
could result in downward pressure on the price for genetic analysis and interpretation generally, which could harm our revenue levels
and sales volume and our ability to gain market share. This downward pricing pressure could intensify in future periods if adoption of
genetic testing becomes more widespread, and we may not be able to maintain acceptable margins on our sales if we are forced to
reduce prices for our tests to try to remain competitive, especially if we are also experiencing increasing expenses as we make efforts
to grow our business or otherwise meet customer demands. The occurrence of these risks could materially harm our ability to achieve
or sustain profitability. In addition, competitors may be acquired by, receive investments from or enter into other commercial
relationships with larger, well-established and well-financed companies as use of NGS for clinical diagnosis and preventative care
increases. Further, companies or governments that effectively control access to genetic testing through umbrella contracts or regional
preferences could promote our competitors or prevent us from performing certain tests in certain territories. If we are unable to
compete successfully against current and future competitors for these or any other reasons, we may be unable to increase market
acceptance and sales volume of our tests, which could prevent us from maintaining or increasing our revenue levels or achieving or
sustaining profitability.
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Our level of commercial success will depend in part on our ability to generate and grow sales with our sales and marketing
team, strategies and partnerships, and we may be unsuccessful in these efforts.
We have limited experience marketing our tests, which we began selling in 2013. We may not be able to market or sell our
existing tests or any tests we may develop in the future in order to drive demand sufficiently to support our desired growth. We
currently sell our tests through a small internal sales force and a number of contractors who serve as independent sales representatives.
Although we expanded our internal sales department in 2017, it remains smaller than many of our competitors’ sales teams. We have
historically relied significantly on organic growth and word-of-mouth among our customers to generate interest in our tests, but our
ability to rely on this type of interest in future periods is uncertain.
We believe our ability to maintain and grow sales volume in the future will depend in large part on our ability to further develop
our sales team and create and implement effective sales and marketing strategies. We have been aggressively pursuing these goals in
recent periods, including increasing the size and restructuring the organization of our sales and marketing team, re-focusing our sales
and marketing initiatives and strategies and increasing the overall scope of our marketing activities, and we expect to continue to
pursue these goals in the near term. These efforts have required and will continue to involve significant time and expense. Moreover,
these efforts may be unsuccessful. For instance, we may not be able to attract and hire the qualified personnel we need to grow our
sales and marketing team as quickly or as successfully as we would like for various reasons, including intense competition in our
industry for qualified personnel and our relative lack of experience selling and marketing our tests. Even if we are able to further
develop our sales and marketing team and strategy, we have limited experience managing such a team and it may not be successful in
growing our customer base or increasing order volumes from our existing customers. Further, our reliance on independent sales
representatives subjects us to risks, as we have very little control over their activities and they are generally free to market and sell
other, potentially competing, products. As a result, these independent sales representatives could devote insufficient time or resources
to marketing and selling our tests, could market them in an ineffective manner or could otherwise be unsuccessful in selling adequate
or expected quantities of our tests.
In addition, our future sales levels will depend in large part on the effectiveness of our sales and marketing strategies, including
our ability to expand our brand awareness, grow our customer base and further penetrate our relationships with existing customers by
providing education about the benefits and full scale of our offering to the medical community in general and to our targeted
geographic and customer markets. We also intend to continue to pursue targeted marketing initiatives, including working with medical
professional societies to promote awareness of the benefits of our tests and genetic testing in general, pursuing or supporting scientific
studies of our tests and publication of results in medical or scientific journals and making presentations at medical, scientific or
industry conferences and trade shows. We have limited experience with this type of activity and we may not be successful in
implementing these initiatives or other marketing strategies we may develop and pursue. If we are not able to drive sufficient revenue
using our sales and marketing strategies to support our planned growth, our business and results of operations would be negatively
affected.
Our sales and marketing strategies include a continued focus on growing our international sales and customer base, which we
plan to pursue through our direct sales team, a number of independent contractor sales representatives, and, if opportunities arise, by
engaging distributors or establishing other types of arrangements, such as joint ventures or other relationships, to manage or assist
with sales, logistics, education and customer support in certain territories. To this end, we have worked with Xi Long USA, Inc., or Xi
Long, a large stockholder of our company, to establish FF Gene Biotech, a joint venture formed in April 2017 to offer genetic testing
to customers in the PRC. Although we believe this joint venture could result in expanded long-term opportunities to address the
genetic testing market in Asia, these expectations could turn out to be wrong and we may never realize the benefits we anticipate from
this joint venture. Although it may become necessary to identify, qualify and engage other commercial partners or distributors with
local industry experience and knowledge in order to effectively market and sell our tests outside the United States, we have not
established any such relationships to cover any non-U.S. territories, except for the FF Gene Biotech joint venture in the PRC. As a
result, we may not be successful in finding, attracting and retaining qualified distributors or other commercial partners or we may not
be able to enter into arrangements covering desired territories on favorable terms. In addition, sales practices utilized by distributors or
other commercial partners that are locally acceptable may not comply with sales practices or standards required under U.S. laws that
apply to us, which could subject us to additional compliance risks. If our sales and marketing efforts outside the United States are not
successful, we may not achieve significant acceptance for our tests in international markets, which could materially and adversely
impact our business operations.
We will need to invest in and expand our infrastructure and hire additional skilled personnel in order to support our desired
growth, and our failure to effectively manage any future growth could jeopardize our business.
To increase the volume of tests we offer and deliver, we must invest in our infrastructure, including our testing capacity and
information systems, enterprise software systems, customer service, billing and collections systems and processes and internal quality
assurance programs. We will also need to invest in our workforce by hiring additional skilled personnel, including biostatisticians,
geneticists, software engineers, laboratory directors and specialists, sales and marketing experts and other scientific, technical and
managerial personnel to market, process, interpret and validate the quality of results of our genetic tests and otherwise manage our
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operations. For example, before we deliver a report for any of our genetic tests, the results summarized in the report must be reviewed
and approved by a licensed and qualified laboratory director. We currently have only one such laboratory director with all of the
required licenses, Dr. Han Lin Gao, who conducts this review and approval for each test we deliver. We are in the process of licensing
additional laboratory directors to assist Dr. Gao, and we may need to hire more licensed laboratory directors in the future to further
scale our business. If we fail to hire additional qualified personnel or otherwise develop our infrastructure sufficiently in advance of
demand or if we fail to generate demand commensurate with our level of investment in our infrastructure, our business, prospects,
financial condition and results of operations could be adversely affected. Additionally, although we do not presently have plans to
acquire new or expand our existing laboratory space, we may need to do so in the future if our test volume increases, and any need to
obtain an additional facility or replace our existing facility with a larger one could involve significant costs and challenges.
The time and resources required to implement new systems, to add and train new skilled personnel and to expand or acquire new
laboratory space as needed are uncertain. Any future growth we may experience could create a strain on our organizational,
administrative and operational infrastructure, including laboratory operations, quality control, customer service, sales and marketing
and management. We may not be able to maintain the quality of or expected turnaround times for our tests or satisfy customer demand
if and when it grows. Our ability to effectively manage any growth we experience will also require us to continue to improve our
laboratory and other operational, financial and management systems and controls and our reporting processes and procedures, which
may involve significant time and costs and which we may not be able to do successfully.
Our ability to achieve or sustain profitability depends on our collection of payment for the tests we deliver, which we may not
be able to do successfully.
Since starting our genetic testing business, we have been focused primarily on providing our tests to hospitals and medical
institutions. These customers typically pay for the cost of our tests using funds reimbursed in connection with a patient’s DRG.
However, our ability to collect payment for the tests we deliver to our hospital and medical institution customers, as well as to other
types of customers, is subject to a number of risks, many of which are not within our control. These risks include the potential for
default or bankruptcy by the party responsible for payment and other risks associated with payment collection generally. Further,
healthcare policy changes that influence the way healthcare is financed or other changes in the market that impact payment rates by
institutional or non-institutional customers could affect our collection rates. For example, because reimbursement under a DRG is
typically provided at a fixed amount intended to cover all services provided to the patient, the cost of our tests may be viewed to limit
the profitability of the billing institution. If we are unable to convince hospitals and medical institutions of the value and benefit
provided by our tests, or if the amount reimbursed under these DRG codes is decreased, these customers may slow, or stop altogether,
their purchases of our tests. Moreover, our ability to collect payment for our tests in a timely manner or at all may decline to the extent
we expand our business into new customer groups, including individual physicians and other practitioners, from which collection rates
may be lower than hospitals and medical institutions. Any inability to maintain our past payment collection levels could cause our
revenue and ability to achieve profitability to decline.
If third-party payors do not provide coverage and adequate reimbursement for our tests, our potential for growth could be
limited.
Coverage and reimbursement by third-party payors, including managed care organizations, private health insurers and
government healthcare programs, such as Medicare and Medicaid, for the types of genetic tests we perform can be limited and
uncertain. Although our existing customer base consists primarily of hospitals and medical institutions, from which we typically
receive direct payment for ordered tests, we believe our potential for future growth is dependent on our ability to attract new customer
groups, including individual physicians and other practitioners. These practitioners may not order our tests unless third-party payors
cover and provide adequate reimbursement for a substantial portion of the price of the tests. If we are not able to obtain coverage and
an acceptable level of reimbursement for our tests from third-party payors, there would typically be a greater co-insurance or co-
payment requirement from the patient for whom the test is ordered or the patient may be forced to pay the entire cost of the test out-of-
pocket, which could dissuade practitioners from ordering our tests and, if ordered, could result in delay in or decreased likelihood of
collecting payment, whether from patients or from third-party payors. We believe our ability to increase the number of tests we sell
and our revenue will depend in part on our ability to achieve broad coverage and reimbursement for our tests from third-party payors.
Coverage and reimbursement by a third-party payor may depend on a number of factors, including a payor’s determination that
a test is appropriate, medically necessary and cost-effective. Each payor makes its own decision as to whether to establish a policy or
enter into a contract to cover our tests and the amount it will reimburse for each test, and any determination by a payor regarding
coverage and amount of reimbursement for our tests would likely be made on an indication-by-indication basis. In addition, the coding
procedure used by all third-party payors with respect to establishing payment rates for various procedures, including our tests, is
complex, does not currently adapt well to the genetic tests we perform and may not enable coverage and adequate reimbursement rates
for our tests. Additionally, if we are not able to obtain sufficient clinical information in support of our tests, third-party payors could
designate our tests as experimental or investigational and decline to cover and reimburse our tests because of this designation. As a
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result, obtaining approvals from third-party payors to cover our tests and establishing adequate reimbursement levels is an
unpredictable, challenging, time-consuming and costly process, and we may never be successful.
To date, we have contracted directly with a regional physician services organization and a national health insurance company to
become an in-network provider and enrolled as a supplier in the Medicare program and some state Medicaid programs. Although
becoming an in-network provider or enrolling as a supplier means that we have agreed with these payors to provide certain of our tests
at negotiated rates, it does not obligate any physicians or other practitioners to order our tests or guarantee that we will receive
reimbursement for our tests from these or any other payors at adequate levels. As a result, these payor relationships, or any other
similar relationships we may establish in the future, may not lead to acceptable levels of reimbursement for our tests or meaningful or
any increases in our physician customer base or the number of billable tests we sell to physicians. We expect to focus on increasing
coverage and reimbursement for our current tests and any future tests we may develop, but we cannot predict whether, under what
circumstances, or at what payment levels payors will cover and reimburse for our tests. Further, even if we are successful, we believe
it could take several years to achieve coverage and adequate contracted reimbursement with third-party payors. If we fail to establish
and maintain broad coverage and reimbursement for our tests, our ability to generate sustained or increased revenue and maintain or
grow our test volume and customer base could be limited and our future prospects and our business could suffer.
We may not be successful in developing and marketing new tests, which could negatively impact our performance and
prospects.
We believe our future success will depend on our ability to continue to expand our test offering and develop and sell new tests.
We may not be successful in launching or marketing any new tests we may develop, and, even if we are successful, the demand for
our other tests could decrease or may not continue to increase at historical rates due to sales of the new tests. Our pipeline of new tests
is in various stages of development and will be time-consuming and costly to fully develop and introduce, as development and
marketing of new tests requires us to conduct research and development activities regarding the new tests and to further scale our
laboratory processes and infrastructure to be able to analyze increasing amounts of more diverse data. Further, we may be unable to
discover or develop and launch new tests for a variety of reasons, including failure of any proposed test to perform as expected, lack
of validation or reference data for the test or failure to demonstrate the utility of the test. Further, any new test we are able to discover
and develop may not be launched in a timely manner, meet applicable regulatory standards, successfully compete with other
technologies and available tests, avoid infringing the proprietary rights of others, achieve coverage and adequate reimbursement from
third-party payors, be capable of performance at commercial levels and at reasonable costs, be successfully marketed or achieve
sufficient market acceptance for us to recoup our time and capital investment in the development of the test. Any failure to
successfully develop, market and sell new tests could negatively impact our ability to attract and retain customers and our revenue and
prospects.
We are exposed to additional business, regulatory, political, operational, financial and economic risks related to our
international operations.
Our existing customer base includes international customers from a variety of geographic markets, including Canada, the PRC
and others. In addition, we have established FF Gene Biotech to offer genetic testing to customers in the PRC. As part of our strategy,
we aim to increase our volume of direct sales to international customers in a variety of geographic markets by conducting targeted
marketing outreach activities and, if opportunities arise, engaging distributors or establishing other types of arrangements, such as
joint ventures or other relationships. However, we may never be successful in achieving these objectives, and even if we are
successful, these strategies may not result in meaningful or any increases in our customer base, test volumes or revenue.
Doing business internationally involves a number of risks, including, among others:
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multiple, conflicting and evolving laws and regulations, such as privacy regulations, tax laws, employment laws,
regulatory requirements and other government approvals, including permitting and licensing requirements;
logistics associated with the shipment of blood or other tissue specimens, including infrastructure conditions,
transportation delays and the impact of U.S. and local laws and regulations, such as export and import restrictions, tariffs
or other charges and other trade barriers, all of which involve increased uncertainty following the results of the 2016 U.S.
presidential election and the trade policies of the current administration, which may threaten existing and proposed trade
agreements and impose more restrictive U.S. export-import regulations;
limits on our ability to penetrate international markets, including legal and regulatory requirements that would force us to
conduct our tests locally by building additional laboratories or engaging in joint ventures or other relationships in order to
offer our tests in certain countries, which relationships could involve significant time and resources to establish, deny us
control over certain aspects of the foreign operations or reduce the economic value to us of these operations;
failure by us, any joint ventures or other arrangements we may establish or any distributors or other commercial partners
we may engage to obtain any regulatory approvals required to market, sell and use our tests in various countries;
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challenges predicting the market for genetic testing generally and tailoring our test menu to meet varying customer
expectations in different countries and territories;
complexities and difficulties obtaining protection for and enforcing our intellectual property rights;
difficulties in staffing and managing foreign operations;
complexities associated with managing multiple payor coverage and reimbursement regimes, government payors or
patient self-pay systems;
financial risks, such as longer payment cycles, difficulty collecting accounts receivable and the impact of local and
regional financial conditions on demand and payment for our tests;
exposure to foreign currency exchange rate fluctuations, including increased risk with respect to the Canadian dollar after
we recently started billing certain of our Canadian hospital customers in their local currency and with respect to the
renminbi, or RMB, related to recording revenue under our agreements with FF Gene Biotech;
risks relating to conversion and repatriation of certain foreign currencies, particularly the RMB, which is subject to legal
procedures and restrictions on currency conversion and movement outside the PRC and which could impact our ability to
receive the anticipated financial benefits of our FF Gene Biotech joint venture;
natural disasters, political and economic instability, including wars, terrorism and political unrest, outbreak of disease,
boycotts and other business restrictions; and
regulatory and compliance risks related to applicable anti-bribery laws, including requirements to maintain accurate
information and control over activities that may fall within the purview of these laws.
Any of these factors could significantly harm our existing relationships with international customers or derail our international
expansion plans, which would cause our revenue and results of operations to suffer.
In addition, we are exposed to a number of additional risks and challenges related to FF Gene Biotech. These risks include,
among others, difficulties predicting the market for genetic testing in Asia, competitive factors in this market, including challenges
securing market share, local differences in customer demands and preferences and regulatory requirements, and our lack of control
over FF Gene Biotech due to our non-majority ownership interest, as well as many of the other risks of doing business internationally
that are discussed above. Further, we could experience declines in our direct sales to customers in Asia if any of these customers
choose to order genetic tests from FF Gene Biotech instead of from us. As a result of these risks, although we believe FF Gene
Biotech could result in expanded long-term opportunities to address the genetic testing market in Asia, this belief could turn out to be
wrong and we may never realize these or any other benefits we anticipate from this joint venture. Moreover, FF Gene Biotech or any
other joint venture we may seek to establish may never produce sufficient revenue to us to recover our capital and other investments in
the joint venture, the joint venture could cause our revenue to decrease if it results in our loss of any direct customers in Asia or other
applicable markets, and we could become subject to liabilities based on our involvement in the joint venture’s operations.
If we are sued for product or professional liability, we could face substantial liabilities that exceed our resources.
Our business depends on our ability to provide reliable and accurate test results that incorporate rapidly evolving information
about the role of genes and gene variants in disease and clinically relevant outcomes associated with these variants. Hundreds of genes
can be implicated in some disorders and overlapping networks of genes and symptoms can be implicated in multiple conditions. As a
result, substantial judgment is required in order to interpret the results of each test we perform and produce a report summarizing these
results. Errors, such as failures to detect genomic variants with high accuracy, or mistakes, such as failures to completely and correctly
identify the significance of gene variants, could subject us to product liability or professional liability claims. Any such claim against
us could result in substantial damages and be costly and time-consuming to defend. Although we maintain liability insurance,
including for errors and omissions, our insurance may not fully protect us from the financial impact of defending against these types of
claims or any judgments, fines or settlement costs arising out of any such claims. Additionally, any liability claim brought against us,
with or without merit, could increase our insurance rates or prevent us from securing adequate insurance coverage in the future.
Moreover, any liability lawsuit could damage our reputation or force us to suspend sales of our tests. The occurrence of any of these
events could have a material adverse effect on our business, reputation and results of operations.
If our sole laboratory facility becomes inoperable, if we are forced to vacate the facility or if we are unable to obtain additional
laboratory space as and when needed, we would be unable to perform our tests and our business would be harmed.
We perform all of our tests at a single laboratory in Temple City, California. Our laboratory facility could be damaged or
rendered inoperable by natural or man-made disasters, including earthquakes, floods, fires and power outages, which could render it
difficult or impossible for us to perform our tests for some period of time. The inability to perform our tests or the backlog that could
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develop if our laboratory becomes inoperable for even a short time could result in the loss of customers or harm to our reputation.
Although we maintain insurance for damage to our property and disruption of our business, this insurance may not be sufficient to
cover all of our potential losses and may not continue to be available to us on acceptable terms, if at all.
Further, if we need to move to a different facility or obtain additional laboratory space, we may have difficulty locating suitable
space in a timely manner, on reasonable terms or at all, and even if acceptable space was available, it would be challenging, time-
consuming and expensive to obtain or transfer the licensure and accreditation required for a commercial laboratory like ours and the
equipment we use to perform our tests. These challenges could be amplified if we or our joint ventures or other commercial partners,
such as FF Gene Biotech, seek to procure and maintain laboratory space outside the United States as we pursue international
expansion. If we are unable to obtain or are delayed in obtaining new laboratory space as needed, we may not be able to provide our
existing tests or develop and launch new tests, which could result in harm to our business, reputation, financial condition and results of
operations.
We rely on a limited number of suppliers and, in some cases, a sole supplier, for certain of our laboratory substances,
equipment and other materials, and any delays or difficulties securing these materials could disrupt our laboratory operations
and materially harm our business.
We rely on a limited number of suppliers for certain of our laboratory substances, including reagents, as well as for the
sequencers and various other equipment and materials we use in our laboratory operations. In particular, we rely on Illumina, Inc. as
the sole supplier of the next generation sequencers and associated reagents we use to perform our genetic tests and as the sole provider
of maintenance and repair services for these sequencers. We do not have long-term agreements with any of our suppliers and, as a
result, they could cease supplying these materials and equipment to us at any time due to an inability to reach agreement with us on
supply terms, disruptions in their operations, a determination to pursue other activities or lines of business or for other reasons, or they
could fail to provide us with sufficient quantities of materials that meet our specifications. Transitioning to a new supplier or locating a
temporary substitute, if any are available, would be time-consuming and expensive, could result in interruptions in or otherwise affect
the performance specifications of our laboratory operations or could require that we revalidate our tests. In addition, the use of
equipment or materials provided by a replacement supplier could require us to alter our laboratory operations and procedures.
Moreover, we believe there are currently only a few manufacturers that are capable of supplying and servicing some of the equipment
and other materials necessary for our laboratory operations, including sequencers and various associated reagents. As a result,
replacement equipment and materials that meet our quality control and performance requirements may not be available on reasonable
terms, in a timely manner or at all. If we encounter delays or difficulties securing, reconfiguring or revalidating the equipment,
reagents and other materials we require for our tests, our operations could be materially disrupted and our business, financial
condition, results of operations and reputation could be adversely affected.
Billing and collections processing for our tests is complex and time-consuming, and any delay in transmitting and collecting
claims could have an adverse effect on our revenue.
Billing for our tests is complex, time-consuming and expensive. Depending on the billing arrangement and applicable law, we
bill various different parties for our tests, including customers directly in the case of our hospital and medical institution customers, as
well as Medicare, Medicaid, insurance companies and patients, all of which may have different billing requirements. We may face
increased risk in our collection efforts due to the complexities of these billing requirements, including long collection cycles, which
could adversely affect our business, results of operations and financial condition.
Several factors make the billing process complex, including:
differences between the list price for our tests and the reimbursement rates of payors;
compliance with complex federal and state regulations related to billing government healthcare programs, including Medicare
and Medicaid;
disputes among payors as to which party is responsible for payment;
differences in coverage among payors and the effect of patient co-payments or co-insurance;
differences in information and billing requirements among payors;
incorrect or missing billing information; and
the resources required to manage the billing and claims appeals process.
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We have started to develop internal systems and procedures to handle these billing and collections functions and we have
engaged a third party to assist with some of these functions, but we will still need to make significant efforts and expend substantial
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resources to further develop our systems and procedures to handle these aspects of our business, which could become increasingly
important as we focus on establishing coverage and reimbursement policies with third-party payors. As a result, these billing
complexities, along with the related uncertainty in obtaining payment for our tests, could negatively affect our revenue and cash flow,
our ability to achieve or sustain profitability and the consistency and comparability of our results of operations. In addition, if claims
for our tests are not submitted to payors on a timely basis, or if we are required to switch to a different provider to handle our
processing and collections functions, our revenue and our business could be adversely affected.
Ethical, legal and social concerns related to the use of genetic information could reduce demand for our tests.
Genetic testing has raised ethical, legal and social issues regarding privacy and the appropriate uses of the resulting
information. Government authorities could, for social or other purposes, limit or regulate the use of genetic information or genetic
testing or prohibit testing for genetic predisposition to certain conditions, particularly for those that have no known cure. Similarly,
these concerns may cause patients to refuse to use, or physicians to be reluctant to order, genetic tests such as ours, even if
permissible. These and other ethical, legal and social concerns may limit market acceptance and adoption of our tests or reduce the
potential markets for our tests, any of which could have an adverse effect on our business, financial condition and results of
operations.
Actual or attempted security breaches, loss of data or other disruptions could compromise sensitive information related to our
business or to patients or prevent us from accessing critical information, any of which could expose us to liability and
adversely affect our business and our reputation.
In the ordinary course of our business, we generate, collect and store sensitive data, including PHI, personally identifiable
information, intellectual property and proprietary information and other business-critical information, such as research and
development data, commercial information and business and financial information. We manage and maintain the data we generate,
collect and store utilizing a combination of on-site systems and managed data center systems. We also communicate sensitive patient
data when we deliver reports summarizing test results to our customers, which we deliver via our online encrypted web portal,
encrypted email or fax or overnight courier. We face a number of risks related to protecting this information, including loss of access,
unauthorized modification or inappropriate disclosure.
The secure processing, storage, maintenance and transmission of this information are vital to our operations and business
strategy, and we devote significant resources to protecting the confidentiality and integrity of this information. Although we have
implemented security measures and other controls designed to protect sensitive information from unauthorized access, use or
disclosure, our information technology and infrastructure could fail, be inadequate or vulnerable to attacks by hackers or viruses or be
breached due to employee error, malfeasance or other disruptions. A breach or interruption could compromise our information
systems, and the information we store could be accessed by unauthorized parties, manipulated, publicly disclosed, lost or stolen. Any
such unauthorized access, manipulation, disclosure or other loss of information could result in legal claims or proceedings and could
result in liability or penalties under federal and state laws that protect the privacy of personal information, discussed below under “—
We are subject to broad legal requirements regarding the information we test and analyze, and any failure to comply with these
requirements could result in harsh penalties, damage our reputation and materially harm our business.” Additionally, unauthorized
access, manipulation, loss or dissemination could significantly damage our reputation and disrupt our operations, including our ability
to perform our tests, analyze and provide test results, bill customers or other payors, process claims for reimbursement, provide
customer service, conduct research and development activities, collect, process, and prepare company financial information, conduct
education and outreach activities and manage the administrative aspects of our operations, any of which could adversely affect our
business.
The loss of any member of our senior management team could adversely affect our business.
Our success depends in large part on the skills, experience and performance of our executive management team and others in
key leadership positions, especially Ming Hsieh, our founder, Chief Executive Officer and Chairman of our board of directors, and
Dr. Gao, our Chief Scientific Officer and Laboratory Director. The continued efforts of these persons will be critical to us as we
continue to develop our technologies and test processes and focus on growing our business. If we lose one or more key executives, we
could experience difficulties maintaining our operations, including the ability to deliver reports to customers after review and approval
by a licensed and qualified laboratory director, competing effectively, advancing our technologies, developing new tests and
implementing our business strategies. All of our executives and employees, including Mr. Hsieh and Dr. Gao, are at-will, which
means that either we or the executive or employee may terminate their employment at any time. We do not carry key man insurance
for any of our executives or other employees. In addition, we do not have long-term retention agreements in place with any of our
executives or key employees.
We rely on highly skilled personnel in a broad array of disciplines, and if we are unable to hire, retain or motivate these
individuals, we may not be able to maintain the quality of our tests or grow our business.
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Our business, including our research and development programs, laboratory operations and administrative functions, largely
depends on our continued ability to identify, hire, train, motivate and retain highly skilled personnel for all areas of our organization,
including biostatisticians, geneticists, software engineers, laboratory directors and specialists, sales and marketing experts and other
scientific, technical and managerial personnel. Competition in our industry for qualified executives and other employees is intense,
and we may not be able to attract or retain the qualified personnel we need to execute our business plans due to high levels of
competition for these personnel among our competitors, other life science businesses, universities and public and private research
institutions. In addition, our compensation arrangements may not be successful in attracting new employees and retaining and
motivating our existing employees. If we are not able to attract and retain the necessary personnel to accomplish our business
objectives, we may experience constraints that could adversely affect our ability to expand our business and support our clinical
laboratory operations and our sales and marketing and research and development efforts, which would negatively affect our prospects
for future growth and success.
Any inability to obtain additional capital when needed and on acceptable terms may limit our ability to execute our business
plans.
We expect our capital expenditures and operating expenses to increase over the next several years as we seek to expand our
infrastructure, sales and marketing and other commercial operations and research and development activities. We may seek to raise
additional capital through securities offerings, credit facilities or other debt financings, asset sales or collaborations or licensing
arrangements. Additional funding may not be available to us when needed, on acceptable terms or at all. If we raise 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. 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.
We may acquire businesses or assets, form joint ventures, make investments in other companies or technologies or establish
other strategic relationships that could harm our operating results, dilute our stockholders’ ownership or cause us to incur
debt or significant expense.
As part of our business strategy, we may pursue acquisitions of complementary businesses or assets, investments in other
companies, technology licensing arrangements, joint ventures or other strategic relationships. As an organization, we have limited
experience with respect to acquisitions, investments or the formation of strategic relationships or joint ventures. If we make
acquisitions in the future, we may not be able to successfully integrate the acquired businesses or technologies into our existing
operations, we could assume unknown or contingent liabilities and we could be forced to record significant write-offs or incur debt as
a result of the acquisitions, any of which could harm our operating results. Further, integration of an acquired business or technology
could involve significant difficulties, and could require management and capital resources that otherwise would be available for
ongoing development of our existing business or pursuit of other opportunities. If we pursue relationships with pharmaceutical
companies or other strategic relationships, our ability to establish and maintain these relationships could be challenging due to several
factors, including competition with other genetic testing companies and internal and external constraints placed on pharmaceutical and
other organizations that limit the number and type of relationships they can establish with companies like ours. Moreover, we may not
be able to identify or complete any acquisition, investment, technology license, joint venture or other strategic relationship in a timely
manner, on a cost-effective basis or at all, and we may not realize the anticipated benefits of any such transaction sufficiently to
recoup our costs.
To finance any acquisitions, investments, joint ventures or other strategic relationships, we may seek to raise additional funds
through securities offerings, credit facilities, asset sales or collaborations or licensing arrangements. Each of these methods of
fundraising is subject to a variety of risks, including those discussed above under “—Any inability to obtain additional capital when
needed and on acceptable terms may limit our ability to execute our business plans.” For example, we may seek to fund these
transactions with issuances of our capital stock, even if the price of our common stock is low or volatile, which would involve risks
associated with capital-raising equity offerings, including dilution to existing stockholders and the possible decline of the market price
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of our common stock. Further, additional funds from capital-raising transactions may not be available when needed, on acceptable
terms or at all. Any inability to fund any acquisitions, investments or strategic relationships we pursue could cause us to forfeit
opportunities we believe are promising or valuable, which could harm our prospects.
We depend on our information technology systems, and any failure of these systems, due to hardware or software
malfunctions, delays in operation, failures to implement new or enhanced systems or cybersecurity breaches, could harm our
business.
We depend on information technology and telecommunications systems for significant elements of our operations, such as our
laboratory information management systems, including test validation, specimen tracking and quality control; our bioinformatics
analytical software systems; our reference library of information relating to genetic variants and their role in disease; personal
information storage, maintenance and transmission; our customer-facing web-based software and customer service functions; our
report production systems; our billing and reimbursement procedures; our scientific and medical data analysis and other research and
development activities and programs; and our general and administrative activities, including disclosure controls, internal control over
financial reporting and other public reporting functions. In addition, our third-party service providers depend on technology and
telecommunications systems in order to provide contracted services for us. Now that we are a public company, we expect we will need
to continue to expand and strengthen a number of enterprise software systems that affect a broad range of business processes and
functions, particularly if and as our operations grow, including, for example, systems handling human resources, financial and other
disclosure controls and reporting, customer relationship management, regulatory compliance, security controls and other infrastructure
functions.
Information technology and telecommunications systems are vulnerable to disruption and damage from a variety of sources,
including power outages and other telecommunications or network failures, natural disasters, the outbreak of war or acts of terrorism.
Moreover, despite network security and back-up measures, our servers and other electronic systems are potentially vulnerable to
cybersecurity breaches, such as physical or electronic break-ins, computer viruses and similar disruptive events. Despite the
precautionary measures we have taken to detect and prevent or solve problems that could affect our information technology and
telecommunications systems, there may be significant downtime or failures of these systems or those used by our third-party service
providers. Any such downtime or failure could prevent us from conducting tests, preparing and providing reports to customers, billing
payors, responding to customer inquiries, conducting research and development activities, maintaining our financial and disclosure
controls and other reporting functions and managing the administrative aspects of our business. Moreover, any such downtime or
failure could force us to transfer data collection operations to an alternate provider of server-hosting services, which could involve
significant costs and result in further delays in our ability to conduct tests, deliver reports to our customers and otherwise manage our
operations. Further, although we carry property and business interruption insurance, the coverage may not be adequate to compensate
for all losses that may occur in the event of system downtime or failure. Any such disruption or loss of information technology or
telecommunications systems on which critical aspects of our operations depend could have a material adverse effect on our business
and our reputation.
Additionally, if and as our business grows, we will need to continually improve and expand the scope of our technology
systems in order to maintain their adequacy for the scale of our operations. Any failure to make such improvements or any significant
delay in the planned implementation of new or enhanced systems could render our systems obsolete or inadequate, in which case our
service to our customers and our other business activities could suffer and we could be more vulnerable to electronic breaches from
outside sources.
We rely on commercial courier delivery services to transport specimens to our laboratory facility in a timely and cost-efficient
manner, and if these delivery services are disrupted, our business would be harmed.
Our business depends on our ability to quickly and reliably deliver test results to our customers. We typically receive specimens
from customers within days of shipment, for analysis at our Temple City, California laboratory. Disruptions in delivery service,
whether due to labor disruptions, bad weather, natural disasters, terrorist acts or threats or for other reasons, could adversely affect
specimen integrity and our ability to process specimens in a timely manner and otherwise service our customers, and ultimately our
reputation and our business. In addition, if we are unable to continue to obtain expedited delivery services on commercially reasonable
terms, our operating results may be adversely affected.
Regulatory Risks
Any changes in laws, regulations or the enforcement discretion of the FDA with respect to the marketing of diagnostic
products, or violations of laws or regulations by us, could adversely affect our business, prospects, results of operations or
financial condition.
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The laws and regulations governing the marketing of diagnostic products are evolving, extremely complex and in many
instances, there are no significant regulatory or judicial interpretations of these laws and regulations. Pursuant to its authority under
the FDC Act, the FDA has jurisdiction over medical devices, including potentially our tests. Among other things, pursuant to the FDC
Act and its implementing regulations, the FDA regulates the research, testing, manufacturing, safety, labeling, storage, recordkeeping,
premarket clearance or approval, marketing and promotion, and sales and distribution of medical devices in the United States to
ensure that medical products distributed domestically are safe and effective for their intended uses. In addition, the FDA regulates the
import and export of medical devices.
Although the FDA has statutory authority to assure that medical devices, including potentially our tests, are safe and effective
for their intended uses, the FDA has historically exercised its enforcement discretion and not enforced applicable provisions of the
FDC Act and regulations with respect to LDTs, which are a particular type of medical device. We believe our tests are LDTs. As a
result, we believe our tests are not currently subject to the FDA’s enforcement of its medical device regulations and the applicable
FDC Act provisions.
Even though we commercialize our tests as LDTs, our tests may in the future become subject to more onerous regulation by the
FDA. For example, the FDA may disagree with our assessment that our tests fall within the definition of an LDT and seek to regulate
our tests as medical devices. Moreover, the FDA has issued draft guidance and a 2017 Discussion Paper to allow for further public
discussion about an appropriate LDT oversight approach and to give congressional committees the opportunity to develop a legislative
solution. The FDA has also solicited public input and published two draft guidance documents relating to FDA oversight of NGS-
based tests. These two draft guidance documents describe the FDA’s thinking and proposed approach regarding the possible use of
FDA-recognized standards to support analytical validity, and public human genetic variant databases to support clinical validity, of
these tests. Until the FDA finalizes its regulatory position regarding LDTs and NGS-based tests, or legislation is passed concerning
regulation of LDTs, it is unknown how the FDA may regulate our tests in the future and what testing and data may be required to
support any required clearance or approval.
If the FDA begins to enforce its medical device requirements for LDTs or if the FDA disagrees with our assessment that our
tests are LDTs, we could for the first time be subject to enforcement of a variety of regulatory requirements, including registration and
listing, medical device reporting and quality control, and we could be required to obtain premarket clearance or approval for our
existing tests and any new tests we may develop, which may force us to cease marketing our tests until we obtain the required
clearance or approval. The premarket review process can be lengthy, expensive, time-consuming and unpredictable. Further, obtaining
pre-market clearance may involve, among other things, successfully completing clinical trials. Clinical trials require significant time
and cash resources and are subject to a high degree of risk, including risks of experiencing delays, failing to complete the trial or
obtaining unexpected or negative results. If we are required to obtain premarket clearance or approval and/or conduct premarket
clinical trials, our development costs could significantly increase, our introduction of any new tests we may develop may be delayed
and sales of our existing tests could be interrupted or stopped. Any of these outcomes could reduce our revenue or increase our costs
and materially adversely affect our business, prospects, results of operations or financial condition. Moreover, any cleared or approved
labeling claims may not be consistent with our current claims or adequate to support continued adoption of and reimbursement for our
tests. For instance, if we are required by the FDA to label our tests as investigational, or if labeling claims the FDA allows us to make
are limited, order levels may decline and reimbursement may be adversely affected. As a result, we could experience significantly
increased development costs and a delay in generating additional revenue from our existing tests or from tests we may develop.
In addition, while we qualify all materials used in our products in accordance with CLIA regulations and guidelines, the FDA
could promulgate regulations or guidance documents impacting our ability to purchase materials necessary for the performance of our
tests. If any of the reagents we obtain from suppliers and use in our tests are affected by future regulatory actions, our business could
be adversely affected, including by increasing the cost of testing or delaying, limiting or prohibiting the purchase of reagents
necessary to perform testing with our products.
Failure to comply with any applicable FDA requirements could trigger a range of enforcement actions by the FDA, including
warning letters, civil monetary penalties, injunctions, criminal prosecution, recall or seizure, operating restrictions, partial suspension
or total shutdown of operations and denial of or challenges to applications for clearance or approval, as well as significant adverse
publicity.
If we fail to comply with applicable federal, state, local and foreign laboratory licensing requirements, we could lose the ability
to perform our tests or experience disruptions to our business.
We are subject to CLIA, a federal law that establishes quality standards for all laboratory testing and is intended to ensure the
accuracy, reliability and timeliness of patient results. CLIA requires that we hold a certificate specific to the laboratory examinations
we perform and that we comply with various standards with respect to personnel qualifications, facility administration, proficiency
testing, quality control, quality assurance and inspections. CLIA certification is required in order for us to be eligible to bill federal
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and state healthcare programs, as well as many private third-party payors, for our tests. We have obtained CLIA certification to
conduct our tests at our laboratory in Temple City, California. To renew this certification, we are subject to survey and inspection
every two years and we may be subject to additional unannounced inspections.
We are also required to maintain a license to conduct testing in the State of California. California laws establish standards for
day-to-day operation of our clinical reference laboratory in Temple City, including with respect to the training and skills required of
personnel, quality control and proficiency testing requirements. In addition, certain other states require us to maintain out-of-state
laboratory licenses or obtain approval on a test-specific basis to perform testing on specimens from these states. Additional states
could adopt similar licensure requirements in the future, which could require us to modify, delay or discontinue our operations in such
jurisdictions. We are also subject to regulation in foreign jurisdictions, which we expect will increase as we seek to expand
international utilization of our tests or if jurisdictions in which we pursue operations adopt new or modified licensure requirements.
Foreign licensure requirements could require review and modification of our tests in order to offer them in certain jurisdictions or
could impose other limitations, such as restrictions on the transport of human blood or other tissue necessary for us to perform our
tests that may limit our ability to make our tests available outside the United States. Additionally, complying with licensure
requirements in new jurisdictions may be expensive, time-consuming and subject us to significant and unanticipated delays.
Failure to comply with applicable clinical laboratory licensure requirements could result in a range of enforcement actions,
including license suspension, limitation or revocation, directed plan of correction, onsite monitoring, civil monetary penalties, civil
injunctive suits, criminal sanctions and exclusion from the Medicare and Medicaid programs, as well as significant adverse publicity.
Any sanction imposed under CLIA, its implementing regulations or state or foreign laws or regulations governing clinical laboratory
licensure, or our failure to renew our CLIA certificate or any other required local, state or foreign license or accreditation, could have
a material adverse effect on our business, financial condition and results of operations. In such case, even if we were able to bring our
laboratory back into compliance, we could incur significant expenses and lose revenue while doing so.
In addition to CLIA requirements, we elect to participate in the CAP accreditation program. CMS has deemed CAP standards to
be equally or more stringent than CLIA regulations and has approved CAP as a recognized accrediting organization. Inspection by
CAP is performed in lieu of inspection by CMS for CAP-accredited laboratories. Because we are accredited by the CAP Laboratory
Accreditation Program, we are deemed to also comply with CLIA. While not required to operate a CLIA-certified laboratory, many
private insurers require CAP accreditation as a condition to contracting with clinical laboratories to cover their tests. In addition, some
countries outside the United States require CAP accreditation as a condition to permitting clinical laboratories to test samples taken
from their citizens. Failure to maintain CAP accreditation could have a material adverse effect on the sales of our tests and the results
of our operations.
We are subject to broad legal requirements regarding the information we test and analyze and any failure to comply with
these requirements could result in harsh penalties, damage our reputation and materially harm our business.
Our business is subject to federal and state laws that protect the privacy and security of personal health information, including
HIPAA, HITECH and similar state laws, as well as numerous other federal, state and foreign laws, including consumer protection
laws and regulations, that govern the collection, dissemination, use, access to, confidentiality and security of patient health
information. In addition, new laws and regulations that further protect the privacy and security of medical records or medical
information are regularly considered by federal and state governments. Further, with the recent increase in publicity regarding data
breaches resulting in improper dissemination of consumer information, federal and state governments have passed or are considering
laws regulating the actions that a business must take if it experiences a data breach, such as prompt disclosure to affected customers.
The Federal Trade Commission and states’ Attorneys General have also brought enforcement actions and prosecuted some data breach
cases as unfair and/or deceptive acts or practices under the Federal Trade Commission Act. In addition to data breach notification
laws, some states have enacted statutes and rules requiring businesses to reasonably protect certain types of personal information they
hold or to otherwise comply with certain specified data security requirements for personal information. We intend to continue to
comprehensively protect all personal information and to comply with all applicable laws regarding the protection of such information.
Any failure to implement appropriate security measures to protect the confidentiality and integrity of personal information or
any breach or other failure of these systems resulting in the unauthorized access, manipulation, disclosure or loss of this information
could result in our noncompliance with these laws. Penalties for failure to comply with a requirement of HIPAA and HITECH vary
significantly depending on the failure and could include civil monetary or criminal penalties.
In addition, the interpretation, application and interplay of consumer and health-related data protection laws in the United
States, Europe and elsewhere are often uncertain, contradictory and in flux. As a result, it is possible that laws may be interpreted and
applied in a manner that is inconsistent with our current practices. Moreover, these laws and their interpretations are constantly
evolving and they may become more stringent over time. Complying with these laws or any new laws or interpretations of their
application could involve significant time and substantial costs or require us to change our business practices and compliance
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procedures in a manner adverse to our business. We may not be able to obtain or maintain compliance with the diverse privacy and
security requirements in all of the jurisdictions in which we currently or plan to do business, and failure to comply with any of these
requirements could result in civil or criminal penalties, harm our reputation and materially adversely affect our business.
We conduct business in a heavily regulated industry. Complying with the numerous statutes and regulations pertaining to our
business is expensive and time-consuming, and any failure by us, our consultants or commercial partners to comply could
result in substantial penalties.
Our industry and our operations are heavily regulated by various federal, state, local and foreign laws and regulations, and the
regulatory environment in which we operate could change significantly and adversely in the future. These laws and regulations
currently include, among others:
•
•
•
the FDA’s enforcement discretion with respect to LDTs;
CLIA’s and CAP’s regulation of our laboratory activities;
federal and state laws and standards affecting reimbursement by government payors, including certain coding requirements to
obtain reimbursement and certain changes to the payment mechanism for clinical laboratory services resulting from the
Protecting Access to Medicare Act of 2014, or PAMA;
• HIPAA and HITECH, which establish comprehensive federal standards with respect to the privacy and security of PHI, and
requirements for the use of certain standardized electronic transactions with respect to transmission of such information;
•
•
•
•
•
•
•
•
•
•
•
•
state laws governing the maintenance of personally identifiable information of state residents, including medical information,
and which impose varying breach notification requirements, some of which allow private rights of action by individuals for
violations and also impose penalties for such violations;
the federal Anti-Kickback Statute, which generally prohibits knowingly and willfully offering, paying, soliciting or receiving
remuneration, directly or indirectly, in return for or to induce a person to refer to an individual any good, facility, item or
service that is reimbursable under a federal healthcare program;
the federal Stark Law, which generally prohibits a physician from making a referral for certain designated health services
covered by the Medicare program, including laboratory and pathology services, if the physician or an immediate family
member has a financial relationship with the entity providing the designated health services;
the federal false claims laws, which generally impose liability on any person or entity that, among other things, knowingly
presents, or causes to be presented, a false or fraudulent claim for payment to the federal government;
the federal Civil Monetary Penalties Law, which generally prohibits, among other things, the offering or transfer of
remuneration to a Medicare or state healthcare program beneficiary if it is likely to influence the beneficiary’s selection of a
particular provider, practitioner or supplier of services reimbursable by Medicare or a state healthcare program;
the Affordable Care Act which, among other things, establishes a requirement for providers and suppliers to report and return
any overpayments received from government payors under the Medicare and Medicaid programs;
other federal and state fraud and abuse laws, such as anti-kickback laws, prohibitions on self-referral, fee-splitting
restrictions, insurance fraud laws, anti-markup laws, prohibitions on the provision of tests at no or discounted cost to induce
physician or patient adoption and false claims acts, some of which may extend to services reimbursable by any third-party
payor, including private insurers;
the federal Physician Sunshine Payment Act and various state laws on reporting relationships with healthcare providers and
customers, which could be determined to apply to our LDTs;
the prohibition on reassignment of Medicare claims;
state laws that prohibit other specified healthcare practices, such as billing physicians for tests that they order, waiving
coinsurance, copayments, deductibles and other amounts owed by patients, business corporations practicing medicine or
employing or engaging physicians to practice medicine and billing a state Medicaid program at a price that is higher than
what is charged to one or more other payors;
the FCPA and applicable foreign anti-bribery laws;
federal, state and local regulations relating to the handling and disposal of regulated medical waste, hazardous waste and
biohazardous waste and workplace safety for healthcare employees;
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•
•
laws and regulations relating to health and safety, labor and employment, public reporting, taxation and other areas applicable
to businesses generally, all of which are subject to change, including, for example, the significant changes to the taxation of
business entities were enacted in December 2017; and
similar foreign laws and regulations that apply to us in the countries in which we operate or may operate in the future.
Any future growth of our business, including, in particular, growth of our international business and continued reliance on
consultants, commercial partners and other third parties, may increase the potential for violating these laws. In some cases, our risk of
violating these or other laws and regulations is further increased because of the lack of their complete interpretation by applicable
regulatory authorities or courts, and their provisions are thus open to a variety of interpretations.
We have adopted policies and procedures designed to comply with these laws and regulations and, in the ordinary course of our
business, we conduct internal reviews of our compliance with these laws. Our compliance is also subject to review by applicable
government agencies. It is not always possible to identify and deter misconduct by employees, distributors, consultants and
commercial partners, and the precautions we take to detect and prevent this activity may not be effective in controlling unknown or
unmanaged risks or losses or in protecting us from government investigations or other actions or lawsuits stemming from a failure to
comply with applicable laws or regulations. Additionally, we are subject to the risk that a person or government could allege such
fraud or other misconduct, even if none occurred. Any action brought against us for violation of these or other laws or regulations,
even if we successfully defend against it, could cause us to incur significant legal expenses, divert our management’s attention from
the operation of our business and harm our reputation. If our operations, including the conduct of our employees, consultants and
commercial partners, are found to be in violation of any of these laws and regulations, we may be subject to applicable penalties
associated with the violation, including administrative, civil and criminal penalties, damages, fines, individual imprisonment,
exclusion from participation in federal healthcare programs, refunding of payments received by us and curtailment or cessation of our
operations. Any of these consequences could seriously harm our business and our financial results.
Healthcare policy changes, including recently enacted and proposed new legislation reforming the U.S. healthcare system,
could cause significant harm to our business, operations and financial condition.
The Affordable Care Act made a number of substantial changes to the way healthcare is financed both by governmental and
private insurers. For example, the Affordable Care Act requires each medical device manufacturer to pay an excise tax on the medical
devices it sells. The medical device tax has been suspended through 2019. It is unclear at this time when, or if, sales of our LDTs will
trigger the medical device tax, and it is possible that this tax will apply to some or all of our existing tests or tests we may develop in
the future. Additionally, the Affordable Care Act introduces mechanisms to reduce the per capita rate of growth in Medicare spending
if expenditures exceed certain targets. Any such reductions could affect reimbursement payments for our tests. The Affordable Care
Act also contains a number of other provisions, including provisions governing enrollment in federal and state healthcare programs,
reimbursement matters and fraud and abuse, which we expect will impact our industry and our operations in ways that we cannot
currently predict.
In April 2014, Congress passed PAMA, which included substantial changes to the way in which clinical laboratory services will
be paid under Medicare. Under PAMA, certain clinical laboratories are required to periodically report to CMS private payor payment
rates and volumes for their tests. Laboratories that fail to report the required payment information may be subject to substantial civil
monetary penalties. As required under PAMA, CMS will use the rates and volumes reported by laboratories to develop Medicare
payment rates for laboratory tests equal to the volume-weighted median of the private payor payment rates for the tests, effective
January 1, 2018. The impact of this new payment system on rates for our tests, including any current or future tests we may develop, is
uncertain.
We cannot predict whether or when these or other recently enacted healthcare initiatives will be implemented at the federal or
state level or how any such legislation or regulation may affect us. For instance, the payment reductions imposed by the Affordable
Care Act and the changes to reimbursement amounts paid by Medicare for tests such as ours based on the procedure set forth in
PAMA, could limit the prices we will be able to charge or the amount of available reimbursement for our tests, which would reduce
our revenue. Additionally, these healthcare policy changes could be amended or additional healthcare initiatives could be implemented
in the future. For instance, there is uncertainty regarding the continued effect or the Affordable Care Act in its current form following
the results of the 2016 U.S. presidential election and in light of the policies of the current administration, which has threatened to
repeal, replace or change the Affordable Care Act. Further, the impact on our business of the expansion of the federal and state
governments’ role in the U.S. healthcare industry generally, including the social, governmental and other pressures to reduce
healthcare costs while expanding individual benefits, is uncertain. Any future changes or initiatives could have a materially adverse
effect on our business, financial condition, results of operations and cash flows.
If the hazardous materials we use in our operations cause contamination or injury, we could be liable for resulting damages.
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Our operations require the use of regulated medical waste, hazardous waste and biohazardous waste, including chemicals,
biological agents and compounds and blood and other tissue specimens. We are subject on an ongoing basis to federal, state and local
laws and regulations governing the use, storage, handling and disposal of these hazardous materials and other specified waste
products. Although we typically use licensed or otherwise qualified outside vendors to dispose of this waste, applicable laws and
regulations could hold us liable for damages and fines if our, or others’, business operations or other actions result in contamination to
the environment or personal injury due to exposure to hazardous materials. We cannot eliminate the risk of contamination or injury,
and any liability imposed on us for any resulting damages or injury could exceed our resources or any applicable insurance coverage.
The cost to secure such insurance coverage and to comply with these laws and regulations could become more significant in the
future, and any failure to comply could result in substantial costs and other business and reputational consequences, any of which
could negatively affect our operating results.
We could be adversely affected by violations of the FCPA and other anti-bribery laws.
Our international operations are subject to various anti-bribery laws, including the FCPA and similar anti-bribery laws in the
non-U.S. jurisdictions in which we operate. The FCPA prohibits companies and their intermediaries from offering, making, or
authorizing improper payments to non-U.S. or foreign officials for the purpose of obtaining or retaining business or securing any other
improper advantage. These laws are complex and far-reaching in nature, and we may be required in the future to alter one or more of
our practices to be in compliance with these laws or any changes to these laws or their interpretation.
We currently engage in significant business outside the United States, and we plan to increase our international operations in
the future. These operations could involve dealings with governments, foreign officials and state-owned entities, such as government
hospitals, outside the United States. In addition, we may engage distributors, other commercial partners or third-party intermediaries,
such as representatives or contractors, or establish joint ventures or other arrangements to manage or assist with promotion and sale of
our tests abroad and obtaining necessary permits, licenses and other regulatory approvals. Any such third parties could be deemed to
be our agents and we could be held responsible for any corrupt or other illegal activities of our employees or these third parties, even
if we do not explicitly authorize or have actual knowledge of such activities. We have instituted policies, procedures, and internal
controls reasonably designed to promote compliance with the FCPA and other anti-corruption laws and we exercise a high degree of
vigilance in maintaining, implementing and enforcing these policies and controls. However, these policies and controls could be
circumvented or ignored and they cannot guarantee compliance with these laws and regulations. Any violations of these laws or
allegations of such violations could disrupt our operations, involve significant management distraction, involve significant costs and
expenses, including legal fees, and harm our reputation. Additionally, other U.S. companies in the medical device and pharmaceutical
fields have faced substantial fines and criminal penalties in the recent past for violating the FCPA, and we could also incur these types
of penalties, including criminal and civil penalties, disgorgement, and other remedial measures, if we violate the FCPA or other
applicable anti-bribery laws. Any of these outcomes could result in a material adverse effect on our business, prospects, financial
condition, or results of operations.
Our services present the potential for embezzlement, identity theft or other similar illegal behavior by our employees,
consultants, service providers or commercial partners.
Our operations involve the use and disclosure of personal and business information that could be used to impersonate third
parties or otherwise gain access to their data or funds. If any of our employees, consultants, service providers or commercial partners
takes, converts or misuses these funds or data, we could be liable for any resulting damages, which could harm our financial condition
and damage our business reputation.
Intellectual Property Risks
We currently own no patents or patent applications related to our technology platform and rely on trade secret protection,
non-disclosure agreements and invention assignment agreements to protect our proprietary information, which may not be
effective.
We currently rely on trade secret protection, non-disclosure agreements and invention assignment agreements with our
employees, consultants and third-parties to protect our confidential and proprietary information. Although our competitors have
utilized and are expected to continue to utilize technologies and methods similar to ours and have aggregated and are expected to
continue to aggregate libraries of genetic information similar to ours, we believe our success will depend in part on our ability to
develop proprietary methods and libraries and to defend any advantages afforded to us by these methods and libraries relative to our
competitors. If we do not protect our intellectual property and other confidential information adequately, competitors may be able to
use our proprietary technologies and information and thereby erode any competitive advantages they provide us.
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We will be able to protect our proprietary rights from unauthorized use by third parties only to the extent these rights are
effectively maintained as confidential. We expect to rely primarily on trade secret and contractual protections for our confidential and
proprietary information, and we have taken security measures we believe are appropriate to protect this information. These measures,
however, may not provide adequate protection for our trade secrets, know-how or other confidential information. We seek to protect
our proprietary information by, among other things, entering into confidentiality agreements with employees, consultants and other
third parties. These confidentiality agreements may not sufficiently safeguard our trade secrets and other confidential information, and
may not provide adequate remedies in the event of unauthorized use or disclosure of this information. Enforcing a claim that a party
illegally disclosed or misappropriated a trade secret or other proprietary information could be difficult, expensive and time-consuming
and the outcome could be unpredictable. In addition, trade secrets or other confidential information could otherwise become known or
be independently developed by others in a manner that could prevent legal recourse by us. If any of our trade secrets or other
confidential or proprietary information were disclosed or misappropriated or if any such information was independently developed by
a competitor, our competitive position could be harmed and our business could suffer.
Litigation or other proceedings or third-party claims of intellectual property infringement or misappropriation could require
us to spend significant time and money and prevent us from selling our tests.
We believe our ability to succeed will depend in part on our avoidance of infringement of patents and other proprietary rights
owned by third parties, including the intellectual property rights of competitors. There are numerous third-party-owned U.S. and
foreign patents, pending patent applications and other intellectual property rights that cover technologies relevant to genetic testing.
We may be unaware of patents or other intellectual property rights that a third-party might assert are infringed by our business, and
there may be pending patent applications that, if issued, could be asserted against us. As a result, our existing or future operations may
be alleged or found to infringe existing or future patents or other intellectual property rights of others. Moreover, as we continue to sell
our existing tests and if we launch new tests and enter new markets, competitors may claim that our tests infringe or misappropriate
their intellectual property rights as part of strategies designed to impede our existing operations or our entry into new markets.
If a patent infringement or misappropriation of intellectual property lawsuit was brought against us, we could be forced to
discontinue or delay our development or sales of any tests or other activities that are the subject of the lawsuit while it is pending, even
if it is not ultimately successful. In the event of a successful claim of infringement against us, we could be forced to pay substantial
damages, including treble damages and attorneys’ fees if we were found to have willfully infringed patents; obtain one or more
licenses, which may not be available when needed, on commercially reasonable terms or at all; pay royalties, which may be
substantial; or redesign any infringing tests or other activities, which may be impossible or require substantial time and expense. In
addition, third parties making claims against us for infringement or misappropriation of their patents or other intellectual property
rights could seek and obtain injunctive or other equitable relief, which, if granted, could prohibit us from performing our tests. Further,
defense against these claims, regardless of their merit or success, could cause us to incur substantial expenses, be a substantial
diversion to our management and other employee resources and significantly harm our reputation. Any of these outcomes could delay
our introduction of new tests, significantly increase our costs or prevent us from conducting certain of our essential activities, which
could materially adversely affect our ability to operate and grow our business.
Developments in patent law could have a negative impact on our business.
From time to time, the U.S. Supreme Court, other federal courts, the U.S. Congress or the U.S. Patent and Trademark Office, or
USPTO, may change the standards of patentability, and any such changes could have a negative impact on our business.
Three cases involving diagnostic method claims and “gene patents” have been decided by the Supreme Court in recent years. In
March 2012, the Supreme Court issued a decision in Mayo Collaborative v. Prometheus Laboratories, or Prometheus, a case
involving patent claims directed to optimizing the amount of drug administered to a specific patient, holding that the applicable
patents’ claims failed to incorporate sufficient inventive content above and beyond mere underlying natural correlations to allow the
claimed processes to qualify as patent-eligible processes that apply natural laws. In June 2013, the Supreme Court decided Association
for Molecular Pathology v. Myriad Genetics, or Myriad, a case challenging the validity of patent claims relating to the breast cancer
susceptibility genes BRCA1 and BRCA2, holding that isolated genomic DNA that exists in nature, such as the DNA constituting the
BRCA1 and BRCA2 genes, is not patentable subject matter, but that cDNA, which is an artificial construct created from RNA
transcripts of genes, may be patent eligible. In June 2014, the Supreme Court decided Alice Corporation Pty. Ltd. v. CLS Bank
International, or Alice, which affirmed the Prometheus and Myriad decisions and provided additional interpretation.
If we make efforts to seek patent protection for our technologies and tests, these efforts may be negatively impacted by the
Prometheus, Myriad and Alice decisions, rulings in other cases or guidance or procedures issued by the USPTO. However, we cannot
fully predict the impact of the Prometheus, Myriad and Alice decisions on the ability of genetic testing, biopharmaceutical or other
companies to obtain or enforce patents relating to DNA, genes or genomic-related discoveries in the future, as the contours of when
claims reciting laws of nature, natural phenomena or abstract ideas may meet patent eligibility requirements are not clear and may take
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years to develop via interpretation at the USPTO and in the courts. There are many previously issued patents claiming nucleic acids
and diagnostic methods based on natural correlations that issued before these recent Supreme Court decisions and, although many of
these patents may be invalid under the standards set forth in these decisions, they are presumed valid and enforceable until they are
successfully challenged, and third parties holding these patents could allege that we infringe or request that we obtain a license under
the patents. Whether based on patents issued before or after these Supreme Court decisions, we could be forced to defend against
claims of patent infringement or obtain license rights, if available, under these patents. In particular, although the Supreme Court has
held in Myriad that isolated genomic DNA is not patent-eligible subject matter, third parties could allege that our activities infringe
other classes of gene-related patent claims. There are numerous risks associated with any patent infringement claim that may be
brought against us, as discussed above under “—Litigation or other proceedings or third-party claims of intellectual property
infringement or misappropriation could require us to spend significant time and money and prevent us from selling our tests.”
In addition, the Leahy-Smith America Invents Act, or America Invents Act, which was signed into law in 2011, includes a
number of significant changes to U.S. patent law. These changes include a transition from a “first-to-invent” system to a “first-to-file”
system, changes to the way issued patents are challenged and changes to the way patent applications are disputed during the
examination process. These changes may favor larger and more established companies that have greater resources to devote to patent
application filing and prosecution. The USPTO has developed new regulations and procedures to govern the full implementation of
the America Invents Act, but the impact of the America Invents Act on the cost of prosecuting any patent applications we may file,
our ability to obtain patents based on our discoveries if we pursue them and our ability to enforce or defend any patents that may issue
remains uncertain.
These and other substantive changes to U.S. patent law could affect our susceptibility to patent infringement claims and our
ability to obtain any patents we may pursue and, if obtained, to enforce or defend them, any of which could have a material adverse
effect on our business.
We may not be able to enforce our intellectual property rights outside the United States.
The laws of some foreign countries do not protect proprietary rights to the same extent as the laws of the United States, and
many companies have encountered significant challenges in establishing and enforcing their proprietary rights outside the United
States. These challenges can be caused by the absence of rules and methods for the establishment and enforcement of intellectual
property rights in certain jurisdictions. In addition, the legal systems of some countries, particularly developing countries, do not favor
the enforcement of certain intellectual property protection, especially relating to healthcare. These aspects of many foreign legal
systems could make it difficult for us to prevent or stop the misappropriation of our intellectual property rights in these jurisdictions.
Moreover, changes in the law and legal decisions by courts in foreign countries could affect our ability to obtain adequate protection
for our technologies and enforce our intellectual property rights. As a result, our efforts to protect and enforce our intellectual property
rights outside the United States may prove inadequate, in which case our ability to remain competitive and grow our business and
revenue could be materially harmed.
Third parties may assert that our employees or consultants have wrongfully used or disclosed confidential information or
misappropriated trade secrets.
We employ individuals who were previously employed at universities and biometric solution, genetic testing, diagnostic or
other healthcare companies, including our competitors or potential competitors. Further, we may become subject to ownership
disputes in the future arising from, for example, conflicting obligations of consultants or others who are involved in developing our
and other parties’ technologies and intellectual property rights. Although we try to ensure that our employees and consultants do not
use the proprietary information or know-how of others in their work for us, we may be subject to claims that we or our employees or
consultants have inadvertently or otherwise used or disclosed intellectual property rights, including trade secrets or other proprietary
information, of a former employer or other third-party. Litigation may be necessary to defend against these claims, should they arise.
If we fail in defending against any such claims, we could be subject to monetary damages and the loss of valuable intellectual property
rights or personnel. Even if we are successful in defending against any such claims, litigation could result in substantial costs, distract
management and other employees and damage our reputation.
Public Company Risks
We are incurring increased costs and demands in order to comply with laws and regulations applicable to public companies.
As a public company, we are experiencing significant additional demands that we did not experience as a private company. For
example, the Sarbanes-Oxley Act of 2002, as amended, or Sarbanes-Oxley Act, and related and other rules implemented by the SEC
and the Nasdaq Stock Market, or Nasdaq, impose a number of requirements on public companies that are not applicable to private
companies, including with respect to corporate governance practices. For instance, as a result of becoming a public company, a
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majority of our directors are required to be independent and we are required to maintain audit and compensation committees
comprised solely of independent directors, maintain a variety of corporate governance policies, adopt and maintain policies regarding
internal and disclosure controls and procedures and prepare reports on our internal control over financial reporting. Until completion
of our reorganization from a limited liability company to a corporation in September 2016, we operated without a board of directors
under the direction of Mr. Hsieh, who served as the Manager of our predecessor Fulgent LLC. Further, the SEC and other regulators
have continued to adopt new rules and regulations and make additional changes to existing regulations that require our compliance,
including pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act, or Dodd-Frank Act, enacted in July 2010.
There are significant corporate governance and executive compensation-related disclosure and other provisions in the Dodd-Frank Act
that require the SEC to adopt additional rules and regulations in these areas.
Moreover, compliance with the rules and regulations applicable to public companies has increased our legal, accounting and
financial compliance costs. For instance, we have hired additional personnel for, and devoted more resources to, our financial
reporting functions since becoming a public company, and these needs will increase if our operations grow. Additionally, if we
continue to grow, we will need to implement new and more sophisticated financial and accounting systems and adopt additional
procedures for financial reporting in order to continue to meet our obligations as a public company. Any transition of accounting
systems can be expensive and can result in delays in our ability to process and report transactions in a timely manner. Our
management and other personnel will need to continue to devote significant attention to maintaining our compliance with these
obligations, which is time-consuming and expensive. If these requirements divert the attention of management and other personnel
from other aspects of our operations or if they require substantial costs, our business, financial condition and results of operations
could be adversely affected. We also expect that, as a public company, it will be more expensive for us to attract and compensate
qualified directors and officers and secure adequate director and officer liability insurance at a reasonable cost to us.
If we are unable to maintain effective internal control over financial reporting, investors could lose confidence in the accuracy
and completeness of our reported financial information and the market price of our common stock could decline.
As a public company, we are required to maintain internal control over financial reporting and report any material weaknesses
in these internal controls. Section 404 of the Sarbanes-Oxley Act requires that we evaluate and determine the effectiveness of our
internal control over financial reporting and, beginning with this report, provide a management report on these internal controls.
Although we have implemented systems, processes and controls and performed this evaluation as of the end of 2017, we will need to
maintain and enhance them if and as we grow, and we may need to hire additional personnel and devote more resources to our
financial reporting function in order to do so.
If we identify one or more material weaknesses during the process of annually evaluating our internal controls, we may not
detect errors on a timely basis and our financial statements may be materially misstated. In addition, in that event, our management
would be unable to conclude that our internal control over financial reporting is effective. Further, when we are no longer an emerging
growth company or smaller reporting company, our independent registered public accounting firm will be required to issue an
attestation report on the effectiveness of our internal control over financial reporting. When that occurs, our independent registered
public accounting firm may conclude that there are material weaknesses in our internal controls or the level at which our internal
controls are documented, designed, implemented or reviewed even if our management concludes that our internal control over
financial reporting is effective.
If we or our auditors were to conclude that our internal control over financial reporting was not effective because one or more
material weaknesses had been identified or if internal control deficiencies result in the restatement of our financial results, investors
could lose confidence in the accuracy and completeness of our financial disclosures and the price of our common stock could decline.
Our disclosure controls and procedures may not prevent or detect all errors or acts of fraud.
As a result of becoming a public company, we are now subject to the periodic reporting and other requirements of the Exchange
Act. We have implemented disclosure controls and procedures designed to provide reasonable assurance that information we must
disclose in reports we file or submit under the Exchange Act is accumulated and communicated to management and recorded,
processed, summarized and reported within the time periods specified in the rules and forms of the SEC. However, any disclosure
controls and procedures, no matter how well-conceived and operated, can provide only reasonable, not absolute, assurance that the
objectives of the control system are met. These inherent limitations include the realities that judgments in decision-making can be
faulty and that breakdowns can occur because of simple errors or mistakes. Additionally, controls can be circumvented by the
individual acts of some persons, by collusion of two or more people or by an unauthorized override of the controls. As a result,
because of these inherent limitations in our control system, misstatements or omissions due to error or fraud may occur and may not
be detected, which could result in failures to file required reports in a timely manner and filing reports containing incorrect
information. Any of these outcomes could result in SEC enforcement actions, monetary fines or other penalties, damage to our
reputation and harm to our financial condition and stock price.
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We may elect to comply with reduced public company reporting requirements available to us because we are an emerging
growth company and a smaller reporting company, which could make our common stock less attractive to investors.
We are an emerging growth company, as defined in the JOBS Act, and we will remain an emerging growth company until
December 31, 2021, unless our gross revenue exceeds $1.07 billion in any fiscal year before that date, we issue more than $1.0 billion
of non-convertible debt in any three-year period before that date or the market value of our common stock held by non-affiliates
exceeds $700.0 million as of the last business day of the second fiscal quarter of any fiscal year before that date. In addition, as of the
end of 2017, we are a smaller reporting company, as defined in applicable SEC rules, and we will remain a smaller reporting company
until the market value of our common stock held by non-affiliates equals or exceeds $75.0 million as of the last business day of the
second fiscal quarter of our current fiscal year or any future fiscal year. As an emerging growth company and a smaller reporting
company, we are eligible for exemptions from certain reporting requirements applicable to other public companies, including an
exemption from the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act, reduced financial statement and other
financial disclosure requirements in registration statements and periodic reports we file, reduced disclosure obligations regarding
executive compensation and, so long as we remain an emerging growth company, exemption from the requirements to hold non-
binding advisory votes on executive compensation and obtain stockholder approval of any golden parachute payments not previously
approved. We have relied on many of these exemptions in our registration statements and periodic reports to date, and investors may
find our common stock less attractive if we choose to continue to rely on these exemptions, in which case there may be a less active
trading market for our common stock and our stock price may be more volatile.
Under the Securities Act, emerging growth companies can elect to delay adoption of new or revised accounting standards until
those standards apply to private companies. We have irrevocably elected not to avail ourselves of this exemption and, as a result, we
are subject to the same new or revised accounting standards at the same time as other public companies that are not emerging growth
companies.
Common Stock Risks
An active, liquid trading market for our common stock may never develop, which could make it difficult for stockholders to
sell their shares of our common stock.
Prior to the completion of our initial public offering in October 2016, no public market for our common stock existed. An active
trading market for our common stock may never develop, or if developed, may not be sustained. Further, as of March 1, 2018,
Mr. Hsieh, our founder, Chief Executive Officer and Chairman of our board of directors, beneficially owned approximately 44% of
our outstanding voting equity. As a result, fewer shares are actively traded in the public market, which reduces the liquidity of our
common stock. The lack of an active trading market could impair our stockholders’ ability to sell their shares at the desired time or at
a price considered reasonable. Further, an inactive trading market may impair our ability to raise capital by selling shares of our
common stock in the future, and may impair our ability to enter into strategic relationships or acquire companies or technologies using
shares of our common stock as consideration.
Our common stock is listed on the Nasdaq Global Market under the symbol “FLGT.” If we fail to satisfy the continued listing
standards of Nasdaq, however, we could be de-listed, which would negatively impact the price and liquidity of our common stock.
The price of our common stock may be volatile and you could lose all or part of your investment.
The trading price of our common stock has experienced, and may continue to experience, wide fluctuations and significant
volatility. This volatility may be exacerbated by the relatively small and illiquid market for our common stock. Other factors that may
contribute to this volatility include, among others:
•
•
•
•
•
actual or anticipated fluctuations in our operating results;
competition from existing tests or new tests that may emerge, particularly if competitive factors in our industry, including
prices for genetic testing, become more acute;
failures to meet or exceed financial estimates and projections of the investment community or guidance we have provided to
the public;
issuance of new or updated research or reports by securities analysts or changed recommendations for our common stock;
announcements by us or our competitors of significant acquisitions, investments, strategic relationships, joint ventures,
collaborations or capital commitments;
35
•
•
•
•
•
•
•
•
•
•
the timing and amount of our investments in our business and the market’s perception of these investments and their impact
on our prospects;
actual or anticipated changes in laws or regulations applicable to our business or our tests;
additions or departures of key management or other personnel;
changes in coverage and reimbursement by current or potential payors;
inability to obtain additional funding as and when needed on reasonable terms;
disputes or other developments with respect to our or others’ intellectual property rights;
product liability claims or other litigation;
sales of our common stock by us or our stockholders;
general economic, political, industry and market conditions, including factors not directly related to our operating
performance or the operating performance of our competitors, such as increased uncertainty in the U.S. regulatory
environment for healthcare, trade and tax-related matters following the results of the 2016 U.S. presidential election;
and the other risk factors discussed in this report.
In addition, the stock market in general, and the market for the stock of companies in the life sciences and technology industries
in particular, has experienced extreme price and volume fluctuations in recent years that have at times been unrelated or
disproportionate to the operating performance of specific companies. These broad market and industry factors may negatively affect
the market price of our common stock, regardless of our actual operating performance. In addition, in the past, following periods of
volatility in the overall market and the market price of a particular company’s securities, securities class action litigation has often
been instituted against the company. This type of litigation, if instituted against us, could result in substantial costs and a diversion of
our management’s attention and resources.
Our principal stockholders and management own a significant percentage of our capital stock and are able to exert significant
control over matters subject to stockholder approval.
As of March 1, 2018, our executive officers, directors, holders of 5% or more of our outstanding voting equity and their
respective affiliates collectively beneficially owned approximately 70.1% of our outstanding voting equity, and Mr. Hsieh, our
founder, Chief Executive Officer and Chairman of our board of directors, beneficially owned approximately 44% of our outstanding
voting equity. As a result, these stockholders have the ability to control matters submitted to our stockholders for approval, including
elections of directors, amendments to our organizational documents or approval of any merger, sale of assets or other major corporate
transaction. This concentration of ownership may prevent or discourage unsolicited acquisition proposals or offers to acquire our
common stock that some of our stockholders feel are in their best interests, as the interests of these stockholders may not coincide with
the interests of our other stockholders and they may act in a manner that advances their best interests and not necessarily those of all of
our stockholders. Further, this concentration of ownership could adversely affect the prevailing market price for our common stock.
Sales of a substantial number of shares of our common stock in the public market, or the perception that such sales could
occur, could cause the price of our common stock to fall.
Sales of a substantial number of shares of our common stock in the public market could occur at any time. Any such sales, or
the perception in the market that sales are pending or could occur, could reduce the market price of our common stock. As of March 1,
2018, we had 17,866,870 outstanding shares of common stock. All of these shares are freely tradable without restriction in the public
market, subject to certain volume and manner of sale limitations applicable to shares held by our affiliates, as that term is defined in
the Securities Act.
Moreover, Xi Long, which holds an aggregate of 2,025,623 shares of our common stock, has the right, subject to certain
conditions, to include its shares in registration statements we may file for ourselves or other stockholders and to require us to file
registration statements covering its shares following May 16, 2019. In addition, as of December 31, 2017, there were 1,399,082 shares
of our common stock subject to outstanding equity-based awards and 487,826 additional shares of our common stock reserved for
issuance pursuant to future such awards that we may grant under our equity incentive plan. Subject to certain volume and manner of
sale limitations applicable to our affiliates and any other applicable legal and contractual limitations, all of these shares are registered
under the Securities Act or are otherwise eligible under applicable securities laws for free trading in the public market upon their
issuance.
36
Future issuances of our common stock or rights to purchase our common stock, including pursuant to our equity incentive
plan, could result in additional dilution to the percentage ownership of our stockholders and could cause the price of our
common stock to fall.
To raise capital or for other strategic purposes, we may sell common stock, convertible securities or other equity securities in one or
more transactions at prices and in a manner we determine from time to time. We also may issue common stock or grant other equity
awards for compensatory purposes under our equity incentive plan. If we issue common stock, convertible securities or other equity
securities, including equity awards under our equity incentive plan, our then-existing stockholders could be materially diluted by such
issuances and, if we issue preferred stock, new investors could gain rights, preferences and privileges senior to the holders of our
common stock, any of which could cause the price of our common stock to decline.
We do not intend to pay dividends on our common stock, so any returns will be limited to the value of our common stock.
We currently anticipate that we will retain any future earnings to finance the continued development, operation and expansion
of our business. As a result, we do not anticipate declaring or paying any cash dividends or other distributions in the foreseeable
future. Further, if we were to enter into a credit facility or issue debt securities or preferred stock in the future, we may be
contractually restricted from paying dividends. If we do not pay dividends, our common stock may be less valuable because
stockholders must rely on sales of their common stock after price appreciation, which may never occur, to realize any gains on their
investment.
If securities or industry analysts do not publish research or reports about our business or if they issue an adverse or
misleading opinion regarding our common stock, our stock price and trading volume could decline.
If a trading market for our common stock develops, that trading market will be influenced by the research and reports that
industry or securities analysts publish about us or our business. We have only recently obtained research coverage by securities and
industry analysts. If one or more of these analysts ceases coverage of us or fails to publish reports on us regularly, we could lose
visibility in the financial markets, which could cause the price and trading volume of our common stock to decline. Further, if any of
these analysts issues an adverse or misleading opinion regarding us, our business model, our industry or our stock performance or if
our operating results fail to meet analyst expectations, the price of our common stock could decline.
Provisions in our charter documents and Delaware law could discourage, delay or prevent a change in control of our company
or changes in our management and depress the market price of our common stock.
Our certificate of incorporation and bylaws contain provisions that could depress the market price of our common stock by
acting to discourage, delay or prevent a change in control of our company or changes in our management that our stockholders may
deem advantageous. These provisions, among other things:
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authorize our board of directors to issue, without further action by our stockholders, up to 1,000,000 shares of undesignated
or “blank check” preferred stock;
prohibit stockholder action by written consent, thus requiring all stockholder actions to be taken at a duly noticed and held
meeting of our stockholders;
specify that special meetings of our stockholders can be called only by our board of directors, the Chairman of our board of
directors or our President, thereby eliminating the ability of our stockholders to call special meetings;
permit only our board of directors to establish the number of directors and fill vacancies on the board of directors, except as
may be required by law;
permit our board of directors to amend our bylaws, subject to the power of our stockholders to repeal any such amendment;
do not permit cumulative voting on the election of directors; and
establish advance notice requirements for stockholders to propose nominees for election as directors or matters to be acted
upon at annual meetings of stockholders.
In addition, we are subject to Section 203 of the Delaware General Corporation Law, or DGCL, which imposes certain
restrictions on mergers, business combinations and other transactions between us and holders of 15% or more of our common stock.
Section 203 may have the effect of discouraging, delaying or preventing a change in control of our company.
Holders of our common stock could be adversely affected if we issue preferred stock.
37
Pursuant to our certificate of incorporation, our board of directors is authorized to issue up to 1,000,000 shares of preferred
stock without any action by our stockholders. Our board of directors also has the power, without stockholder approval, to set the terms
of any series of preferred stock that may be issued, including, among others, voting rights, dividend rights and preferences over our
common stock with respect to dividends or in the event of a dissolution, liquidation or winding up. If we issue preferred stock in the
future that has preferences over our common stock with respect to payment of dividends or upon a liquidation, dissolution or winding
up, or if we issue preferred stock that is convertible into our common stock at greater than a one-to-one ratio, the voting and other
rights of the holders of our common stock and the market price of our common stock could be adversely affected.
Our certificate of incorporation designates the Court of Chancery of the State of Delaware as the sole and exclusive forum for
certain types of actions and proceedings that may be initiated by our stockholders, which could limit our stockholders’ ability
to obtain a judicial forum they consider favorable for disputes with us or our directors, officers or other employees.
Our certificate of incorporation provides that, unless we consent in writing to the selection of an alternative forum, the Court of
Chancery of the State of Delaware shall be the sole and exclusive forum for:
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any derivative action or proceeding brought on our behalf;
any action asserting a claim of breach of a fiduciary duty owed by any of our directors, officers or other employees to us or to
our stockholders;
any action asserting a claim against us arising pursuant to any provision of the DGCL, our certificate of incorporation or our
bylaws; and
any action asserting a claim against us governed by the internal affairs doctrine.
Any person or entity purchasing or otherwise acquiring any interest in shares of our capital stock is deemed to have notice of
and consented to this provision of our certificate of incorporation. This choice-of-forum provision may limit a stockholder’s ability to
bring a claim in a judicial forum it finds favorable for disputes with us or our directors, officers or other employees, which may
discourage these lawsuits. Alternatively, if a court were to find this provision of our certificate of incorporation inapplicable to, or
unenforceable in respect of, one or more of the specified types of actions or proceedings, we may incur additional costs associated
with resolving these matters in other jurisdictions, which could adversely affect our business, financial condition or results of
operations.
Item 1B. Unresolved Staff Comments.
None.
Item 2. Properties.
Our corporate headquarters and laboratory operations are located in Temple City, California, where we lease and occupy
approximately 12,000 square feet of office and laboratory space under leases that will expire in January 2021. The Company has
options to renew some of these leases for three years. We use these facilities for all of our laboratory testing and management
activities and certain research and development, administrative and other functions. We also lease approximately 1,437 square feet of
office space near Atlanta, Georgia under a lease that will expire in August 2020 and approximately 7,049 square feet of office space in
El Monte, California under two leases that will expire in September 2022 and January 2023, where we conduct certain research and
development, customer service, report generation and other administrative activities, although no laboratory activities occur at either
of these facilities. We believe our existing facilities are adequate for our current and expected near-term needs and additional space
would be available on commercially reasonable terms if required.
Item 3. Legal Proceedings.
From time to time, we may be involved in legal proceedings arising in the ordinary course of our business. We are not presently
a party, and our properties are not presently subject, to any legal proceedings that, in the opinion of management, would have a
material effect on our business. Regardless of outcome, litigation can have an adverse impact on us due to defense and settlement
costs, diversion of management resources, negative publicity and reputational harm, among other factors.
Item 4. Mine Safety Disclosures.
Not applicable.
38
PART II
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
Market Information
On September 29, 2016, our common stock was listed for trading on the Nasdaq Global Market under the symbol “FLGT.”
There was no public market for our common stock prior to September 29, 2016. The following table sets forth the high and low sales
prices of our common stock as reported on the Nasdaq Global Market for the periods presented:
2017:
Quarter ended December 31, 2017
Quarter ended September 30, 2017
Quarter ended June 30, 2017
Quarter ended March 31, 2017
2016:
Quarter ended December 31, 2016
Quarter ended September 30, 2016
High
Low
$
$
$
4.90
6.76
11.07
13.67
11.79
9.22
$
3.01
4.57
4.90
10.45
8.14
9.18
As of March 1, 2018, there were 7 holders of record of our common stock, plus an indeterminate number of additional
stockholders whose shares of our common stock are held on their behalf by brokerage firms or other agents.
Holders of Common Stock
We currently anticipate that we will retain any future earnings to finance the continued development, operation and expansion of
our business. As a result, we do not anticipate declaring or paying any cash dividends or other distributions in the foreseeable future.
Any determination to pay dividends would be at the discretion of our board of directors and would depend on our results of operation,
financial condition and other factors that our board of directors, in its discretion, considers relevant.
Dividend Policy
Use of Proceeds from Registered Securities
On October 4, 2016, we completed the initial public offering of our common stock, or the IPO, in which we issued and sold an
aggregate of 4,830,000 shares of common stock (including 630,000 shares issued and sold on October 7, 2016 pursuant to the
underwriters’ exercise in full of their option to purchase additional shares) at a public offering price of $9.00 per share. We received
net proceeds of approximately $36.0 million, after deducting underwriting discounts and commissions and offering expenses paid or
payable by us of approximately $4.4 million. The shares issued and sold in the IPO were registered under the Securities Act on a
registration statement on Form S-1 (File No. 333-213469), as amended, and the final prospectus dated September 28, 2016 included in
such registration statement, or the Prospectus.
To date, we have used $2.5 million of the net proceeds from the IPO, all of which was used for contributions to our joint
venture, FF Gene Biotech, made during the third quarter of 2017 in partial satisfaction of our contribution obligations under the joint
venture cooperation agreement. All other net proceeds from the IPO are invested in short-term, investment-grade, interest-bearing
securities, such as money market accounts, certificates of deposit, commercial paper and guaranteed obligations of the U.S.
government. There has been no material change in the planned use of proceeds from the IPO from that described in the Prospectus.
Item 6. Selected Financial Data.
Not applicable.
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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
On September 30, 2016, Fulgent Therapeutics LLC became a wholly owned subsidiary of Fulgent Genetics, Inc. in a transaction
we refer to as the Reorganization. As used in the following discussion and analysis, unless the context otherwise requires, (i) the term
“Fulgent LLC” refers to Fulgent Therapeutics LLC, (ii) the term “Fulgent Inc.” refers to Fulgent Genetics, Inc. and (iii) the terms
“Fulgent,” the “company,” “we,” “us” and “our” refer, for periods prior to completion of the Reorganization, to Fulgent LLC and,
for periods after completion of the Reorganization, to Fulgent Inc. and its consolidated subsidiaries after giving effect to the
Reorganization. Following the Reorganization, Fulgent Inc. is a holding company with no material assets other than 100% of the
equity interests in its subsidiaries, including Fulgent LLC, and Fulgent LLC is considered Fulgent Inc.’s predecessor for accounting
purposes and Fulgent LLC’s financial statements for all periods prior to completion of the Reorganization constitute Fulgent Inc.’s
historical financial statements. In this discussion and analysis, Fulgent LLC’s equity interests are referred to as “units” and Fulgent
LLC’s equity holders are referred to as “members.”
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.
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 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 our actual future results, levels of activity, performance and achievements or other future events
may be materially different than what we currently expect. The forward-looking statements in this discussion and analysis speak only
as of the date of this document, 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 growing technology company with an initial 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 test menu currently includes approximately 18,000 single-gene tests and more than
850 pre-established, multi-gene, disease-specific panels that collectively test for approximately 7,700 genetic conditions, including
various cancers, cardiovascular diseases, neurological disorders and pediatric conditions.
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 2017, and we
believe these investments could help stimulate further demand in the long-term.
We offer tests at competitive prices, averaging approximately $1,130 per billable test delivered in 2017, and at a lower cost to us
than many of our competitors, averaging approximately $516 per billable test delivered in 2017. Our volume has grown rapidly since
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our commercial launch, with 16,578 billable tests delivered in 2017, 12,507 billable tests delivered in 2016, and an aggregate of over
36,903 billable tests delivered to approximately 750 customers from inception through December 31, 2017. We have experienced
compound quarterly growth of 8.2% in the number of billable tests delivered in our last eight completed fiscal quarters. We recorded
revenue and loss from continuing operations of $18.7 million and $2.5 million, respectively, in 2017, compared to revenue and loss
from continuing operations of $18.3 million and $5.4 million, respectively, in 2016. We achieved profitability in the first three months
and the first half of 2017, but we have recorded losses in all other periods since our inception.
2017 Developments
FF Gene Biotech Joint Venture
On April 25, 2017, we, through an affiliated company formed for the purpose of the relationship, entered into a cooperation
agreement with Xilong Scientific Co., Ltd., or Xilong Scientific, and Fuzhou Jinqiang Investment Partnership (LP), or FJIP, to form a
joint venture under the laws of the People’s Republic of China, or PRC, called Fujian Fujun Gene Biotech Co., Ltd. or FF Gene
Biotech. FF Gene Biotech offers genetic testing services to customers in the PRC. Pursuant to the terms of the cooperation agreement,
we have agreed to contribute to FF Gene Biotech genetic sequencing and other equipment with a total cost of 60,000,000 renminbi, or
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. As of
December 31, 2017, 43,600,000 RMB (or approximately $6.7 million U.S. dollars) of our total contribution obligation remains to be
contributed to FF Gene Biotech under the terms of the cooperation agreement. To date, we have purchased and contributed to FF Gene
Biotech equipment with an aggregate fair value of $2.5 million pursuant to our contribution obligations under the cooperation
agreement, all of which was contributed in the third quarter of 2017.
Additionally, on April 25, 2017, we entered into a license agreement with FF Gene Biotech, pursuant to which we have granted
to FF Gene Biotech a license to use certain of our clinical molecular diagnostic gene detection technology and related software and
our proprietary reference library of genetic information, along with any improvements on this technology we may develop during the
term of the license agreement. Under the license agreement, FF Gene Biotech will pay to us, on a quarterly basis, certain royalties
based on the revenue of FF Gene Biotech, and we have agreed to provide certain technical services to FF Gene Biotech in connection
with the license granted under the agreement. The license agreement expires on December 31, 2018 and may be extended by mutual
agreement of the parties. We recorded minimal royalties under the license agreement in the year ended December 31, 2017, but we
expect to begin generating more royalties as FF Gene Biotech grows its operations and sales.
We believe FF Gene Biotech could expand our long-term opportunities to address the genetic testing market in Asia. However,
establishing FF Gene Biotech and our relationships with this joint venture are subject to a number of risks, including market,
regulatory and other factors that could cause the joint venture to fail to produce to us the revenue or other benefits we anticipate, or a
potential decline in our direct sales to customers in Asia if any of these customers choose to order genetic tests from FF Gene Biotech
instead of from us.
Factors Affecting Our Performance
Market and Industry Trends
Genetic testing has experienced significant growth in recent years. If this growth trend continues, we believe genetic testing
could become a more accepted part of standard medical care and the knowledge of a person’s unique genetic makeup could begin to
play a more important role in the practice of medicine. The advent of next generation sequencing, or NGS, technology, a relatively
new genetic testing technique that enables millions of DNA fragments to be sequenced in parallel, has dramatically lowered the cost
and improved the quality of genetic testing, contributing to increased adoption generally and increased volumes for our tests.
The growth of genetic testing in recent years has caused increased competition in our industry. This increased competition, as
well as cost-saving initiatives on the part of government entities and other third-party payors, has resulted in downward pressure on
the price for genetic analysis and interpretation, which could intensify in future periods if adoption of genetic testing becomes more
widespread. We have reduced the prices for certain of our tests in recent periods to maintain our competitive position, and increased
downward pricing pressure could harm our revenue and margins and our ability achieve and sustain profitability. The impact of this
pricing pressure has been and may continue to be intensified if we continue to incur increased expenses in order to meet customer
demands and make investments in our business.
While adoption of genetic testing has increased in recent years, we believe widespread utilization has been tempered because of
certain challenges and barriers to adoption that exist in today’s market. Among these industry challenges are that genetic testing can
41
be prohibitively expensive, only a limited number of genetic tests are currently reimbursable, certain genetic conditions cannot be
diagnosed due to the limited scope of some genetic analysis, genetic testing can be an inefficient process and the interpretation of
genetic results can be cumbersome and time-consuming. We have approached these competitive and operational industry challenges
by building and continually advancing a multi-faceted technology platform that we believe will facilitate our ability to address many
of these challenges.
Number and Mix of Billable Tests Delivered
Our performance is closely correlated with the number of tests for which we bill our customers, which we refer to as billable
tests. The number of billable tests we deliver in any period depends on a number of factors, including the other factors affecting our
performance described in this discussion and analysis. We believe the number of billable tests that we deliver is an important indicator
of the performance of our business.
In addition, 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 billable tests delivered in any period, and the customers that order these tests,
impacts our financial results for the period.
Mix of Customers
Through December 31, 2017, we have sold our tests to approximately 750 total 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 has 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 genetic
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.
Our existing customer base consists primarily of hospitals and medical institutions, which are typically frequent and high-
volume users of genetic tests. Additionally, collection of billings from these institutional customers is generally more attainable than
from other types of customers in today’s reimbursement environment, as approximately 86% of our test billings that were generated
and due in 2017 were paid during that period. As a result, we believe our ability to maintain, strengthen and build this customer base
could have a meaningful impact on our potential for growth.
We are also making efforts to diversify our customer market, including building relationships with research and other
institutional customers, as well as a national clinical laboratory, regional medical networks and various other organizations to facilitate
access to physicians, practitioners and other new customer groups, including certain U.S. military and other government agencies. 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. Subject to limited exceptions,
none of these relationships obligate any party to order our tests at any agreed volume or frequency or at all, and as a result, these
relationships may not lead to meaningful or any increases in our customer base, the number of billable tests we deliver or our revenue.
However, we believe our ability to establish these relationships with new customer groups is critical to the growth of our business.
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 our recently-launched Beacon carrier screening panels. We are also continually seeking to
expand our test menu with new genes and panel tests, including our plans to expand our oncology test options by launching somatic
cancer panels and leverage our expertise in pediatrics by launching newborn genetic panel tests, both in the first half of 2018. In
addition, all of our 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.
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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 per billable test 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.
We calculate our cost per billable test by dividing the number of billable tests delivered in any given period by our cost of
revenue in the same period. 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 the amount of our cost per billable test. Moreover, changes in our other operating expenses, due to investments in these aspects
of our business or other factors, are not taken into account in the calculation of this measure but impact our overall results, which can
limit the utility of cost per billable test as an overall cost measurement tool.
Ability to Obtain Reimbursement
In today’s market, third-party payors generally restrict the reimbursement of genetic testing to only a narrow subset of genetic
tests and certain patients who meet specific criteria. The lack of widespread favorable reimbursement policies has presented a
challenge for genetic testing companies in building sustainable business models. 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 achieve profitability with this payor
group. 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 a regional physician services organization and a
national health insurance company 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 per billable test 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.
Impact of Certain Recent Accounting Pronouncements
The majority of our revenue is generated from hospitals, medical institutions and research institutions, with a lesser amount
from reimbursement by third-party payors, including managed care organizations, private health insurers and government healthcare
programs, such as Medicare and Medicaid. In 2017, 2016 and all other historical periods, we have recognized revenue based on a
revenue recognition standard that requires the satisfaction of specified criteria, including when the amount of revenue becomes fixed
or determinable and when collectability of revenue is reasonably assured, in order to recognize the revenue. Under this standard, if all
of the required criteria were not satisfied before payment was received, then we recognized revenue on a cash basis, which means that
revenue is recognized only when we receive a cash payment from a customer for the genetic tests it has ordered. As a result, for
revenue received from hospitals and medical institutions, in general, we have recognized revenue upon our delivery to a customer of
genetic test results from an ordered test, because all criteria to recognize this revenue have been satisfied at that time. For revenue
received from third-party payors, in general, we have recognized revenue on a cash basis due to the inability to satisfy the criteria
described above before receipt of payment.
Beginning on January 1, 2018, we are recognizing revenue pursuant to a comprehensive new revenue recognition standard
based on several recent accounting pronouncements. Under the new standard, which is designed to depict the transfer of promised
goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for
those goods or services, we expect to recognize revenue from all customers on an accrual basis, which means that revenue will be
recognized at the time of delivery to customers of genetic test results from an ordered test based on our expectation of receiving a cash
payment for such tests. In general, the new revenue recognition standard will result in our recognition of revenue from hospitals and
medical institutions at a similar time as we recognized revenue from these customers under the prior standard, and will result in our
recognition of revenue from third-party payors earlier than we recognized revenue from these customers under the prior standard.
Upon adopting the new standard on January 1, 2018, we will record an adjustment of $327,000 to beginning accumulated deficit
and accounts receivable to reflect genetic tests previously delivered to third-party payors for which revenue was not recognized as of
such date.
43
Equity-Based Compensation
In January 2016, our predecessor Fulgent LLC granted an award of fully vested equity to one of our employees. The equity-
based compensation expense associated with this award was recorded in full in the period in which the award was granted. As a result,
there were substantially increased equity-based compensation expenses in 2016 than in 2017. We do not intend to grant additional
awards of fully vested equity and, as a result, we do not expect we will experience similar levels of equity-based compensation
expense in future periods. Generally, we record equity-based compensation over the requisite service period from the grant date of the
applicable award.
Before the Reorganization, Fulgent LLC issued options that were not exercisable, whether or not vested, until the earlier of a
liquidity event or an incorporation of Fulgent LLC, each as defined in Fulgent LLC’s equity incentive plan under which the awards
were granted. An incorporation was deemed to have occurred upon completion of the Reorganization on September 30, 2016, at which
time the options became immediately exercisable, to the extent vested. As a result, no expense was recorded for these options prior to
their exercisability, and equity-based compensation expense of $1.1 million was recorded for these options as of the completion of the
Reorganization on September 30, 2016. See “Reorganization” below for more information.
Before the Reorganization, Fulgent LLC granted awards of units that constituted profits interests, which are a type of equity
award containing a participation threshold that entitled the recipient of the award to participate in the value of Fulgent LLC only to the
extent it appreciated from and after the grant date of the award. Pursuant to the determination of the Manager of Fulgent LLC, the
participation thresholds applicable to units that constituted profits interests (i) were ignored and not applied in calculating the number
of shares of our common stock that were issued in exchange for such units in the Reorganization, and (ii) did not carry over to such
shares of our common stock. Ignoring all profits interest thresholds upon the conversion of the units that constituted profits interests
into shares of our common stock in the Reorganization resulted in equity-based compensation expense of $1.4 million that we
recorded as of the completion of the Reorganization on September 30, 2016. See “Reorganization” below for more information.
Xi Long Financing
In May 2016, our predecessor Fulgent LLC completed a transaction with Xi Long and certain of Fulgent LLC’s other members.
In this transaction, (i) Xi Long acquired Class D-1 preferred and Class D common units of Fulgent LLC from certain existing
members of Fulgent LLC for an aggregate purchase price of $12.0 million, which units were required to be redeemed and exchanged
by Fulgent LLC, on a one-for-one basis, for Class D-2 preferred units of Fulgent LLC, and (ii) Fulgent LLC sold additional Class D-2
preferred units to Xi Long for gross proceeds of $15.2 million. Fulgent LLC incurred issuance costs of $185,000 for the transaction,
resulting in net proceeds to Fulgent LLC of $15.0 million. As a result of the transaction, Xi Long had acquired Class D-2 preferred
units of Fulgent LLC for an aggregate purchase price of $27.2 million, even though, at issuance, the fair value of the acquired Class
D-2 preferred units, as evidenced by Fulgent LLC’s then-most recent third-party valuation, was $32.6 million. The $5.5 million
difference between the fair value of, and the aggregate consideration paid by Xi Long for, the Class D-2 preferred units of Fulgent
LLC that were issued in the transaction was not attributable to any stated rights or privileges. Rather, Fulgent LLC, Xi Long and the
members of Fulgent LLC who were party to the transaction determined to complete the transaction consistent with their discussions,
notwithstanding that the fair value of the Class D-2 preferred units as evidenced by Fulgent LLC’s third-party valuation had increased
from the time these discussions were initiated to the time the transaction was completed. The $5.5 million difference was determined
to be a cost of completing the transaction with Xi Long and was recorded as an expense in the accompanying consolidated statement
of operations for 2016.
Upon completion of the Reorganization, all outstanding units of Fulgent LLC, including the Class D-2 preferred units issued to
Xi Long in this transaction, were cancelled in exchange for shares of our common stock. See “Reorganization” below for more
information.
Foreign Currency Exchange Rate Fluctuations
Much 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. For instance, all of our revenue-producing transactions have
historically been denominated in U.S. dollars, but we started billing certain of our Canadian hospital customers in their local currency
in the second quarter of 2017, and we may expand this practice in the future to other customers in Canada or other international
markets. Additionally, all payments we receive from FF Gene Biotech, including royalty revenue under the license agreement and our
share of any earnings of the joint venture, are paid to us in RMB and then converted by us to U.S. dollars, and we expect these
payments to increase in the future. These or other changes in the currencies in which we receive payments and record revenue could
result in an increased impact in future periods of foreign currency translations and exchange rate fluctuations.
44
Our business and prospects are exposed to numerous risks and uncertainties. For more information, see “Item 1A. Risk Factors”
in this report.
Business Risks and Uncertainties
Discontinued Operations
Prior to April 4, 2016, Fulgent LLC conducted the following two lines of business: the genetic testing business we are currently
pursuing, which Fulgent LLC conducted directly; and our former pharmaceutical business, or the Pharma Business, which was
conducted through Fulgent LLC’s former subsidiary, Fulgent Pharma LLC, or Fulgent Pharma. Prior to April 4, 2016, all of Fulgent
LLC’s equity interests were separated into two series of units based on these two lines of business, with the Class D units having
economic rights based on the genetic testing business we are currently pursuing and the Class P units having economic rights based on
the Pharma Business. On April 4, 2016, Fulgent LLC separated the Pharma Business from the genetic testing business we are
currently pursuing in a transaction we refer to as the Pharma Split-Off. To effect the Pharma Split-Off, Fulgent LLC redeemed each
member’s Class P units, distributed to each such member substantially identical units of Fulgent Pharma and caused Fulgent Pharma
to assume all then-outstanding options to acquire Class P units.
The operating results of the Pharma Business have been reported as discontinued operations for all applicable periods presented
in the consolidated financial statements included in this report. In 2017 and 2016, we recorded income from discontinued operations
of zero and $41,000, respectively.
Reorganization
On September 30, 2016, our predecessor Fulgent LLC became our wholly owned subsidiary upon completion of the Reorganization.
Prior to the Reorganization, Fulgent Inc. did not conduct any activities other than activities incidental to its formation and preparation
for its initial public offering.
Upon completion of the Reorganization, among other things: each then-outstanding 7.6 units of Fulgent LLC (which consisted of
voting and non-voting common units, some of which constituted profits interests, and two classes (Class D-1 and Class D-2) of
preferred units convertible into Class D common units) were cancelled in exchange for one share of our common stock; all
outstanding options to acquire units of Fulgent LLC were cancelled and exchanged, at a ratio of 7.6-to-1, for equivalent options to
acquire shares of our common stock and all such options became immediately exercisable to the extent vested; and all outstanding
restricted share units relating to units of Fulgent LLC were cancelled and exchanged, at a ratio of 7.6-to-1, for equivalent restricted
stock units relating to shares of our common stock.
After completion of the Reorganization, we continue to exist as a holding company, with no material assets other than 100% of
the equity interests in Fulgent LLC and our other subsidiaries. We consolidate the financial results of Fulgent LLC, and the historical
financial statements of Fulgent LLC are our historical financial statements.
Financial Overview
Revenue
We generate revenue from sales of our genetic tests. 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. We generally bill directly to a hospital, medical or research institution customer, or to a patient, a third-party payor or a
combination of a patient and a third-party payor. Some of the revenue we generate relates to certain research services we provide for
our research institution and other similar institutional customers, which we refer to as “sequencing as a service.” The amount of
research revenue recorded to date has been relatively small, but this amount increased in the third and fourth quarters of 2017 and we
expect it may continue to grow. Relative to our other tests, we generally sell sequencing as a service tests at substantially lower price
points, resulting in less revenue to us for sales of the same number of tests, and we generally incur less cost of revenue in delivering
these tests. As a result, an increase or decrease in orders of sequencing as a service tests as a percentage of our total billable tests
delivered in any given period can materially impact our average price per billable test, revenue and cost of revenue in the period.
In addition, as a result of the establishment of FF Gene Biotech and our related license agreement with FF Gene Biotech in April
2017, we began recording revenue upon our receipt of royalties from FF Gene Biotech under the license agreement, the amount of
which is based on the revenue levels of FF Gene Biotech. Such royalty revenues have been minimal through the end of 2017.
45
Cost of Revenue
Cost of revenue reflects the aggregate costs incurred in delivering test results, including sequencing as a service tests, and
consists of: personnel costs, including salaries, employee benefit costs, bonuses and equity-based compensation expenses; costs of
laboratory supplies; depreciation of laboratory equipment; amortization of leasehold improvements; and allocated overhead expenses,
including rent and utilities. Costs associated with performing tests are recorded as tests are processed. We expect cost of revenue to
generally increase as we increase the number of billable tests we deliver.
Operating Expenses
Our operating expenses are classified into three categories: research and development; selling and marketing; and general and
administrative. For each category, 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. These costs consist of
personnel costs, laboratory supplies, consulting costs and allocated overhead expenses, including rent 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.
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.
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 increased general and
administrative expenses as a result of completing our initial public offering in October 2016 and operating as a public company,
including expenses related to compliance with the rules and regulations of the Securities and Exchange Commission, or the SEC, and
the Nasdaq Stock Market, additional insurance expenses, investor relations activities and other administrative and professional
services.
Provision for (Benefit from) Income Taxes
Provision for income taxes consists of U.S. federal and state income taxes. To date, we have not had significant U.S. federal and
state income taxes because of the status of our predecessor Fulgent LLC as a pass-through entity for tax purposes. As a result, for all
periods prior to the Reorganization, all taxable income or loss and tax credits of Fulgent LLC generally were reflected in the personal
income tax returns of Fulgent LLC’s members, and no provision for federal or state income taxes was provided in our consolidated
financial statements. We became a taxable entity upon completion of the Reorganization on September 30, 2016.
We record a valuation allowance when it is more likely than not that some portion or all of a deferred tax asset will not be
realized. In making such a determination, we consider all the available positive and negative evidence, including future reversals of
existing taxable temporary differences, projected future taxable income, and ongoing prudent and feasible tax planning strategies, to
assess the amount of the valuation allowance. When we determine to establish or reduce the valuation allowance against the deferred
tax assets, our provision for income taxes will increase or decrease, respectively, in the period in which the determination is made.
The factors that most significantly impact our effective tax rate include the levels of certain deductions, including those related
to equity-based compensation, the effect of state income taxes, and changes in tax laws. We expect these factors will continue to cause
our consolidated effective tax rate to differ significantly from the U.S. federal income tax rate in future periods.
46
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.
Results of Operations
Year Ended December 31,
2017
2016
$
Change
%
Change
Statement of Operations Data:
Revenue
Cost of revenue
Gross profit
Operating expenses:
Research and development
Selling and marketing
General and administrative
Total operating expenses
Operating income (loss)
Interest and other income (expense)
Income (loss) before income taxes and equity loss in investee
Provision for (benefit from) income taxes
Income (loss) before equity loss in investee
Equity loss in investee
Income (loss) from continuing operations
Other Operating Data:
Billable tests delivered
Average price per billable test delivered
Cost per billable test delivered
* Percentage not meaningful.
Revenue
$
$
$
$
(dollars in thousands, except Other Operating Data)
2%
27%
(12)%
18,276 $
6,722
11,554
18,730 $
8,551
10,179
454
1,829
(1,375)
4,223
4,205
5,233
13,661
(3,482)
481
(3,001)
(1,015)
(1,986)
(524)
(2,510) $
3,558
2,469
4,609
10,636
918
(5,386)
(4,468)
920
(5,388)
—
(5,388) $
665
1,736
624
3,025
(4,400)
5,867
1,467
(1,935)
3,402
(524)
2,878
19%
70%
14%
28%
(479)%
(109)%
(33)%
(210)%
(63)%
*
(53)%
16,578
1,130 $
516 $
12,507
1,461 $
537 $
4,071
(331)
(21)
33%
(23)%
(4)%
Revenue increased $454,000, or 2%, from $18.3 million in 2016 to $18.7 million in 2017. The increase in revenue between
periods was primarily due to an increased number of billable tests delivered, partially offset by decreases in the average price per
billable test delivered and revenue from certain key customers in the PRC.
We believe the increase in the number of billable tests delivered between periods was primarily attributable to the expansion of
our test menu, an increase in sales to certain of our existing customers and an increase in sequencing as a service test orders, combined
with growth in the genetic testing market and increased physician awareness and acceptance of genetic tests generally, partially offset
by fewer new customers due in part to the time and effort required to convert customers from other laboratories.
The average price of the billable tests we delivered decreased from $1,461 in 2016 to $1,130 in 2017. We believe this decrease
was due to (i) the mix of tests we delivered in these periods, including more sequencing as a service and other lower price-point tests
in 2017, (ii) the mix of customers ordering tests in these periods, which may order tests at different rates depending on the
arrangements we have negotiated with them, and (iii) our reduction of prices for certain of our tests due to general price degradation
for genetic tests and other competitive factors.
Revenue from non-U.S. sources decreased $311,000, or 3%, from $10.0 million in 2016 to $9.7 million in 2017. The decrease in
revenue from non-U.S. sources between periods was primarily due to decreased sales to customers in the PRC, which decreased
revenue by $627,000, partially offset by an increase of $293,000 in revenue from sales to customers in Canada. The decrease in sales
to customers in the PRC was primarily attributable to decreased sales to two customers that contributed a significant portion of our
revenue in the third and fourth quarters of 2016 and the first quarter of 2017 but ordered significantly fewer tests and generated
significantly less revenue to us in all other quarters of 2017; we expect our revenue contribution from these two customers could
continue to decline and represent a very small portion of our overall revenue going forward.
In 2017 and 2016, aggregating customers that are under common control or are affiliates, one customer contributed 12% and
15% of our revenue, respectively, and two other customers contributed 10% and 15%, respectively, in the respective periods.
47
Cost of Revenue
Cost of revenue increased $1.8 million, or 27%, from $6.7 million in 2016 to $8.6 million in 2017. The increase was primarily
due to increases of $938,000 in reagents and supplies expenses related to increased billable tests delivered, $623,000 in personnel
costs related to increased headcount, $502,000 in depreciation costs due to increased medical laboratory equipment purchased to
expand our capacity and throughput, and $138,000 in consulting and outside labor costs related to third-party laboratory experts,
partially offset by a decrease of $276,000 in equity-based compensation expense related to certain expenses recorded in September
2016 in connection with the Reorganization, which did not recur in 2017.
Cost per billable test delivered decreased slightly between periods, as the increase in our cost of revenue was offset by the
increase in the number of billable tests we delivered.
Our gross profit decreased $1.4 million, or 12%, from $11.6 million in 2016 to $10.2 million in 2017. The decrease in gross
profit was primarily due to an increase in cost of revenue between periods that exceeded the slight increase in revenue over the same
period. Our gross profit as a percentage of revenue, or gross margin, decreased from 63.2% to 54.3% between periods. The decrease in
gross margin was primarily due to the decrease in our average price per billable test, combined with the increase in personnel-related
costs of revenue related to increased headcount.
Research and Development
Research and development expenses increased $665,000, or 19%, from $3.6 million in 2016 to $4.2 million in 2017. The
increase was primarily due to increases of $777,000 in personnel costs related to increased headcount, $98,000 in depreciation costs
due to equipment purchases, $88,000 in consulting and outside labor costs related to third-party healthcare consulting, and $41,000 in
software and software licensing costs related to new licenses purchased for our genetic testing operations, partially offset by a
decrease of $354,000 in equity-based compensation expense related to certain expenses recorded in September 2016 in connection
with the Reorganization, which did not recur in the 2017.
Selling and Marketing
Selling and marketing expenses increased $1.7 million, or 70%, from $2.5 million in 2016 to $4.2 million in 2017. The increase
was primarily due to increases of $795,000 in personnel costs and $104,000 in travel expenses, both related to increased headcount,
$638,000 in marketing costs related to our targeted marketing initiatives, and $241,000 in consulting fees to train sales personnel and
obtain new contracts, partially offset by a decrease of $136,000 in equity-based compensation expense related to certain expenses
recorded in September 2016 in connection with the Reorganization, which did not recur in 2017.
General and Administrative
General and administrative expenses increased $624,000, or 14%, from $4.6 million in 2016 to $5.2 million in 2017. The
increase was primarily due to increases of $665,000 in accounting fees and $459,000 in legal and other professional fees, both related
to services performed in connection with being a public company, $446,000 in facility costs and $292,000 in personnel costs, both
related to increased headcount, $238,000 in other taxes primarily related to payments of local business property tax, and $232,000 in
insurance costs related to additional directors and officers liability insurance and other policies, partially offset by a decrease of $1.8
million in equity-based compensation expense related to the grant of a fully vested equity-based award in January 2016 and certain
expenses recorded in September 2016 in connection with the Reorganization, neither of which recurred in 2017.
Interest and Other Income (Expense)
Interest income was $457,000 for 2017. This income mainly related to interest received on various investments in marketable
securities. Interest income was not significant in 2016.
Other income (expense) was not significant for 2017. The primary component of other income (expense) for 2017 was foreign
currency valuation gains (losses). Other expense was $5.4 million for 2016. The primary component of other expense for 2016 was a
charge related to the difference between the fair value and the effective issuance price of the Class D-2 preferred units we issued in the
Xi Long financing in May 2016, which was determined to be a cost of completing the transaction with Xi Long and was recorded in
other expense in our consolidated statements of operations.
Provision for (Benefit from) Income Taxes
We recorded income tax (benefit) expense of $(1.0 million) and $920,000 for 2017 and 2016, respectively. Our effective income
tax rate was 34.2% and (20.6)% of income (loss) before income taxes for 2017 and 2016, respectively.
48
The effect of state income taxes and certain expenses or adjustments related to equity-based compensation are the primary
factors impacting our effective tax rate for 2017 and 2016.
The Tax Cuts and Jobs Act of 2017, or 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. We account for changes in tax rates and tax laws in the period of enactment. As a result, for 2017, due to
the reduction in the corporate income tax rate with the enactment of the 2017 Tax Act, we recorded a tax expense of $22,000 related to
the revaluation of our net deferred tax assets. We have determined that the various other provisions of the 2017 Tax Act are not
expected to have a material impact on our results of operations or financial condition, largely because of the amount of our federal net
operating loss carryover and we have no known unrepatriated foreign earnings.
As of December 31, 2017, our net state deferred tax asset was $90,000 and our net federal deferred tax asset was $36,000. As of
December 31, 2016, our net state deferred tax asset was $54,000 and our net federal deferred tax liability was $243,000. The
temporary differences in existence for 2017 and 2016 are primarily from depreciation and equity-based compensation.
See Note 11, Income Taxes, to our consolidated financial statements included in this report for more information regarding our
income taxes.
Equity Loss in Investee
Equity loss in investee was $524,000 in 2017 and relates to our 30% ownership interest in FF Gene Biotech. We did not have
any income or loss from equity method investments in 2016.
Liquidity and Capital Resources
Liquidity and Sources of Cash
We had $6.5 million and $7.9 million in cash and cash equivalents as of December 31, 2017 and 2016, respectively, and $34.9
million and $38.6 million in marketable securities, consisting of corporate bonds, as of December 31, 2017 and 2016, respectively.
Since inception, our operations have been financed primarily by our founder, Chief Executive Officer and Chairman of our
board of directors, Ming Hsieh, and, in recent periods, by cash from our operations and equity financings. In May 2016, we closed an
equity financing with Xi Long for net proceeds to us of approximately $15.0 million, and in October 2016, we closed the initial public
offering of our common stock for net proceeds to us of approximately $36.0 million, after deducting underwriting discounts and
commissions and offering expenses paid or payable by us.
Our primary uses of cash are to fund our operations 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. In addition, in the third and fourth quarters of 2016, we used an aggregate of $5.9 million in cash to
make tax and other distributions to the members of Fulgent LLC, but we do not expect to make these or other types of distributions or
dividends in the foreseeable future. Further, in April 2017, in connection with the establishment of FF Gene Biotech, we became
obligated to contribute to FF Gene Biotech genetic sequencing and other equipment with a total cost of 60,000,000 RMB over a three-
year period. To date, we have purchased and contributed to FF Gene Biotech equipment with an aggregate fair value of $2.5 million
pursuant to these contribution obligations, all of which was contributed in the third quarter of 2017. Depending on the performance of
FF Gene Biotech, this joint venture may never produce sufficient revenue to us to recover these capital and other investments and
could cause our revenue to decrease if any of our direct customers in Asia choose to order genetic tests from FF Gene Biotech instead
of from us, any of which could negatively affect our liquidity and cash flow.
We believe our existing cash, along with cash from our operations and proceeds from our equity financings, will be sufficient to
meet our anticipated cash requirements for at least the next 12 months. Much of the losses we have incurred in certain prior periods,
including all periods in 2016, were attributable to a variety of non-cash charges, including equity-based compensation expenses
related to grants of fully vested equity-based awards and recognition of previously unrecognized compensation expense in connection
with the Reorganization and certain other expenses associated with the accounting for our equity financing with Xi Long in May 2016.
As a result, in spite of the losses we recorded during these periods, cash provided by continuing operations has been positive since
2015 and has significantly contributed to our ability to meet our liquidity needs, including paying for capital expenditures.
Additionally, if our business grows and we are able to achieve increased efficiencies and economies of scale in line with this growth,
49
we expect that increased revenue levels would increase our ability to rely on cash from our operations to support our business in future
periods, even if our expenses also increase as a result of the growth of our business. Based on these factors, we anticipate that cash
from our operations will continue to play a meaningful role in our ability to meet our liquidity requirements and pursue our business
plans and strategies in the next 12 months and in the longer term.
However, our expectations regarding the cash that may be provided by our operations and our cash needs in future periods could
turn out to be wrong, in which case we may require additional financing to support our operations, as we do not presently have any
commitments for future capital. For instance, 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, the amount and timing of sales of billable tests, the prices we charge for our tests due to changes in product mix, customer mix,
general price degradation for genetic 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. Additional funding may not be available to us when needed, on acceptable terms or at all. If we raise 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. 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
Continuing Operations
The following table summarizes cash flows from continuing operations for each of the periods presented:
Cash provided by operating activities
Cash used in investing activities
Operating Activities
Year Ended December 31,
2017
2016
$
$
(in thousands)
1,331
(2,049)
$
$
4,436
(42,795)
Cash provided by operating activities in 2017 was $1.3 million. The difference between net loss and cash provided by operating
activities for the period was primarily due to the effect of $2.1 million in equity-based compensation expenses and $1.7 million in the
depreciation of assets. Cash provided by operating activities decreased between periods primarily due to the negative effect of a $1.5
million increase in other current assets resulting primarily from an increase in prepaid income taxes, insurance, licenses and
subscriptions, and a $363,000 decrease in accounts payable resulting primarily from purchases of medical laboratory equipment and
reagents, partially offset by the positive effect of a $1.1 million increase in accrued liabilities mainly related to payroll liabilities and
deferred revenue and a $214,000 decrease in accounts receivable mainly due to the timing of collections from customers.
Cash provided by operating activities in 2016 was $4.4 million. The difference between net loss and cash provided by operating
activities for the period was primarily due to the effect of a $5.5 million non-cash charge associated with the difference between the
fair value and the effective issuance price of the Fulgent LLC units issued to Xi Long in May 2016, which was recorded as other
expense, and the effect of $4.7 million of non-cash equity-based compensation charges associated with the grant of a fully vested
equity-based award and the recognition of previously unrecognized compensation expense in connection with the Reorganization.
Cash provided by operating activities increased between periods primarily due to a $1.1 million increase in accounts payable, which
resulted from purchases of medical laboratory equipment and reagents, partially offset by the negative effect of a $2.3 million increase
in accounts receivable related to increased revenue, a $381,000 increase in other current assets due to prepaid insurance and
maintenance on equipment and a $372,000 decrease in accrued liabilities due to payroll liabilities and customer deposits.
50
Investing Activities
Cash used in investing activities in 2017 was $2.0 million, which primarily related to $11.7 million in purchases of marketable
securities, purchased equipment with an aggregate fair value of $2.5 million contributed to FF Gene Biotech, and $2.9 million in
purchases of fixed assets consisting mainly of medical laboratory equipment, computer hardware and leasehold improvements,
partially offset by maturities of $11.2 million of marketable securities and sales of $3.8 million of marketable securities.
Cash used in investing activities in 2016 was $42.8 million, which primarily related to purchases of $39.0 million of marketable
securities consisting of debt securities and certificates of deposit and $3.8 million of fixed assets consisting mainly of medical
laboratory equipment, computer hardware, software and leasehold improvements. Our purchases of medical laboratory equipment
have been increasing to expand our capacity and throughput.
Discontinued Operations
Cash used in operating activities by discontinued operations was zero and $31,000 in 2017 and 2016, respectively. There was
no cash provided by or used in investing activities by discontinued operations in 2017 or 2016.
Financing Activities
Cash used in financing activities in 2017 was $770,000, which represents payments of $801,000 for our initial public offering
costs, partially offset by $31,000 in cash proceeds from exercises of stock options.
Cash provided by financing activities in 2016 was $45.8 million, which represents net proceeds of $36.0 million from our initial
public offering completed in October 2016 and $15.0 million from our equity financing with Xi Long completed in May 2016,
partially offset by a $4.6 million distribution to Mr. Hsieh in his capacity as a member of Fulgent LLC, as a return of capital
contribution to Mr. Hsieh, and $1.3 million in tax distributions to the former members of Fulgent LLC based on the income tax
liabilities of such former members attributable to Fulgent LLC’s 2016 net taxable income through the date of the Reorganization.
Critical Accounting Policies and Use of Estimates
This discussion and analysis is based on our consolidated financial statements, which have been prepared in accordance with
generally accepted accounting principles in the United States of America, 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. 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 genetic tests. We currently receive payments from: hospitals and medical institutions
with which we have direct-bill relationships; research institutions; individual patients and third-party payors.
We recognize revenue when all of the following criteria are met: (i) persuasive evidence of an arrangement exists; (ii) delivery
has occurred; (iii) the fee is fixed or determinable and (iv) collectability is reasonably assured. Criterion (i) is satisfied when we have
an arrangement or contract in place. Criterion (ii) is satisfied when we deliver a report to the ordering physician or test results to the
research institution. Determination of criteria (iii) and (iv) are based on management’s judgments regarding whether the fee is fixed or
determinable, and whether the collectability of the fee is reasonably assured. We recognize revenue on a cash basis when we cannot
conclude that either criterion (iii) or (iv) has been met.
Our test results are delivered electronically, and as such there are no shipping and handling fees incurred by us or billed to
customers. Our sales are typically exempt from state sales taxation due to the nature of the results delivered. As a result, we do not
charge customers state sales tax.
51
Equity-Based Compensation
We have included equity-based compensation expense as part of cost of revenue and operating expenses in our consolidated
statements of operations as follows:
Year Ended December 31,
2017
2016
Cost of revenue
Research and development
Selling and marketing
General and administrative
Total
$
$
$
(in thousands)
479
807
318
515
2,119
$
754
1,161
454
2,285
4,654
Before the Reorganization, our equity-based awards included fully vested awards, including common units subject to profits
interest thresholds, and option and restricted share unit awards subject to time-based vesting and, for option awards, exercisability
restrictions until a liquidity event or incorporation of Fulgent LLC, each as defined in the equity incentive plan under which the
awards were granted. For purposes of these option awards, an incorporation was deemed to have occurred upon completion of the
Reorganization, at which time the options became immediately exercisable, to the extent vested. Following the Reorganization, our
equity-based awards have included option and restricted stock unit awards subject to time-based vesting.
We account for equity-based compensation arrangements with our employees, consultants and non-employee directors using a
fair value method, which requires us to recognize compensation expense for costs related to all equity-based awards. The fair value
method requires us to estimate the fair value of equity-based awards to employees and non-employees on the date of grant. The fair
value is then recognized as equity-based compensation expense over the period during which the recipient is required to perform
services in exchange for the award, which is typically the vesting period of the award. For fully vested equity-based awards, the entire
fair value is recognized as equity-based compensation expense in the period in which the award is granted. For equity-based awards
granted to non-employees, the fair value is subject to periodic remeasurement over the vesting period of the award.
Estimations of the fair value of all equity-based awards are based on the determination of the fair value of the underlying equity,
consisting of shares of our common stock or, before the Reorganization, common units. In estimating the fair value of option awards
and, before the Reorganization, common units subject to profits interest thresholds, we use the Black-Scholes option-pricing model.
Black-Scholes Option-Pricing Model
The Black-Scholes option-pricing model requires the input of various assumptions, including:
•
•
•
•
•
Expected Term. The expected term represents the period that our equity-based awards are expected to be outstanding. We
determine the expected term assumption based on the vesting terms, exercise terms and contractual terms of the options,
and in the case of equity-based awards subject to a profits interest threshold granted before the Reorganization, based on
the estimated time to liquidity.
Risk-Free Interest Rate. We determine the risk-free interest rate by using the equivalent to the expected term based on the
U.S. Treasury yield curve in effect as of the date of grant.
Dividend Yield. The assumed dividend yield is based on our expectation that we will not pay dividends in the foreseeable
future, which is consistent with its history of not paying dividends.
Expected Volatility. We do not have sufficient history to estimate the volatility of the price of our common equity. We
calculate expected volatility based on historical volatility data of a representative group of companies that are publicly
traded. We selected representative companies with comparable characteristics to us, including risk profiles and position
within the industry, and with historical equity price information sufficient to meet the expected term of the equity-based
awards. We compute the historical volatility of this selected group using the daily closing prices for the selected
companies’ equity during the equivalent period of the calculated expected term of our equity-based awards. We will
continue to use the representative group volatility information until the historical volatility of our equity is relevant to
measure expected volatility for future option grants.
Forfeiture Rate. We have early adopted Accounting Standard Update No. 2016-09, Stock Compensation (Topic 718):
Improvements to Employee Share-Based Payment Accounting, and we have elected to account for forfeitures as they
occur.
52
There is a high degree of subjectivity involved when using option-pricing models to estimate fair value. There is not currently a
market-based mechanism or other practical application to verify the reliability and accuracy of the estimates stemming from these
valuation models, nor is there a means to compare and adjust the estimates to actual values. As a result, although the fair value of
certain of our equity-based awards is determined using an option-pricing model, this value may not be indicative of the fair value that
would be observed in a market transaction between a willing buyer and willing seller. If factors change and different assumptions are
used when valuing our option or other equity-based awards, our equity-based compensation expense could be materially different in
the future.
Determination of Fair Value on Grant Dates
For all periods after completion of our initial public offering on October 4, 2016, the fair value of the shares of our common
stock underlying option and restricted stock unit awards is determined by our board of directors or the compensation committee
thereof based on the closing sales price of our common stock on the date of grant as reported by the Nasdaq Global Market.
For all periods before completion of the Reorganization and our initial public offering, the fair value of the common units
underlying Fulgent LLC’s equity-based awards was estimated on each grant date by Fulgent LLC’s Manager. In determining fair
value, the Manager considered valuations prepared by an independent third party in a manner consistent with the American Institute of
Certified Public Accountants Practice Aid, Valuation of Privately-Held Company Equity Securities Issued as Compensation. In
conducting the valuations, we used a range of assumptions and methodologies and considered all objective and subjective factors we
believed to be relevant, including management’s best estimate of our business condition, prospects and operating performance at each
valuation date and the following additional factors: the fact that we were a privately held company with illiquid securities; our stage of
commercialization; the likelihood of achieving a liquidity event for our equity, such as an initial public offering, given prevailing
market conditions; our historical operating results; valuations of comparable public companies; our discounted future cash flows,
based on our projected operating results; and our capital structure, including the rights and preferences of its various classes of equity.
These valuations involved significant assumptions, judgments and estimates about, among other things, the market for genetic
tests and other industry trends, our future operating performance, our stage of commercial growth, average sales prices for our tests,
growth or other changes in our customer base, our ability to obtain reimbursement from third-party payors, the timing of a potential
initial public offering or other liquidity event and the determination of the appropriate valuation method at each valuation date. If
different assumptions, judgments and estimates had been made, our results during the periods in which these evaluations were made,
including the amount of our equity-based compensation expense, income (loss) applicable to common equity holders and income
(loss) per unit applicable to common equity holders, could have been materially different.
In determining the fair value of Fulgent LLC’s Class D common units related to awards of such units and options to acquire
such units granted in 2016 before completion of the Reorganization and our initial public offering, we estimated the enterprise value
of the business using the option pricing back-solve method within the market approach, which considers the sale price of equity in a
recent financing and “backsolves” the equity value using an option-pricing model that gives consideration to a company’s
capitalization structure and rights of preferred and common equity holders.
The estimated enterprise value of the business was then allocated to Fulgent LLC’s common units using the probability-
weighted expected return method, commonly referred to as PWERM, in which equity is valued based upon the probability-weighted
present value of expected future returns considering various future available outcomes and the rights of each class of equity, and
applying a marketability discount of 20% due to the illiquidity of the common units prior to completion of the IPO.
See Note 2, Summary of Significant Accounting Policies, to our consolidated financial statements included in this report for
information about recent accounting pronouncements.
Recent Accounting Pronouncements
The JOBS Act
We qualify as an “emerging growth company” as defined in the Jumpstart Our Business Startups Act of 2012, as amended, or
JOBS Act. As an emerging growth company, we may take advantage of specified reduced disclosure and other requirements that are
otherwise applicable to public companies that are not emerging growth companies, including an extended transition period to comply
with new or revised accounting standards applicable to public companies. We have chosen to “opt out” of this extended transition
period and, as a result, we will comply with new or revised accounting standards as required when they are adopted. This decision to
53
opt out of the extended transition period under the JOBS Act is irrevocable. We will remain an emerging growth company until
December 31, 2021, unless our gross revenue exceeds $1.07 billion in any fiscal year before that date, we issue more than $1.0 billion
of non-convertible debt in any three-year period before that date or the market value of our common stock held by non-affiliates
exceeds $700.0 million as of the last business day of the second fiscal quarter of any fiscal year before that date.
Off-Balance Sheet Arrangements
We did not have during the periods presented, and we do not currently have, any off-balance sheet arrangements, as defined in the
rules and regulations of the SEC, that have or are reasonably likely to have a current or future effect on our financial condition,
changes in financial condition, revenue or expenses, results of operations, liquidity, capital expenditures or capital resources that is
material to investors.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
Not applicable.
54
Item 8. Financial Statements and Supplementary Data.
The information required by this Item 8 immediately follows the signature page to this report and is incorporated herein by
reference.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
None.
Item 9A. Controls and Procedures.
Evaluation of Disclosure Controls and Procedures
Disclosure controls and procedures are controls and other procedures of a company that are designed to ensure that information
required to be disclosed by the company in the reports that it files or submits under the Exchange Act is recorded, processed,
summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include,
without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports
that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its
principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions
regarding required disclosure. As required by Rule 13a-15(b) under the Exchange Act, our management, with the participation of our
Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of our disclosure controls and
procedures as of December 31, 2017. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded
that our disclosure controls and procedures were effective as of December 31, 2017.
Management’s Annual Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting for our
company, as this term is defined in Rule 13a-15(f) under the Exchange Act. As required by Rule 13a-15(c) under the Exchange Act,
our management, with the participation of our Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the
effectiveness of our internal control over financial reporting as of December 31, 2017, based on the criteria set forth in the Internal
Control—Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based
on this evaluation, our management concluded that our internal control over financial reporting was effective as of December 31,
2017.
This report does not include an attestation report of our independent registered public accounting firm regarding our internal
control over financial reporting, in accordance with applicable SEC rules that permit us to provide only management’s report in this
report.
Changes in Internal Control over Financial Reporting
There has been no change in our internal control over financial reporting during the quarter ended December 31, 2017, that has
materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
Inherent Limitations on Disclosure Controls and Procedures and Internal Control over Financial Reporting
Management recognizes that any controls and procedures, no matter how well-designed and operated, can provide only
reasonable assurance of achieving their objectives, and management necessarily applies its judgment in evaluating the benefits of
possible controls and procedures relative to their costs. Because of these inherent limitations, our disclosure and internal controls may
not prevent or detect all instances of fraud, misstatements or other control issues. In addition, projections of any evaluation of the
effectiveness of disclosure or internal controls to future periods are subject to risks, including, among others, that controls may
become inadequate because of changes in conditions or that the degree of compliance with policies or procedures may deteriorate.
Item 9B. Other Information.
None.
55
Item 10. Directors, Executive Officers and Corporate Governance.
PART III
The information required by this item is incorporated by reference to the definitive proxy statement for our 2018 annual meeting
of stockholders or an amendment to this report, in either case to be filed with the SEC within 120 days after the end of our fiscal year
ended December 31, 2017.
Item 11. Executive Compensation.
The information required by this item is incorporated by reference to the definitive proxy statement for our 2018 annual meeting
of stockholders or an amendment to this report, in either case to be filed with the SEC within 120 days after the end of our fiscal year
ended December 31, 2017.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
The information required by this item is incorporated by reference to the definitive proxy statement for our 2018 annual meeting
of stockholders or an amendment to this report, in either case to be filed with the SEC within 120 days after the end of our fiscal year
ended December 31, 2017.
Item 13. Certain Relationships and Related Transactions, and Director Independence.
The information required by this item is incorporated by reference to the definitive proxy statement for our 2018 annual meeting
of stockholders or an amendment to this report, in either case to be filed with the SEC within 120 days after the end of our fiscal year
ended December 31, 2017.
Item 14. Principal Accounting Fees and Services.
The information required by this item is incorporated by reference to the definitive proxy statement for our 2018 annual meeting
of stockholders or an amendment to this report, in either case to be filed with the SEC within 120 days after the end of our fiscal year
ended December 31, 2017.
56
Item 15. Exhibits, Financial Statement Schedules.
(a)(1) Consolidated Financial Statements.
PART IV
The following financial statements are included immediately following the signature page hereof and are filed as part of this
report:
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets as of December 31, 2017 and 2016
Consolidated Statements of Operations for the Years Ended December
31, 2017 and 2016
Consolidated Statements of Comprehensive Loss for the Years Ended
December 31, 2017 and 2016
Consolidated Statements of Stockholders’/Members’ Equity for the
Years Ended December 2017 and 2016
Consolidated Statements of Cash Flows for the Years Ended December
31, 2017 and 2016
Notes to Consolidated Financial Statements
F-2
F-3
F-4
F-5
F-6
F-7
F-8
(a)(2)
Financial Statement Schedules.
All financial statement schedules have been omitted, as they are not required, not applicable, or the required information is
otherwise included.
(a)(3) Exhibits.
The information required by this Item 15(a)(3) is set forth on the Exhibit Index immediately preceding the signature page of this
report and is incorporated herein by reference.
Item 16. Form 10-K Summary.
We have elected not to provide summary information.
57
Exhibit
Number
2.1
3.1
3.1.1
3.1.2
3.2
4.1
4.2
10.1#
10.2#
10.3#
10.4#
10.5#
10.6#
10.7#
10.8#
10.9#
10.10#
10.11#
10.12#
EXHIBIT INDEX
Description
Agreement and Plan of Merger, dated September 16, 2016, by and among the registrant, Fulgent MergerSub, LLC and
Fulgent Therapeutics LLC (incorporated by reference to Exhibit 2.1 to Amendment No. 1 to the registrant’s
Registration Statement on Form S-1 (File No. 333-213912) filed with the SEC on September 19, 2016).
Certificate of Incorporation of the registrant, dated May 13, 2016 (incorporated by reference to Exhibit 3.1 to the
registrant’s Quarterly Report on Form 10-Q filed with the SEC on August 14, 2017).
Certificate of Amendment to Certificate of Incorporation of the registrant, dated August 2, 2016 (incorporated by
reference to Exhibit 3.1.1 to the registrant’s Quarterly Report on Form 10-Q filed with the SEC on August 14, 2017).
Certificate of Amendment to Certificate of Incorporation of the registrant, dated May 17, 2017 (incorporated by
reference to Exhibit 3.1.2 to the registrant’s Quarterly Report on Form 10-Q filed with the SEC on August 14, 2017).
Bylaws of the registrant (incorporated by reference to Exhibit 3.2 to Amendment No. 2 to the registrant’s Registration
Statement on Form S-1 (File No. 333-213912) filed with the SEC on September 26, 2016).
Form of Certificate of Common Stock of the registrant (incorporated by reference to Exhibit 4.1 to Amendment No. 1 to
the registrant’s Registration Statement on Form S-1 (File No. 333-213912) filed with the SEC on September 19, 2016).
Investor’s Rights Agreement, dated May 17, 2016, by and between Fulgent Therapeutics LLC and Xi Long USA, Inc.
(incorporated by reference to Exhibit 4.2 to the registrant’s Registration Statement on Form S-1 (File No. 333-213912)
filed with the SEC on September 2, 2016).
Form of Indemnification Agreement between the registrant and each of its officers and directors (incorporated by
reference to Exhibit 10.1 to the registrant’s Registration Statement on Form S-1 (File No. 333-213912) filed with the
SEC on September 2, 2016).
Amended and Restated 2015 Equity Incentive Plan of Fulgent Therapeutics LLC (incorporated by reference to Exhibit
10.2 to the registrant’s Registration Statement on Form S-1 (File No. 333-213912) filed with the SEC on September 2,
2016).
Form of Notice of Option Grant and Option Agreement under the Amended and Restated 2015 Equity Incentive Plan
of Fulgent Therapeutics LLC (incorporated by reference to Exhibit 10.3 to the registrant’s Registration Statement on
Form S-1 (File No. 333-213912) filed with the SEC on September 2, 2016).
Form of Notice of Profits Interest Grant and Profits Interest Agreement under the Amended and Restated 2015 Equity
Incentive Plan of Fulgent Therapeutics LLC (incorporated by reference to Exhibit 10.4 to the registrant’s Registration
Statement on Form S-1 (File No. 333-213912) filed with the SEC on September 2, 2016).
Form of Notice of Restricted Share Unit Grant and Restricted Share Unit Agreement under the Amended and Restated
2015 Equity Incentive Plan of Fulgent Therapeutics LLC (incorporated by reference to Exhibit 10.5 to the registrant’s
Registration Statement on Form S-1 (File No. 333-213912) filed with the SEC on September 2, 2016).
2016 Omnibus Incentive Plan of the registrant (incorporated by reference to Exhibit 10.6 to Amendment No. 2 to the
registrant’s Registration Statement on Form S-1 (File No. 333-213912) filed with the SEC on September 26, 2016).
Form of Notice of Stock Option Award and Stock Option Award Agreement under the 2016 Omnibus Incentive Plan of
the registrant (incorporated by reference to Exhibit 10.7 to the registrant’s Registration Statement on Form S-1 (File
No. 333-213912) filed with the SEC on September 2, 2016).
Form of Notice of Restricted Stock Unit Award and Restricted Stock Unit Agreement under the 2016 Omnibus
Incentive Plan of the registrant (incorporated by reference to Exhibit 10.8 to the registrant’s Annual Report on Form
10-K filed with the SEC on March 16, 2017).
Form of Option Substitution Award under the 2016 Omnibus Incentive Plan of the registrant (incorporated by reference
to Exhibit 10.9 to the registrant’s Registration Statement on Form S-1 (File No. 333-213912) filed with the SEC on
September 2, 2016).
Form of Notice of Restricted Stock Unit Substitution Award and Restricted Stock Unit Agreement under the 2016
Omnibus Incentive Plan of the registrant Form of Notice of Restricted Stock Unit Substitution Award and Restricted
Stock Unit Agreement under the 2016 Omnibus Incentive Plan of the registrant (incorporated by reference to Exhibit
10.10 to the registrant’s Registration Statement on Form S-1 (File No. 333-213912) filed with the SEC on September 2,
2016).
Employment Agreement, dated May 25, 2016, by and among Fulgent Therapeutics LLC, the registrant and Ming Hsieh
(incorporated by reference to Exhibit 10.11 to the registrant’s Registration Statement on Form S-1 (File No. 333-
213912) filed with the SEC on September 2, 2016).
Employment Agreement, dated May 25, 2016, by and among Fulgent Therapeutics LLC, the registrant and Paul Kim
(incorporated by reference to Exhibit 10.12 to the registrant’s Registration Statement on Form S-1 (File No. 333-
213912) filed with the SEC on September 2, 2016).
58
10.13#
10.14#
10.15#
10.16#
10.17
10.18
10.19
10.20#*
10.21§
10.22§
10.23*
21.1
23.1*
24.1*
31.1*
31.2*
32.1†
Amended and Restated Employment Agreement, dated May 25, 2016, by and among Fulgent Therapeutics LLC, the
registrant and Han Lin Gao (incorporated by reference to Exhibit 10.13 to the registrant’s Registration Statement on
Form S-1 (File No. 333-213912) filed with the SEC on September 2, 2016).
Severance Agreement, dated July 7, 2016, by and among Fulgent Therapeutics LLC, the registrant and Ming Hsieh
(incorporated by reference to Exhibit 10.14 to the registrant’s Registration Statement on Form S-1 (File No. 333-
213912) filed with the SEC on September 2, 2016).
Severance Agreement, dated July 7, 2016, by and among Fulgent Therapeutics LLC, the registrant and Paul Kim
(incorporated by reference to Exhibit 10.15 to the registrant’s Registration Statement on Form S-1 (File No. 333-
213912) filed with the SEC on September 2, 2016).
Severance Agreement, dated July 7, 2016, by and among Fulgent Therapeutics LLC, the registrant and Han Lin Gao
(incorporated by reference to Exhibit 10.16 to the registrant’s Registration Statement on Form S-1 (File No. 333-
213912) filed with the SEC on September 2, 2016).
Contribution and Allocation Agreement, dated May 19, 2016, by and among Fulgent Therapeutics LLC, Fulgent
Pharma LLC and Ming Hsieh (incorporated by reference to Exhibit 10.17 to the registrant’s Registration Statement on
Form S-1 (File No. 333-213912) filed with the SEC on September 2, 2016).
Form of Fourth Amended and Restated Operating Agreement of Fulgent Therapeutics LLC, to be in effect upon
completion of the Reorganization (included as an exhibit to Exhibit 2.1, incorporated by reference to Exhibit 2.1 to
Amendment No. 1 to the registrant’s Registration Statement on Form S-1 (File No. 333-213912) filed with the SEC on
September 19, 2016).
Commercial Leases, dated April 14, 2015, April 28, 2016, March 24, 2016 and August 1, 2016, by and between E & E
Plaza LLC and Fulgent Therapeutics LLC (incorporated by reference to Exhibit 10.19 to the registrant’s Registration
Statement on Form S-1 (File No. 333-213912) filed with the SEC on September 2, 2016).
Director Compensation Program of the registrant, effective as of September 28, 2016 and amended November 2, 2017.
Cooperation Agreement on the Establishment of Fujian Fujun Gene Biotech Co., Ltd., dated April 25, 2017, by and
among Shenzhen Fujin Gene Science & Technology Co., Ltd., Xilong Scientific Co., Ltd. and Fuzhou Jinqiang
Investment Partnership (LP) (incorporated by reference to Exhibit 10.1 to the registrant’s Quarterly Report on Form 10-
Q filed with the SEC on August 14, 2017).
Technical Know-How License Agreement, dated April 25, 2017, by and between the registrant and Fujian Fulgent
Gene Biotech Co., Ltd. (incorporated by reference to Exhibit 10.2 to the registrant’s Quarterly Report on Form 10-Q
filed with the SEC on August 14, 2017).
Commercial Lease, dated January 31, 2018, by and between E & E Plaza LLC and Fulgent Therapeutics LLC.
Subsidiaries of the registrant (incorporated by reference to Exhibit 21.1 to the registrant’s Annual Report on Form 10-K
filed with the SEC on March 16, 2017).
Consent of Deloitte & Touche LLP, independent registered public accounting firm, relating to the financial statements
of the registrant.
Power of Attorney (included on the signature page hereto).
Certification of Principal Executive Officer pursuant to Rules 13a-14(a) and 15d-14(a) under the Securities Exchange
Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
Certification of Principal Financial Officer pursuant to Rules 13a-14(a) and 15d-14(a) under the Securities Exchange
Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
Certification of Principal Executive Officer and Principal Financial Officer pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101.INS*
101.SCH*
101.CAL*
101.DEF*
101.LAB*
101.PRE*
XBRL Instance Document
XBRL Taxonomy Extension Schema Document
XBRL Taxonomy Extension Calculation Linkbase Document
XBRL Taxonomy Extension Definition Linkbase Document
XBRL Taxonomy Extension Label Linkbase Document
XBRL Taxonomy Extension Presentation Linkbase Document
*
†
#
§
Filed herewith.
Furnished herewith.
Management contract or compensatory plan, contract or arrangement.
Confidential treatment has been granted with respect to portions of this exhibit pursuant to Rule 24b-2 under the Exchange Act,
and these confidential portions have been redacted from the version of this agreement that is incorporated by reference in this
report. A complete copy of this exhibit, including the redacted portions, has been separately furnished to the SEC.
59
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the registrant has duly
caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
SIGNATURES
Date: March 19, 2018
FULGENT GENETICS, INC.
By:
/s/ Ming Hsieh
Ming Hsieh
President, Chief Executive Officer
POWER OF ATTORNEY
IN WITNESS WHEREOF, each person whose signature appears below constitutes and appoints Ming Hsieh and Paul Kim as
his true and lawful agent, proxy and attorney-in-fact, each acting alone, with full power of substitution and resubstitution, for him and
in his name, place and stead, in any and all capacities, to (i) act on and sign any amendments to this report, with exhibits thereto and
other documents in connection therewith, (ii) act on and sign such certificates, instruments, agreements and other documents as may
be necessary or appropriate in connection therewith, and in each case file the same with the SEC, hereby approving, ratifying and
confirming all that such agent, proxy and attorney-in-fact or any of his substitutes may lawfully do or cause to be done by virtue
thereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this report has been signed below by the
following persons on behalf of the registrant in the capacities and on the dates indicated.
Name and Signature
Title
/s/ Ming Hsieh
Ming Hsieh
/s/ Paul Kim
Paul Kim
/s/John Bolger
John Bolger
/s/ James J. Mulay (Mulé)
James J. Mulay (Mulé)
/s/ Yun Yen
Yun Yen
President, Chief Executive Officer and Chairman of the Board
(principal executive officer)
Chief Financial Officer
(principal financial and accounting officer)
Director
Director
Director
Date
March 19, 2018
March 19, 2018
March 19, 2018
March 19, 2018
March 19, 2018
60
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets as of December 31, 2017 and 2016
Consolidated Statements of Operations for the Years Ended December 31, 2017 and 2016
Consolidated Statements of Comprehensive Loss for the Years Ended December 31, 2017 and 2016
Consolidated Statements of Stockholders’/Members’ Equity for the Years Ended December 31, 2017 and 2016
Consolidated Statements of Cash Flows for the Years Ended December 31, 2017 and 2016
Notes to Consolidated Financial Statements
F-2
F-3
F-4
F-5
F-6
F-7
F-8
F-1
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Stockholders and the Board of Directors of Fulgent Genetics, Inc.
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of Fulgent Genetics, Inc. and subsidiaries (the "Company") as of
December 31, 2017, the related consolidated statements of operations, comprehensive loss, stockholders’/members’ equity, and
cash flows, for each of the two years in the period ended December 31, 2017, and the related notes (collectively referred to as the
"financial statements"). In our opinion, the financial statements present fairly, in all material respects, the financial position of the
Company as of December 31, 2017, and the results of its operations and its cash flows for each of the two years in the period ended
December 31, 2017, in conformity with accounting principles generally accepted in the United States of America.
Basis for Opinion
These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the
Company's financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting
Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the
U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the
audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error
or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial
reporting. As part of our audits, we are required to obtain an understanding of internal control over financial reporting, but not for
the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we
express no such opinion.
Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to
error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis,
evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting
principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial
statements. We believe that our audits provide a reasonable basis for our opinion.
DELOITTE & TOUCHE LLP
Los Angeles, CA
March 19, 2018
We have served as the Company's auditor since 2016.
F-2
CONSOLIDATED FINANCIAL STATEMENTS
FULGENT GENETICS, INC.
Consolidated Balance Sheets
(in thousands, except par value data)
Assets
Current assets
Cash and cash equivalents
Marketable securities
Trade accounts receivable, net of allowance for doubtful accounts of $287 and $151, as
of December 31, 2017 and 2016, respectively
Other current assets
$
Total current assets
Marketable securities, long term
Equity method investments
Fixed assets, net
Deferred tax asset
Other long-term assets
Total assets
Liabilities and Stockholders’ Equity
Current liabilities
Accounts payable
Accrued liabilities
Income tax payable
Total current liabilities
Other long-term liabilities
Deferred tax liability
Total liabilities
Commitments and contingencies (Note 8)
Stockholders’ equity
Common stock, $0.0001 par value per share, 50,000 and 200,000 shares authorized,
17,847 and 17,676 shares issued and outstanding at December 31, 2017 and 2016,
respectively.
Preferred stock, $0.0001 par value per share, 1,000 shares authorized, no shares issued
or outstanding at December 31, 2017 and 2016
Additional paid-in capital
Accumulated other comprehensive income (loss)
Accumulated deficit
Total stockholders’ equity
Total liabilities and stockholders’ equity
$
$
$
December 31,
2017
2016
6,490
19,994
$
4,005
2,438
32,927
14,883
1,937
7,272
126
39
57,184
2,089
911
—
3,000
6
—
3,006
2
—
111,884
(44)
(57,664)
54,178
57,184
$
$
$
7,897
12,971
4,364
906
26,138
25,597
—
6,234
54
17
58,040
2,756
436
124
3,316
2
243
3,561
2
—
109,734
(103)
(55,154)
54,479
58,040
The accompanying notes are an integral part of these consolidated financial statements.
F-3
FULGENT GENETICS, INC.
Consolidated Statements of Operations
(in thousands, except per share data)
Revenue
Cost of revenue
Gross profit
Operating expenses:
Research and development
Selling and marketing
General and administrative
Total operating expenses
Operating income (loss)
Interest and other income (expense)
Income (loss) before income taxes and equity loss in investee
Provision for (benefit from) income taxes
Income (loss) before equity loss in investee
Equity loss in investee
Income (loss) from continuing operations
Income (loss) from discontinued operations
Net income (loss)
Continuing operations:
Income (loss) per common share:
Basic and Diluted
Weighted-average common shares:
Basic and Diluted
$
$
$
Year Ended December 31,
2016
2017
18,730
8,551
10,179
4,223
4,205
5,233
13,661
(3,482)
481
(3,001)
(1,015)
(1,986)
(524)
(2,510)
—
(2,510)
$
$
18,276
6,722
11,554
3,558
2,469
4,609
10,636
918
(5,386)
(4,468)
920
(5,388)
—
(5,388)
41
(5,347)
(0.14)
$
(1.00)
17,739
13,710
The accompanying notes are an integral part of these consolidated financial statements.
F-4
FULGENT GENETICS, INC.
Consolidated Statements of Comprehensive Loss
(in thousands)
Net income (loss)
Other comprehensive income (loss), net of tax:
Foreign currency translation gain (loss)
Net unrealized gain (loss) on marketable securities
Comprehensive income (loss)
Year Ended December 31,
2017
2016
(2,510)
$
81
(22)
(2,451)
$
(5,347)
—
(103)
(5,450)
$
$
The accompanying notes are an integral part of these consolidated financial statements.
F-5
FULGENT GENETICS, INC.
Consolidated Statements of Stockholders’/Members’ Equity
(in thousands)
Members' Equity
Stockholders' Equity
Shares
Amount
Additional
Paid-In
Capital
Accumulated
Other
comprehensive
Loss
Accumulated
Deficit
Total
Equity
58,306
(12,390)
- $
- $
- $
- $
(53,160) $
11,900
5,146
(490)
Amount
Units
186,000 $
(96,000)
15,395
32,452
(4,618)
(1,663)
-
-
(5,645)
(1,767)
2,500
2,978
-
(4,592)
(97,632)
(1,253)
(72,071)
-
-
-
- $
-
-
- $
-
32,452
(1,663)
(3,727)
(3,727)
(4,820)
(6,587)
12,846
2
72,069
4,830
17,676 $
-
81
90
-
-
17,847 $
1,676
35,989
2 $
-
-
-
-
-
2 $
109,734 $
2,119
31
-
-
-
111,884 $
(103)
(103) $
-
-
-
59
-
(44) $
(5,347)
(55,154) $
-
-
-
-
(2,510)
(57,664) $
2,978
(4,592)
(1,253)
-
1,676
35,989
(103)
(5,347)
54,479
2,119
31
-
59
(2,510)
54,178
Balance at December 31, 2015
Split-off of Pharma business
Issuance of Class D-2 preferred units
(net of $185 issuance costs)
Repurchase and retirement of Class D-
1 preferred units
Deemed dividend on retirement
of Class D-1 preferred units
Repurchase and retirement of Class D
common units
Equity-based compensation (Pre-
Reorganization)
Distribution to Class D-1 preferred
unitholder
Tax distribution to Class D common
and preferred unitholders
Reorganization (Note 1)
Equity-based compensation (Post-
Reorganization)
Issuance of stock in initial public
offering, net of offering costs
Other comprehensive loss, net
Net loss
Balance at December 31, 2016
Equity-based compensation
Exercise of common stock options
Restricted stock awards
Other comprehensive income, net
Net loss
Balance at December 31, 2017
The accompanying notes are an integral part of these consolidated financial statements.
F-6
FULGENT GENETICS, INC.
Consolidated Statements of Cash Flows
(in thousands)
Year Ended December 31,
2016
2017
Cash flow from operating activities:
Net income (loss)
Income (loss) from discontinued operations
Loss from continuing operations
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
Equity-based compensation
Depreciation and amortization
Loss (gain) on disposal of fixed asset
Amortization of premium of marketable securities
Provision for bad debt
Deferred income taxes
Fair value adjustment recorded upon issuance of Class D-2 preferred units
Equity loss in investee
Other
Changes in operating assets and liabilities:
Accounts receivable
Other current assets
Accounts payable
Taxes payable
Accrued liabilities
Other current liabilities
Cash provided by continuing operations
Cash used in discontinued operations
Net cash provided by operating activities
Cash flow from investing activities:
Purchases of fixed assets
Proceeds from disposal of fixed assets
Sale of marketable securities
Purchase of marketable securities
Maturities of marketable securities
Purchase of equipment contributed to Equity Method Investee
Net cash used in investing activities
Cash flow from financing activities:
Proceeds from issuance of common stock, net of offering costs
Cash distributed in split-off of Pharma business
Distribution to Class D-1 preferred unitholder
Payment of initial public offering costs
Proceeds from issuance of Class D-2 preferred units
Repurchase and retirement of Class D-1 preferred and Class D common units
Tax distribution to Class D common and preferred unitholders
Proceeds from exercise of stock options
Net cash provided by (used in) financing activities
Effect of exchange rate changes on cash and cash equivalents
Net increase (decrease) in cash
Cash balance at beginning of period (including $0 and $9 at January 1, 2017 and 2016, respectively, from
discontinued operations)
Cash balance at end of period (including $0 at December 31, 2017 and 2016 from discontinued operations)
Supplemental disclosures of cash flow information:
Income taxes paid
Supplemental disclosures of non-cash investing and financing activities:
Fixed assets included in accounts payable
Initial public offering costs included in accounts payable and accrued expenses
$
$
(2,510)
—
(2,510)
2,119
1,728
5
370
160
(336)
—
524
(15)
214
(1,537)
(363)
(124)
1,098
(2)
1,331
—
1,331
(2,895)
—
3,781
(11,659)
11,185
(2,461)
(2,049)
—
—
—
(801)
—
—
—
31
(770)
81
(1,407)
$
$
$
$
7,897
6,490
$
757
$
1,014
—
$
$
The accompanying notes are an integral part of these consolidated financial statements.
F-7
(5,347)
41
(5,388)
4,654
1,170
—
63
76
246
5,472
—
—
(2,322)
(381)
1,094
124
(372)
—
4,436
(31)
4,405
(3,788)
10
—
(39,017)
—
—
(42,795)
36,790
(159)
(4,592)
—
26,980
(11,977)
(1,253)
—
45,789
—
7,399
498
7,897
550
1,173
801
FULGENT GENETICS, INC.
Notes to Consolidated Financial Statements
Note 1. Overview and Basis of Presentation
The accompanying 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 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 growing technology company with an initial 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
“Diagnostics business”). 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 test menu currently includes
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 typically frequent and high-volume users of genetic tests and which
often pay the Company directly for its tests.
Background and Reorganization
The Company was incorporated in the State of Delaware on May 13, 2016. On August 2, 2016, pursuant to the approval of the
board of directors of the Company, the Company changed its name from Fulgent Diagnostics, Inc. to Fulgent Genetics, Inc. On
September 30, 2016, the Company completed a reorganization pursuant to which Fulgent Therapeutics LLC, a California limited
liability company (referred to, together with its former subsidiary unless otherwise noted or the context otherwise requires, as “Fulgent
LLC”), became a wholly owned subsidiary of the Company (the “Reorganization”). Prior to the Reorganization, the Company had no
material assets and had not conducted any activities other than those incidental to its incorporation and preparation for the initial
public offering of its common stock. Following the Reorganization, the Company is a holding company with no material assets other
than 100% of the equity interests in Fulgent LLC and its other subsidiaries, and Fulgent LLC is considered the Company’s
predecessor for accounting purposes and Fulgent LLC’s financial statements for all periods prior to completion of the Reorganization
constitute the Company’s historical financial statements.
For purposes of these notes and the accompanying consolidated financial statements: (i) Fulgent LLC’s operating agreement, as
amended from time to time, is referred to as the “Operating Agreement;” (ii) Fulgent LLC’s equity holders are referred to as
“members;” (iii) Fulgent LLC’s authorized, issued and outstanding equity interests prior to the Reorganization are referred to as
“units” and consisted of Class D common units and Class D-1 and Class D-2 preferred units; (iv) certain of Fulgent LLC’s Class D
common units outstanding prior to the Reorganization constituted profits interests (which are sometimes referred to simply as “profits
interests”), which are a type of equity-based award containing a participation threshold (which is sometimes referred to as a “profits
interest threshold”) that entitled the recipient of the award to participate in the value of Fulgent LLC only to the extent it appreciated
from and after the grant date of the award; and (v) prior to the Reorganization, Fulgent LLC was managed by its Manager, Ming
Hsieh, who was also Fulgent LLC’s controlling equity holder. In the Reorganization, each outstanding 7.6 units of Fulgent LLC were
cancelled in exchange for one share of the Company’s common stock, such that (i) all outstanding Class D common units of Fulgent
LLC (including profits interests) were cancelled in exchange for an aggregate of 4,059,900 shares of the Company’s common stock;
(ii) all outstanding Class D-1 preferred units of Fulgent LLC were cancelled in exchange for an aggregate of 6,760,733 shares of the
Company’s common stock; (iii) all outstanding Class D-2 preferred units were cancelled in exchange for an aggregate of 2,025,623
shares of the Company’s common stock; (iv) all outstanding options to acquire common units of Fulgent LLC were cancelled in
exchange for equivalent options to acquire up to an aggregate of 591,112 shares of the Company’s common stock, and all such options
became immediately exercisable to the extent vested; and (v) all outstanding restricted share units relating to common units of
Fulgent LLC were cancelled in exchange for equivalent restricted stock units (these restricted share units and restricted stock units are
F-8
both referred to as “RSUs”) relating to 65,789 shares of the Company’s common stock. The Reorganization was accounted for as a
common control transaction and no gain or loss was recorded.
Discontinued Operations
The Company historically conducted two lines of business: the Diagnostics business, which the Company conducted directly
and which is the only business it is presently pursuing, and its former pharmaceutical business (the “Pharma business”), which was
conducted by the Company’s former wholly owned subsidiary, Fulgent Pharma LLC (“Fulgent Pharma”). In addition, Fulgent LLC’s
equity interests were separated into two series based on these two lines of business, with the holders of Fulgent LLC’s Class D
preferred units and Class D voting and non-voting common units (collectively, the “Class D units”) having economic rights based on
the Diagnostics business, and the holders of Fulgent LLC’s Class P preferred units and Class P voting and non-voting common units
(collectively, the “Class P units”) having economic rights based on the Pharma business. These Class D units and Class P units were
intended to “track,” or reflect, the relative performance of the Diagnostics business and the Pharma business, respectively.
In April 2016, Fulgent LLC’s Operating Agreement was amended and restated to provide for the distribution of Fulgent Pharma
in full redemption and cancellation of the Class P units. On April 4, 2016, Fulgent LLC completed the split-off of Fulgent Pharma and
the Pharma business by redeeming all of the then-outstanding Class P units and distributing to each holder of Class P units
substantially identical shares of Fulgent Pharma and causing Fulgent Pharma to assume all then-outstanding options to purchase Class
P units. All Class P units were immediately cancelled upon redemption. The split-off of the Pharma business was a pro-rata
distribution to all of the holders of Class P units, but did not involve the holders of Fulgent LLC’s Class D units. The Manager and
controlling equity holder of Fulgent LLC prior to the Reorganization, Mr. Hsieh, is the Manager and controlling equity holder of
Fulgent Pharma. As a result, the split-off of the Pharma business was accounted for as a common control transaction and the recorded
amount of Fulgent Pharma’s net assets was transferred to the holders of Class P units and no gain or loss was recorded.
The financial condition and results of the Pharma business were included in the accompanying consolidated financial statements
as discontinued operations for all periods presented. The Class P common and preferred units had the right to participate in earnings
and distributions of Fulgent Pharma but were not obligated to fund losses. As a result, in periods of Pharma business net loss, losses
were allocated to the holders of Class P common units subject to profits interest thresholds, as they were determined to be the most
subordinate unit.
The split-off of the Pharma business is presented as discontinued operations in the accompanying consolidated financial
statements for all periods presented.
There were no amounts recorded from discontinued operations in the accompanying consolidated statement of operations for the
year ended December 31, 2017.The major components of statements of operations data comprising the income from discontinued
operations for the year ended December 31, 2016 are as follows:
Year Ended December 31,
2016
(in thousands)
Operating expenses:
Research and development
General and administrative
Total operating expenses
Operating loss
Other income
Income
Initial Public Offering
$
$
350
9
359
(359)
400
41
On October 4, 2016, the Company completed the initial public offering of its common stock (the “IPO”), in which it issued and
sold an aggregate of 4,830,000 shares of common stock (including 630,000 shares issued and sold on October 7, 2016 pursuant to the
underwriters’ exercise in full of their option to purchase additional shares) at a public offering price of $9.00 per share. The Company
received net proceeds of approximately $36.0 million, after deducting underwriting discounts and commissions of $3.0 million and
other offering expenses paid or payable by the Company of approximately $4.4 million. The shares issued and sold in the IPO were
registered under the Securities Act of 1933, as amended, on a registration statement on Form S-1 (File No. 333- 213469), as amended.
F-9
Summarized Financial Information of Equity Method Investment Misstatement
Subsequent to the issuance of its condensed consolidated financial statements for the quarter ended June 30, 2017, the Company
identified an error in its disclosures of summarized financial information of its equity method investment. Investee leasehold
improvements and deposits on equipment, which are non-current assets, were incorrectly reported in such financial statements as
current assets in the summarized balance sheet disclosures as of December 31, 2016 and June 30, 2017. Accordingly, the Company
has restated the December 31, 2016 summarized financial information in these consolidated financial statements to correct this
misstatement, which resulted in the reclassification of $2,810,000 of current assets to non-current assets. The Company evaluated the
materiality of this misstatement from quantitative and qualitative perspectives and concluded that it was immaterial to the periods.
Note 2. Summary of Significant Accounting Policies
Use of Estimates
The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make certain
estimates, judgments, assumptions and decisions that affect the reported amounts and related disclosures, including the selection of
appropriate accounting policies and the assumptions on which to base accounting estimates. In making these estimates and
assumptions and reaching these decisions, the Company applies judgment based on its understanding and analysis of the relevant
circumstances, including historical data and experience available at the date of the accompanying 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)
the valuation of equity-based awards.
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries.
All intercompany transactions and balances have been eliminated in consolidation.
Cash and Cash Equivalents
The Company considers all highly liquid investments with original maturities of three months or less at the date of purchase to
be cash equivalents. Cash and cash equivalents include cash held in banks and money market accounts. Cash equivalents are stated at
fair value.
Accounts Receivable and Allowance for Doubtful Accounts
Accounts receivable are stated at the amount the Company expects to collect. The Company performs credit evaluations of its
customers and generally does not require collateral. The Company establishes an allowance for doubtful accounts based upon factors
surrounding the credit risk of specific customers, historical trends and other information that assists in management’s evaluation. The
Company writes off accounts receivable following a review by management and a determination that the receivable is uncollectible.
A roll-forward of the activity in the Company’s allowance for doubtful accounts is as follows:
Allowance for doubtful accounts at beginning of year
Bad debt expense
Deductions
Allowance for doubtful accounts at end of year
Marketable Securities
December 31,
2017
2016
(in thousands)
151 $
160
(24)
287
$
75
103
(27)
151
$
$
All marketable securities, which consist of debt securities, have been classified as “available for sale” and are carried at fair
value. Unrealized gains and losses, net of any related tax effects, are excluded from earnings and are included in other comprehensive
F-10
loss and reported as a separate component of stockholders’ equity until realized. Realized gains and losses and declines in value
judged to be other than temporary, if any, on marketable securities are included in other income (expense), net. The cost of any
marketable securities sold is based on the specific-identification method. The amortized cost of marketable securities is adjusted for
amortization of premiums and accretion of discounts to maturity. Interest on marketable securities is included in interest income. In
accordance with the Company’s investment policy, management invests to diversify credit risk and only invests in securities with high
credit quality, including U.S. government securities.
The Company regularly evaluates whether declines in the fair value of its investments below their cost are other than temporary.
The evaluation includes consideration of the cause of the impairment, including the creditworthiness of the security issuers, the
number of securities in an unrealized loss position, the severity and duration of the unrealized losses, whether the Company has the
intent to sell the securities, and whether it is more likely than not that the Company will be required to sell the securities before the
recovery of their amortized cost basis. If the Company determines that the decline in fair value of an investment is below its
accounting basis and this decline is other than temporary, the Company would reduce the carrying value of the security it holds and
record a loss for the amount of such decline. The Company has not recorded any realized losses or declines in value judged to be other
than temporary on its investments.
Fair Value of Financial Instruments
The Company's financial instruments consist principally of cash and cash equivalents, marketable securities, accounts receivable
and accounts payable. The carrying amounts of certain of these financial instruments, including cash and cash equivalents, accounts
receivable and accounts payable, approximate fair value due to their short maturities. Fair value of marketable securities is disclosed
in Note 4, Fair Value Measurements, to the accompanying consolidated financial statements.
Concentrations of Credit Risk, Customers and Suppliers
Financial instruments that potentially subject the Company to significant concentrations of credit risk consist primarily of cash,
accounts receivable and marketable securities, which consist of debt securities, and cash equivalents. As of December 31, 2017,
substantially all of the Company’s cash and cash equivalents were deposited in accounts at financial institutions, and amounts may
exceed federally insured limits. Management believes that the Company is not exposed to significant credit risk due to the financial
strength of the depository institutions in which its cash and cash equivalents are held.
In certain periods, a small number of customers has accounted for a significant portion of the Company’s revenue. Three
customers comprised 14%, 12% and 10%, respectively, of total revenue in the year ended December 31, 2017, and one such customer
comprised 15% of total revenue in the year ended December 31, 2016. One customer comprised 13% of total accounts receivable in
the year ended December 31, 2017, and four customers comprised 12%, 11%, 12% and 11%, respectively, of total accounts receivable
in the year ended December 31, 2016, of which the latter two customers represent one customer for concentration disclosure purposes
as they are managed by the same foreign governmental body.
Revenue from the U.S. government was less than 10% of total revenue in each of the years ended December 31, 2017 and 2016.
The Company relies on a limited number of suppliers for certain laboratory substances used in the chemical reactions
incorporated into its processes, referred to as reagents, as well as for the sequencers and various other equipment and materials it uses
in its laboratory operations. In particular, the Company relies on a sole supplier for the next generation sequencers and associated
reagents it uses to perform its genetic tests and as the sole provider of maintenance and repair services for these sequencers. The
Company’s laboratory operations would be interrupted if it encounters delays or difficulties securing these reagents, sequencers, other
equipment or materials or maintenance and repair services, which could occur for a variety of reasons, including if the Company needs
a replacement or temporary substitute for any of its limited or sole suppliers and is not able to locate and make arrangements with an
acceptable replacement or temporary substitute. The Company believes there are currently only a few other manufacturers that are
capable of supplying and servicing some of the equipment and other materials necessary for its laboratory operations, including
sequencers and various associated reagents.
Equity Method Investments
The Company uses the equity method to account for investments in entities that it does not control, but in which it has the
ability to exercise significant influence over operating and financial policies. The Company's proportionate share of the net income or
loss of these companies is included in consolidated net earnings. Judgments regarding the level of influence over each equity method
investment include 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.
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Fixed Assets
Fixed assets are recorded at cost, net of accumulated depreciation and amortization. Depreciation is recorded using the straight-
line method over the estimated useful lives of the assets, which is generally between three and five years. Leasehold improvements are
capitalized and amortized over the shorter of their expected lives or the applicable lease term, including renewal options, if available.
Major replacements and improvements are capitalized, while general repairs and maintenance are expensed as incurred.
Software for Internal Use
The Company capitalizes certain costs incurred to purchase computer software for internal use. These costs include purchased
software packages for Company use. Capitalized computer software costs are amortized over the estimated useful life of the computer
software, which is generally three years. Internally developed software costs are capitalized after management has committed to
funding the project, it is probable that the project will be completed and the software will be used for its intended function. Costs that
do not meet that criteria and costs incurred on projects in the preliminary and post-implementation phases are expensed as incurred.
Impairment of Long-Lived Assets
The Company evaluates the carrying amount of its long-lived assets whenever events or changes in circumstances indicate that
the assets may not be recoverable. An impairment loss would be recognized when estimated future cash flows expected to result from
the use of an asset and its eventual disposition is less than the carrying amount of the asset. To date, there have been no such
impairment losses.
Reporting Segment and Geographic Information
Reporting segments are identified as components of an enterprise about which separate discrete financial information is
available for evaluation by the chief operating decision-maker in making decisions regarding resource allocation and assessing
performance. The Company’s chief operating decision maker is its Chief Executive Officer. The Company views its operations and
manages its business in one reporting segment.
Revenue Recognition
The Company generates revenue from sales of its genetic tests. The Company currently receives payments from: hospitals and
medical institutions with which it has direct-bill relationships; research institutions; individual patients and third-party payors.
The Company recognizes revenue when all of the following criteria are met: (i) persuasive evidence of an arrangement exists;
(ii) delivery has occurred; (iii) the fee is fixed or determinable and (iv) collectability is reasonably assured. Criterion (i) is satisfied
when the Company has an arrangement or contract in place. Criterion (ii) is satisfied when the Company delivers a report to the
ordering physician or test results to the research institution. Determination of criteria (iii) and (iv) are based on management’s
judgments regarding whether the fee is fixed or determinable, and whether the collectability of the fee is reasonably assured. The
Company recognizes revenue on a cash basis when it cannot conclude that either criterion (iii) or (iv) has been met.
The Company’s test results are delivered electronically, and as such there are no shipping and handling fees incurred by it or
billed to customers. The Company’s sales are typically exempt from state sales taxation due to the nature of the results delivered. As a
result, the Company currently does not charge customers state sales tax and continues to assess.
Deferred Revenue
Payments received in advance of services rendered are recorded as deferred revenue and are subsequently recognized as revenue
in the period in which the applicable revenue recognition criteria, as described above, are met. Deferred revenue consists primarily of
revenue from tests performed for customers that have a limited time period following an initial order to request certain follow-up tests
at no additional charge.
Overhead Expenses
The Company allocates overhead expenses, such as rent and utilities, to cost of revenue and operating expense categories based
on headcount. As a result, an overhead expense allocation is reflected in cost of revenue and each operating expense category.
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Cost of Revenue
Cost of revenue reflects the aggregate costs incurred in delivering test results and consists of: personnel costs, including salaries,
employee benefit costs, bonuses and equity-based compensation expenses; costs of laboratory supplies; depreciation of laboratory
equipment; amortization of leasehold improvements and allocated overhead. Costs associated with performing tests are recorded as
tests are processed.
Research and Development Expenses
Research and development expenses represent costs incurred to develop the Company’s technology and future tests. These costs
consist of: personnel costs, including salaries, employee benefit costs, bonuses and equity-based compensation expenses; laboratory
supplies; consulting costs and allocated overhead. The Company expenses all research and development costs in the periods in which
they are incurred.
Selling and Marketing Expenses
Selling and marketing expenses consist of: personnel costs, including salaries, employee benefit costs, bonuses and equity-based
compensation expenses; customer service expenses; direct marketing expenses; educational and promotional expenses; market
research and analysis and allocated overhead. The Company expenses all selling and marketing costs as incurred.
General and Administrative Expenses
General and administrative expenses include executive, finance and accounting, legal and human resources functions. These
expenses consist of: personnel costs, including salaries, employee benefit costs, bonuses and equity-based compensation expenses;
audit and legal expenses; consulting costs and allocated overhead. The Company expenses all general and administrative expenses as
incurred.
Income Taxes
Income taxes are accounted for under the asset and liability method. The Company provides for federal, state and foreign
income taxes currently payable, as well as for taxes deferred due to timing differences between reporting income and expenses for
financial statement purposes versus tax purposes. Deferred tax assets and liabilities are recognized for the future tax consequences
attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their
respective tax bases. Deferred tax assets and liabilities are measured using enacted income tax rates expected to apply to taxable
income in the years in which those temporary differences are expected to be recovered or settled. The effect of a change in income tax
rates is recognized as income or expense in the period that includes the enactment date.
The Company recognizes the effect of income tax positions only if those positions are more likely than not to be sustained.
Recognized income tax positions are measured at the largest amount with a greater than 50% likelihood of being realized. Changes in
recognition or measurement are reflected in the period in which the change in judgment occurs. For income tax positions where it is
not more likely than not that a tax benefit will be sustained, the Company does not recognize a tax benefit in its consolidated financial
statements. The Company records interest and penalties related to uncertain tax positions, if applicable, as a component of income tax
expense.
The Company’s predecessor, Fulgent LLC, is organized as a limited liability company and its members elected to have Fulgent
LLC treated as a partnership for income tax purposes. As a result, for all periods prior to the Reorganization, all taxable income or loss
and tax credits of the Company generally were reflected in the personal income tax returns of Fulgent LLC’s members, and no
provision for federal and state income taxes was provided in the accompanying consolidated financial statements. The Company
became a taxable entity upon completion of the Reorganization on September 30, 2016.
Equity-Based Compensation
The Company grants various types of equity-based awards to its employees, consultants and non-employee directors. Equity-
based compensation costs are reflected in the accompanying statements of operations based upon each award recipient’s role with the
Company. The Company grants to its employees option and RSU awards that generally vest over a specified period of time upon the
satisfaction of service-based conditions. Before the Reorganization, the Company also granted to its employees awards of units and
profits interests that generally were fully vested at grant. The Company measures compensation expense for equity-based awards
granted to employees based on the fair value of the award on the grant date of the award. The Company measures the fair value of
option awards using the Black-Scholes option valuation model, the Company measures the fair value of RSU awards based on the fair
value of the underlying shares of common stock on the grant date of the award, the Company measured the fair value of unit awards
F-13
granted before the Reorganization based on the fair value of the units on the grant date of the award, and the Company measured the
fair value of profits interest awards granted before the Reorganization using the Black-Scholes option-valuation model.
Compensation expense for employee option awards with a service-based vesting condition is recognized over the vesting period
of the award using the accelerated attribution method. Compensation expense for employee RSU awards with a service-based vesting
condition is recognized ratably over the vesting period of the award. Compensation expense for employee equity-based awards with
both performance-based and service-based vesting conditions is recognized over the period required to satisfy both conditions using
the accelerated attribution method.
Transactions with non-employees in which goods or services are the consideration received for the grant of equity-based awards
are accounted for based on the fair value of the consideration received or the fair value of the equity-based award, whichever is more
reliably measurable. The measurement date of the fair value of the equity-based award is the earlier of the date on which the
counterparty’s performance is complete or the date on which it is probable that performance will occur and the fair value is subject to
remeasurement at each reporting date over the term of the award. Compensation expense for non-employee option awards is based on
the measurement date fair value of the award and recognized using the accelerated attribution method. Compensation expense for non-
employee RSU awards is based on the measurement date fair value of the award and recognized ratably over the requisite vesting
period of the award.
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 consolidated statements of stockholders’ equity. The Company’s 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. Gains and losses from these
remeasurements were not significant in the year ended December 31, 2017.
Comprehensive Loss
Comprehensive loss is comprised of net loss and other comprehensive loss. Other comprehensive loss consists of unrealized loss
on marketable securities. The Company did not have reclassifications from other comprehensive loss to the loss during the year ended
December 31, 2017.
Basic and Diluted Net Loss per Share
Basic net loss per common share is computed by dividing the net loss attributable to common stockholders by the weighted-
average number of common shares outstanding during the period. Diluted net loss per common share is computed by dividing the net
loss attributable to common stockholders by the weighted-average number of common shares and dilutive common share equivalents
outstanding during the period. Because the Company has reported a net loss attributable to common stockholders for all periods
presented, diluted net loss per common share is the same as basic net loss per common share for these periods.
Emerging Growth Company
Pursuant to the Jumpstart Our Business Startups Act of 2012 (the “JOBS Act”), a company constituting an “emerging growth
company” is, among other things, entitled to rely upon certain reduced reporting requirements. The Company is an emerging growth
company, but has irrevocably elected not to take advantage of the extended transition period afforded by the JOBS Act for the
implementation of new or revised accounting standards. As a result, the Company will comply with new or revised accounting
standards on the relevant dates on which adoption of such standards is required for public companies that are not emerging growth
companies.
Recent Accounting Pronouncements
ASU No. 2014-09
In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-
09, Revenue from Contracts with Customers (Topic 606), which outlines a comprehensive new revenue recognition model designed to
depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects
to be entitled in exchange for those goods or services. In March 2016, the FASB issued ASU No. 2016-08, Revenue from Contracts
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with Customers (Topic 606)–Principal versus Agent Considerations (Reporting Revenue Gross versus Net), which further clarifies the
implementation guidance on principal versus agent considerations contained in ASU 2014-09. In April 2016, the FASB issued ASU
No. 2016-10, Revenue from Contracts with Customers (Topic 606)–Identifying Performance Obligations and Licensing, which further
clarifies the implementation guidance relating to identifying performance obligations and the licensing implementation guidance. In
May 2016, the FASB issued ASU No. 2016-12, Revenue from Contracts with Customers (Topic 606)–Narrow-Scope Improvements
and Practical Expedients, which further clarifies guidance on collectability, noncash consideration, presentation of sales tax, practical
expedients and transition. In December 2016, the FASB issued ASU No. 2016-20, Technical Corrections and Improvements to Topic
606, Revenue from Contracts with Customers, which makes minor corrections or minor improvements to the codification that are not
expected to have a significant effect on current accounting practice or create a significant administrative cost to most entities. These
standards, pursuant to ASU No. 2015-14, Revenue from Contracts with Customers–Deferral of the Effective Date (Topic 606) issued
by the FASB in August 2015, will be effective for annual periods (including interim periods) beginning after December 15, 2017. The
standard can be applied either retrospectively to each period presented or as a cumulative effect adjustment as of the date of adoption.
The Company plans to implement these standards effective January 1, 2018 based on the modified retrospective method.
In the third and fourth quarters of 2017, the Company performed an analysis of the impact of the new revenue recognition
standard described in the preceding paragraph, which included a review of existing contracts with customers, an evaluation of the
specific terms of such contracts and their appropriate treatment under the new standard, and a comparison of such new treatment to the
Company’s then-existing accounting policies to identify differences.
The Company has completed this analysis, and has substantially completed its new revenue recognition accounting policy
documentation reflecting the new standard. The Company is also in the process of preparing the transition adjustment that will be
reflected in its condensed consolidated financial statements for the quarter ending March 31, 2018. As a result of these analyses and
preparations, the Company has identified the following differences between the new standard and the Company’s revenue recognition
policy utilized in the periods covered by these financial statements and all prior periods:
•
The Company currently recognizes revenue from third-party payors on a cash basis. Under the new revenue recognition
standard, the Company expects to recognize revenue from third-party payors on an accrual basis at the time of delivery of
genetic test results to these customers. This will result in the Company’s recognition of revenue from these parties under the
new standard earlier than it recognized revenue from these parties under the Company's prior revenue recognition.
• Upon adopting the new standard on January 1, 2018, the Company will record an adjustment of $327,000 to beginning
accumulated deficit and accounts receivable, to reflect genetic tests previously delivered to third-party payors for which
revenue was not recognized as of such date.
The Company has evaluated the new disclosure requirements, including any necessary changes to business processes, systems,
and controls to support the additional required disclosures.
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 is effective for the Company in the first quarter of 2018, with early adoption permitted. The Company is currently evaluating the
effect this ASU will have on its consolidated financial statements and related disclosures.
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 will become
effective for interim and annual reporting periods beginning with the year ending December 31, 2019. The standard requires the use of
a modified retrospective transition approach for existing leases. Early adoption is permitted. The Company is currently evaluating the
effect this ASU will have on its consolidated financial statements and related disclosures.
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
F-15
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. 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 is
effective for fiscal years and interim periods beginning after December 15, 2017. Early adoption is permitted for all periods beginning
after December 15, 2016. The Company is currently evaluating 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.
Note 3. Marketable Securities
The Company’s marketable securities consisted of the following:
Amortized
Cost Basis
December 31, 2017
Unrealized
Gains
Unrealized
Losses
(in thousands)
Aggregate
Fair Value
Marketable securities:
Short-term
Money market accounts
Corporate debt securities
Less: Cash equivalents
Total short-term marketable securities
Corporate debt securities
Total long-term marketable securities
$
$
723 $
20,040
(723)
20,040
14,999
14,999
35,039 $
F-16
— $
2
—
2
—
—
2 $
— $
(48)
—
(48)
(116)
(116)
(164) $
723
19,994
(723)
19,994
14,883
14,883
34,877
Marketable securities:
Short-term
Money market accounts
Corporate debt securities
Less: Cash equivalents
Total short-term marketable securities
Corporate debt securities
Total long-term marketable securities
Amortized
Cost Basis
December 31, 2016
Unrealized
Gains
Unrealized
Losses
(in thousands)
Aggregate
Fair Value
$
$
1,580 $
12,988
(1,580)
12,988
25,740
25,740
38,728 $
— $
—
—
—
3
3
3 $
— $
(17)
—
(17)
(146)
(146)
(163) $
1,580
12,971
(1,580)
12,971
25,597
25,597
38,568
As of December 31, 2017 and 2016, the contractual maturities of the Company’s marketable securities less than one year
were $20.0 million and $13.0 million, respectively, and the contractual maturities of the Company’s marketable securities greater than
one year and less than five years were $14.9 million and $25.6 million, respectively. Management determined that the gross unrealized
losses of $164,000 on the Company’s marketable securities as of December 31, 2017 were temporary in nature. Gross unrealized
losses on the Company’s marketable securities were $163,000 as of December 31, 2016. 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 December
31, 2017.
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 the 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:
Level 1:
Level 2:
Inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities that the
reporting entity can access at the measurement date.
Inputs are inputs other than quoted prices included within Level 1 that are observable for the
asset or liability, either directly or indirectly.
Level 3:
Inputs are unobservable inputs for the asset or liability.
The following tables present information about the Company’s financial assets measured at fair value on a recurring basis,
based on the three-tier fair value hierarchy:
Marketable securities:
Corporate debt securities
Money market accounts
Total marketable securities
Total
Level 1
Level 2
Level 3
December 31, 2017
(in thousands)
$
$
34,877 $
723
35,600 $
— $
723
723 $
34,877 $
—
34,877 $
—
—
—
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Marketable securities:
Corporate debt securities
Money market accounts
Total marketable securities
Total
Level 1
Level 2
Level 3
December 31, 2016
(in thousands)
$
$
38,568 $
1,580
40,148 $
— $
1,580
1,580 $
38,568 $
—
38,568 $
—
—
—
The Company’s Level 1 assets include money market instruments and are valued based upon observable market prices. Level 2
assets consist of marketable investment securities consisting of corporate bonds. Level 2 securities are valued based upon observable
inputs that include reported trades, broker/dealer quotes, bids and offers. As of December 31, 2017 and 2016, the Company had no
investments that were measured using unobservable (Level 3) inputs.
There were no transfers between fair value measurement levels during the years ended December 31, 2017 and 2016.
Gross unrealized gains or losses for cash equivalents and marketable securities as of December 31, 2017 were not material. As
of December 31, 2017, unrealized losses for securities in an unrealized loss position for more than 12 months were $107,000. During
the years ended December 31, 2016 and 2017, 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:
Useful Lives
December 31,
2017
2016
Computer hardware
Computer software
Machinery and equipment
Medical lab equipment
General equipment
Furniture and fixtures
Leasehold improvements
Assets not yet placed in service
Total
Less: Accumulated depreciation
Property and equipment, net
3 Years
3 Years
5 Years
5 Years
3 Years
5 Years
Shorter of lease term or estimated useful life
$
$
$
(in thousands)
1,435
463
—
7,145
—
159
763
1,074
11,039
(3,767)
7,272
$
1,293
354
177
4,678
59
86
520
1,114
8,281
(2,047)
6,234
Depreciation expense on fixed assets totaled $1.7 million and $1.2 million for the years ended December 31, 2017 and 2016,
respectively.
Note 6. Other Current Assets
Other current assets consisted of the following:
December 31,
2017
2016
Reagents
Prepaid expenses
Prepaid income taxes
Marketable securities interest receivable
Other receivable
Total
$
$
F-18
$
(in thousands)
231
624
1,313
204
66
2,438
$
322
375
—
209
—
906
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 years ended December 31, 2017 and 2016. Revenue by region was as follows:
Revenue:
United States
Foreign:
Canada
People's Republic of China ("PRC")
Other Countries
Total
Note 8. Commitments and Contingencies
Operating Leases
2017
December 31,
(in thousands)
2016
$
$
9,024
$
4,091
2,614
3,001
18,730
$
8,258
3,798
3,241
2,979
18,276
The Company has commitments under various non-cancelable operating leases with varying terms through January 2023. The
Company has options to renew some of these leases for three years after their expiration. Future minimum payments under non-
cancelable operating leases as of December 31, 2017 are as follows:
Year ending December 31,
2018
2019
2020
2021
Thereafter
Total minimum lease payments
Amounts
(in thousands)
254
181
178
165
134
912
$
$
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 (“CA DPH”). 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 activities.
Rent expense for the years ended December 31, 2017 and 2016 was approximately $250,000, and $204,000, respectively.
On January 31, 2018, we entered into a lease renewal of our headquarters in Temple City, California, which commenced on
February 1, 2018 and expires January 31, 2021. The total annual rent under the lease is approximately $269,000.
FF Gene Biotech
See Note 15 for a description of the Company’s commitments related to its joint venture, FF Gene Biotech (as defined in Note
15).
Purchase Obligations
As of December 31, 2017, the Company had purchase obligations of $1.7 million for reagents and equipment.
F-19
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’/Members’ 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 $37,000 and $58,000 for the years
ended December 31, 2017 and 2016, respectively.
Certificate of Incorporation
In accordance with the Company’s amended certificate of incorporation, the Company is authorized to issue 50,000,000 shares
of common stock, with a par value of $0.0001 per share, and 1,000,000 shares of preferred stock, with a par value of $0.0001 per
share. In May 2017, the Company amended its certificate of incorporation to reduce its authorized shares from 200,000,000 to
50,000,000. Holders of the Company’s common stock are entitled to one vote for each share held on all matters submitted to a vote of
its stockholders. Holders of the Company’s common stock have no cumulative voting rights. Further, as of December 31, 2017,
holders of the Company’s common stock have no preemptive, conversion, redemption or subscription rights and there are no sinking
fund provisions applicable to the Company’s common stock. Upon liquidation, dissolution or winding-up of the Company, holders of
the Company’s common stock are entitled to share ratably in all assets remaining after payment of all liabilities and the liquidation
preferences of any outstanding shares of preferred stock. Subject to preferences that may be applicable to any outstanding shares of
preferred stock, holders of the Company’s common stock are entitled to receive dividends, if any, as may be declared from time to
time by the Company’s board of directors. As of December 31, 2017, there were no outstanding shares of preferred stock.
Reorganization
Upon completion of the Reorganization on September 30, 2016, all of Fulgent LLC’s outstanding units were cancelled in
exchange for shares of the Company’s common stock, at a ratio of 7.6 units of Fulgent LLC cancelled in exchange for each one share
of the Company’s common stock.
The following is a summary of the units of Fulgent LLC that were cancelled in exchange for shares of the Company’s common
stock:
Class D-1 preferred units
Class D-2 preferred units
Class D common units
Class D common units — profits interests
Total
Pre-Reorganization
(in thousands)
51,382
15,395
2,500
28,355
97,632
The units set forth in the table above were cancelled in exchange for an aggregate of 12,846,256 shares of the Company’s
common stock. The members’ equity balance of $72.0 million was reclassified into common stock and additional paid-in capital in the
accompanying consolidated balance sheet as of December 31, 2016.
Distributions
In the year ended December 31, 2016, the Company made distributions as follows: (i) the Company paid $1.3 million in tax
distributions to the former members of Fulgent LLC based on the income tax liabilities of such former members attributable to Fulgent
LLC’s 2016 net taxable income through the date of the Reorganization, and (ii) the Company paid $4.6 million to Mr. Hsieh in his
F-20
capacity as a member of Fulgent LLC as a return of capital contribution. The Company made no distributions in the year ended
December 31, 2017.
Xi Long Financing
In May 2016, Fulgent LLC completed a transaction with Xi Long USA, Inc. (“Xi Long”), an independent investor, and certain
members of Fulgent LLC. In this transaction, (i) Xi Long acquired 4,618,421 Class D-1 preferred units and 5,644,737 Class D
common units from certain existing members of Fulgent LLC for an aggregate purchase price of $12.0 million, which units were
required to be redeemed by Fulgent LLC in exchange for its issuance to Xi Long of an equivalent number of Class D-2 preferred units,
and (ii) Fulgent LLC sold an additional 5,131,579 Class D-2 preferred units to Xi Long for gross proceeds of $15.2 million. Fulgent
LLC incurred issuance costs of $185,000 for the transaction, resulting in net proceeds to Fulgent LLC of $15.0 million. Fulgent LLC
immediately cancelled the redeemed Class D common and Class D-1 preferred units upon completion of the transaction. All Class D-2
preferred units issued to Xi Long in the transaction were converted into an aggregate of 2,025,623 shares of the Company’s common
stock upon completion of the Reorganization.
This transaction was accounted for as: (i) the retirement of the redeemed Class D common units, (ii) the extinguishment of the
redeemed Class D-1 preferred units, with the excess of the consideration transferred over the related carrying amount recorded as a
deemed dividend in the amount of $3.7 million, and (iii) the issuance of 15,394,737 Class D-2 preferred units for $32.6 million. As a
result of the transaction, Xi Long acquired an aggregate of 15,394,737 Class D-2 preferred units for an aggregate purchase price of
$27.2 million, even though, at issuance, the fair value of 15,394,737 Class D-2 preferred units as evidenced by Fulgent LLC’s then
most recent third-party valuation was $32.6 million. The $5.5 million difference between the fair value of, and the aggregate
consideration paid by Xi Long for, the Class D-2 preferred units issued in the transaction was not attributable to any stated rights or
privileges. Rather, Fulgent LLC, Xi Long and the members of Fulgent LLC that were party to the transaction determined to complete
the transaction in line with their discussions, notwithstanding that the fair value of the Class D-2 preferred units as evidenced by
Fulgent LLC’s third-party valuation had increased from the time these discussions were initiated to the time the transaction was
completed. The $5.5 million difference was determined to be a cost of completing the transaction with Xi Long and was recorded as
an expense in the accompanying consolidated statement of operations.
Note 10. Equity-Based Compensation
Prior to the Reorganization, the Company’s employees and other service providers were granted awards under the Fulgent
Therapeutics LLC Amended and Restated 2015 Equity Incentive Plan (the “2015 Plan”), which provided for the issuance of equity-
based awards to eligible employees, directors and consultants. These awards generally consisted of options, RSUs and profits
interests. Options granted under the 2015 Plan typically vested over four years and expired 10 years from the date of grant, and were
not exercisable, whether or not vested, until the earlier of a liquidity event or incorporation, each as defined in the 2015 Plan. Because
the options were subject to both a service condition (as set forth in their vesting schedules) and a performance condition (the
occurrence of a qualifying liquidity event or incorporation), no equity-based compensation expense was recognized for these options
until the performance condition was deemed to have been satisfied, which occurred upon completion of the Reorganization. RSUs
granted under the 2015 Plan typically vested over four years. Awards of profits interests were typically fully vested at the date of
grant.
In connection with the Reorganization, the Company approved its 2016 Omnibus Incentive Plan (the “2016 Plan”), which
provides for the issuance of up to an aggregate of 2,038,480 shares of the Company’s common stock pursuant to awards granted to
eligible employees, directors and consultants. As of December 31, 2017, there were 487,826 shares of the Company’s common stock
remaining available for grants of future awards under the 2016 Plan. The vesting period, contractual life and other material terms and
conditions of awards granted under the 2016 Plan are generally not significantly different from the terms and conditions of awards
granted under the 2015 Plan.
At the effective time of the Reorganization:
•
•
The 2015 Plan was terminated, and no additional awards have since been or will in the future be granted thereunder.
Each outstanding option to purchase 7.6 Class D common units of Fulgent LLC was cancelled in exchange for an
equivalent option granted under the 2016 Plan to purchase one share of the Company’s common stock. The new options
are subject to the same vesting schedule and other material terms and conditions as the cancelled options. The
Reorganization was considered an incorporation pursuant to the terms of the 2015 Plan and the performance condition
applicable to all options was deemed to have been satisfied. As a result, all of the options became immediately
exercisable, to the extent vested, upon completion of the Reorganization. This satisfaction of the performance condition
resulted in a cumulative stock-based compensation expense of $1.1 million for the requisite service period, which the
Company recorded during the period in which the Reorganization occurred.
F-21
•
•
Each outstanding RSU relating to 7.6 Class D common units of Fulgent LLC was cancelled in exchange for an equivalent
RSU granted under the 2016 Plan relating to one share of the Company’s common stock. The new RSUs are subject to the
same vesting schedule and other material terms and conditions as the cancelled RSUs.
Pursuant to the determination of the Manager of Fulgent LLC, the participation thresholds applicable to all Class D
common units that constituted profits interests (i) were ignored and not applied in calculating the number of shares of the
Company’s common stock that were issued in exchange for such units in the Reorganization, and (ii) did not carry over to
such shares of the Company’s common stock. As a result, the holders of Fulgent LLC’s Class D common units that
constituted profits interests received shares of the Company’s common stock in the Reorganization at the same ratio, 7.6-
to-one, as the holders of Fulgent LLC’s Class D common units that were not subject to profits interest thresholds.
Ignoring all profits interest thresholds upon the conversion of the Class D common units that constitute profits interests
into shares of the Company’s common stock resulted in an equity-based compensation expense of $1.4 million that the
Company recorded during the period in which the Reorganization occurred.
The Company has included equity-based compensation expense as part of cost of revenue and operating expenses in the
accompanying consolidated statements of operations as follows:
Year Ended December 31,
2017
2016
Cost of revenue
Research and development
Selling and marketing
General and administrative
Total
Award Activity
$
$
$
(in thousands)
479
807
318
515
2,119
$
754
1,161
454
2,285
4,654
The below discussions of equity-based award activity, including all nomenclature, share numbers and weighted-average exercise
prices, have been adjusted to give retroactive effect to the Reorganization as if it occurred at the beginning of each period presented.
Option Awards
The following table summarizes activity for options to acquire shares of the Company’s common stock in the years ended
December 31, 2017 and 2016:
Number
of
Units/Shares
Subject to
Options
(in
thousands)
Weighted-
Average
Exercise
Price
Weighted-
Average
Grant Date Fair Value
Weighted-
Average
Remaining
Contractual
Life
(in years)
Aggregate
Intrinsic
Value
(in
thousands)
(1)
$
$
$
$
9.8
0.38
1.18
Balance at December 31, 2015
Authorized
Granted
Exercised
Canceled
Balance at December 31, 2016
Authorized
Granted
Exercised
Canceled
Balance at December 31, 2017
Exercisable as of December 31, 2017
(1)
date, have an exercise price in excess of the fair value of the Company’s common stock, and (ii) the fair value of the Company’s
common stock as of the applicable date.
274
—
324
—
(42) $
556
$
—
—
(81) $
(10) $
$
465
$
201
Aggregate intrinsic value is calculated as the difference between (i) the exercise price of options that, as of the applicable
0.38
4.91
0.84
0.77
0.38
0.85
4.19
6.32
8.0
8.0
7.94
$
$
$
$
9.0
$
5,976
578
1,785
779
645
F-22
The Company granted no option awards in the year ended December 31, 2017. The total fair value of options that vested during
the years ended December 31, 2017 and 2016 was $1.1 million and $263,000, respectively. As of December 31, 2017, the remaining
unrecognized compensation expense related to all outstanding option awards was $505,000 and is expected to be recognized over a
weighted-average period of 1.8 years.
Share Awards
In the year ended December 31, 2016, the Company granted one award of 329,000 shares of common stock with a grant date
fair value of $1.6 million. These shares were immediately vested upon grant, and as a result, the full fair value of the award was
recognized in equity-based compensation expense at the time of grant. The award was not granted under the 2015 Plan or the 2016
Plan.
RSU Awards
RSUs are awards that entitle the holder to receive shares of the Company’s common stock upon satisfaction of vesting
conditions. Each RSU represents the contingent right to receive one share of the Company’s common stock upon vesting and
settlement.
No RSU awards were granted prior to the year ended December 31, 2016. The following table summarizes activity for RSUs
relating to shares of the Company’s common stock in the years ended December 31, 2017 and 2016:
Balance at December 31, 2015
Granted
Vested and settled
Forfeited
Balance at December 31, 2016
Granted
Vested and settled
Forfeited
Balance at December 31, 2017
Number of
Shares
(in thousands)
Weighted-Average
Grant Date
Fair Value
—
364
—
(2)
362
708
(90)
(43)
937
$
$
$
$
$
$
—
9.69
9.02
9.69
5.09
9.66
9.33
7.39
The RSU awards granted in the years ended December 31, 2017 and 2016 will result in aggregate equity-based compensation
expense of $4.8 million and $3.5 million, respectively, in each case to be recognized over four years from the grant date of each award
granted in the period. As of December 31, 2017, the remaining unrecognized compensation expense related to all outstanding RSU
awards was $6.2 million and is expected to be recognized over a weighted-average period of 3.4 years.
Fair Value Assumptions for Option Awards
The Company uses the Black-Scholes option-pricing model to measure the fair value of option awards. The Black-Scholes
option-pricing model requires the input of various assumptions, each of which is subjective and requires significant judgment. These
assumptions include the following:
•
•
•
•
Expected Term. The expected term represents the period that the Company’s equity-based awards are expected to be
outstanding. The Company determines the expected term assumption based on the vesting terms, exercise terms and
contractual terms of the options, and, in the case of equity-based awards subject to a profits interest threshold granted
before the Reorganization, based on the estimated time to liquidity.
Risk-Free Interest Rate. The Company determines the risk-free interest rate by using the equivalent to the expected term
based on the U.S. Treasury yield curve in effect as of the date of grant.
Dividend Yield. The assumed dividend yield is based on the Company’s expectation that it will not pay dividends in the
foreseeable future, which is consistent with its history of not paying dividends.
Expected Volatility. The Company does not have sufficient history to estimate the volatility of the price of its common
equity or the expected term of its options. The Company calculates expected volatility based on historical volatility data of
a representative group of companies that are publicly traded. The Company selected representative companies with
F-23
comparable characteristics to it, including risk profiles and position within the industry, and with historical equity price
information sufficient to meet the expected term of the equity-based awards. The Company computes the historical
volatility of this selected group using the daily closing prices for the selected companies’ equity during the equivalent
period of the calculated expected term of its equity-based awards. The Company will continue to use the representative
group volatility information until the historical volatility of its equity is relevant to measure expected volatility for future
option grants.
•
Forfeiture Rate. The Company has early adopted ASU No. 2016-09, Stock Compensation (Topic 718): Improvements to
Employee Share-Based Payment Accounting, and it has elected to account for forfeitures as they occur.
Awards to Employees
The table below sets forth the weighted-average assumptions used in the Black-Scholes option-pricing model to estimate the fair
value of options to acquire shares of the Company’s common stock (or, prior to the Reorganization, options to acquire common units
of Fulgent LLC) granted to employees during the year ended December 31, 2016. The Company did not grant any options to acquire
shares of the Company’s common stock to employees during the year ended December 31, 2017.
Expected term (in years)
Risk-free interest rates
Dividend yield
Expected volatility
Awards to Non-Employees
Year Ended December 31,
2016
6.1
1.4%
—
95.6%
Equity-based compensation expense for options granted to non-employees is measured based on the fair value of the options
because it is more reliably measurable than the fair value of the services received as consideration for the options. Such compensation
expense is recognized as the options are earned.
The fair value of non-employee options is re-calculated at each reporting date until the option vests or there is a substantial
incentive for the non-employee not to perform the required services.
The table below sets forth the weighted-average assumptions used in the Black-Scholes option-pricing model to estimate the fair
value of options to acquire shares of the Company’s common stock (or, prior to the Reorganization, options to acquire common units
of Fulgent LLC) granted to non-employees during the years ended December 31, 2016. The Company did not grant any options to
acquire shares of the Company’s common stock to non-employees during the year ended December 31, 2017.
Expected term (in years)
Risk-free interest rates
Dividend yield
Expected volatility
Year Ended December 31,
2016
10
1.6%
—
96.9%
Determination of Fair Value on Grant Dates
For all periods after completion of the IPO on October 4, 2016, the fair value of the shares of the Company’s common stock
underlying option and RSU awards is determined by the Company’s board of directors or the compensation committee thereof based
on the closing sales price of the Company’s common stock on the date of grant as reported by the Nasdaq Global Market.
For all periods before completion of the Reorganization and the IPO, the fair value of the common units underlying Fulgent
LLC’s equity-based awards was estimated on each grant date by Fulgent LLC’s Manager. In determining fair value, the Manager
considered valuations prepared by an independent third party in a manner consistent with the American Institute of Certified Public
Accountants Practice Aid, Valuation of Privately-Held Company Equity Securities Issued as Compensation. In conducting the
valuations, Fulgent LLC used a range of assumptions and methodologies and considered all objective and subjective factors it
F-24
believed to be relevant, including management’s best estimate of Fulgent LLC’s business condition, prospects and operating
performance at each valuation date and the following additional factors: the fact that Fulgent LLC was a privately held company with
illiquid securities; Fulgent LLC’s stage of commercialization; the likelihood of achieving a liquidity event for Fulgent LLC’s equity,
such as an initial public offering, given prevailing market conditions; Fulgent LLC’s historical operating results; valuations of
comparable public companies; Fulgent LLC’s discounted future cash flows, based on its projected operating results; and Fulgent
LLC’s capital structure, including the rights and preferences of its various classes of equity. These valuations involved significant
assumptions, judgments and estimates.
In determining the fair value of Fulgent LLC’s Class D common units related to awards of such units and options to acquire
such units granted in 2016 before completion of the Reorganization and the IPO, Fulgent LLC estimated the enterprise value of the
business using the option pricing back-solve method within the market approach, which considers the sale price of equity in a recent
financing and “backsolves” the equity value using an option-pricing model that gives consideration to a company’s capitalization
structure and rights of preferred and common equity holders.
The estimated enterprise value of the business was then allocated to Fulgent LLC’s common units using the probability-
weighted expected return method, commonly referred to as PWERM, in which equity is valued based upon the probability-weighted
present value of expected future returns considering various future available outcomes and the rights of each class of equity, and
applying a marketability discount of 20% due to the illiquidity of the common units prior to completion of the IPO.
Note 11. 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.
Prior to the Reorganization, Fulgent LLC was organized as a limited liability company and its members elected to have Fulgent
LLC treated as a partnership for income tax purposes. All taxable income or loss and tax credits generally were reflected in the
personal income tax returns of the Fulgent LLC’s members. Accordingly, no provision for federal and state income taxes was
provided in the accompanying consolidated financial statements prior to the Reorganization. Upon completion of the Reorganization,
the Company converted from a pass-through entity for tax purposes to a taxable entity. The change in tax status resulted in $417,000
income tax expense related to the recognition of a net state deferred tax asset of $86,000 and a net federal deferred tax liability of
$503,000, which represents the temporary differences in existence on September 30, 2016 between the tax basis of the Company’s
assets and liabilities and the amount reported in the financial statements. As of December 31, 2017 and 2016, the net state deferred tax
asset was $90,000 and $54,000, respectively, and the net federal deferred tax asset (liability) was $36,000 and $(243,000),
respectively.
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. As a result, 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.
F-25
Income tax expense (benefit) consisted of the following:
Current:
Federal
State
Total Current
Deferred:
Federal
State
Change in valuation allowance
Total Deferred
Total income tax expense (benefit)
Year Ended December 31,
2017
2016
(in thousands)
$
$
(599)
(80)
(679)
(300)
(36)
—
(336)
(1,015)
$
$
616
58
674
295
(49)
—
246
920
Reconciliation of the difference between the federal statutory income tax rate and the effective income tax rate is as follows:
Year Ended December 31,
2017
2016
Tax provision at federal statutory rate
State taxes
Other
Impact of tax reform (1)
Stock based compensation
Recognition of pre-merger temporary differences
LLC income not subject to corporate taxes
Tax provision
________________
(1) The effective tax rate for the year ended December 31, 2017 includes the Company’s estimate of the effect of the 2017 Tax Act, which primarily relates to the
remeasurment of existing deferred taxes as a result of the change to the U.S. federal corporate income tax rate.
34.00%
0.78%
1.54%
-0.02%
-2.13%
34.17%
34.00%
1.98%
0.16%
-19.51%
-37.23%
-20.60%
F-26
The following table summarizes the elements of the deferred tax assets (liabilities):
Deferred tax assets
Accrued vacation and other accrued expenses
Provision for bad debts
Net operating losses
Stock based compensation
Unrealized loss on investments
State income taxes
Equity Method Investment
Gross deferred tax assets
Less: Valuation allowance
Net deferred tax assets
Deferred tax liabilities
Depreciation
Total deferred tax liabilities
Net deferred tax assets (liabilities)
Year Ended December 31,
2017
2016
(in thousands)
$
$
$
96
65
148
594
37
6
118
1,064
(118)
946
820
820
126
$
69
54
603
58
20
804
-
804
993
993
(189)
During 2017 the Company recorded a deferred tax asset related to its equity method investment in FF Gene Biotech. When
realized, the asset will generate a capital loss which may only be used to offset capital gain income. The Company does not currently
have any capital gain income and has therefore recorded a full valuation allowance against this asset.
Uncertain Tax Positions
The Company is subject to income taxation by the United States government and certain states in which the Company's
activities give rise to an income tax filing requirement. The Company does not have income tax filing requirements in any foreign
jurisdiction, nor are any taxes withheld from income taxes withheld from foreign sales. As of December 31, 2017, there were no
pending tax audits in any jurisdiction.
There were no tax-related interest or penalties accrued at December 31, 2017 and 2016.
While the Company believes it has adequately provided for all tax positions, amounts asserted by taxing authorities could differ
from the Company's accrued positions. Accordingly, additional provisions on federal, state and foreign tax-related matters could be
recorded in future periods as revised estimates are settled or otherwise resolved.
F-27
Note 12. Income (Loss) per Share
Income (loss) per share for the years ended December 31, 2017 and 2016 was computed as if the Reorganization had occurred at
the beginning of each period presented, with the exception of Class P units, as they are not subject to the Reorganization. The
following is a reconciliation of the basic and diluted income (loss) per share computations:
Years Ended
2017
2016
Continuing
Operations
Discontinued
Operations Total
Continuing
Operations
Discontinued
Operations Total
Income (loss)
Deemed dividend on redemption of Class D-1 preferred
units
Distribution to Class D-1 preferred unitholder
Income (loss) allocable to common stockholders
Income (loss) allocated to common stockholders
Income (loss) allocated to Class P common units
Income (loss) allocated to Class P preferred units
Weighted-average common shares - outstanding, basic
and diluted
Weighted-average Class P common units - profits
interests - outstanding, basic and diluted
Weighted-average Class P preferred units - outstanding,
basic and diluted
Income (loss) per Class P common units - profits
interests, basic and diluted
Income (loss) per Class P preferred units, basic and
diluted
Income (loss) per common share from continuing
operations, basic and diluted
(in thousands, except per share data)
$
(2,510) $
— $(2,510) $
(5,388) $
41 $ (5,347)
— — $
— — $
— $(2,510) $
$
$
$
—
—
(2,510) $
(2,510)
—
—
17,739
(3,727)
(4,592)
(13,707) $
(13,707)
—
—
13,710
$
$
— $ (3,727)
— $ (4,592)
41 $(13,666)
18
23
—
10,123
13,238
—
—
$
(0.14)
$
(1.00)
On April 4, 2016, Fulgent LLC completed the split-off of the Pharma business. The financial condition and results of the
Pharma business are included in the accompanying consolidated financial statements as discontinued operations for all periods
presented. The split-off of the Pharma business was effected with a pro-rata distribution to all of the holders of Class P units. As a
result, on April 4, 2016, Fulgent LLC redeemed all Class P preferred and common units, distributed to each holder of such units
substantially identical units of Fulgent Pharma, and caused Fulgent Pharma to assume all then-outstanding options to acquire Class P
common units.
The following securities have been excluded from the calculation of diluted income (loss) per share for all periods presented
because their effect would have been anti-dilutive:
Options
RSUs
2017
Years Ended
(in thousands)
464
526
2016
490
79
The anti-dilutive shares described above were calculated using the treasury stock method. During the years ended December 31,
2017 and 2016, the Company had outstanding options and RSUs that were excluded from the weighted-average share calculation for
continuing operations due to the Company’s net loss positions.
Note 13. Retirement Plans
The Company offers a 401(k) retirement savings plan (the “401(k) Plan”) for its employees, including its executive officers,
who satisfy certain eligibility requirements. The Internal Revenue Code of 1986, as amended, allows eligible employees to defer a
portion of their compensation, within prescribed limits, on a pre-tax basis through contributions to the 401(k) Plan. The Company
matches contributions to the 401(k) Plan based on the amount of salary deferral contributions the participant makes to the 401(k) Plan.
The Company will match up to 3% of an employee’s compensation that the employee contributes to his or her 401(k) Plan account.
F-28
Total Company matching contributions to the 401(k) Plan were $108,000 and $86,000 in the years ended December 31, 2017 and
2016, respectively.
Note 14. 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 recognized zero and
$150,000 during the years ended December 31, 2017 and 2016, respectively, as consideration for such services. Additionally, the
Company subleases certain of its headquarters facilities to the Foundation. The Company recognized $22,000 and $28,000 in the years
ended December 31, 2017 and 2016, respectively, as consideration for such sublease. As of December 31, 2017 and 2016, 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 $82,600
and $353,000 in the years ended December 31, 2017 and 2016, respectively, as consideration for such services. As of December 31,
2017 and 2016, $40,000 and $29,550, respectively, was owed to the Company by the University in connection with this relationship.
As more fully described in Note 15, 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 PRC called Fujian Fujun Gene
Biotech Co., Ltd. (“FF Gene Biotech”). Xilong Scientific is an affiliate of Xi Long, which, as of December 31, 2017, 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 the Company’s laboratory and corporate headquarters are located. Since
the completion of the Pharma Split-Off, Fulgent Pharma reimburses the Company for the portion of the rent the Company pays that is
attributable to the space used by Fulgent Pharma, which amounts are not significant. As of December 31, 2017 and 2016, $3,000 and
zero, respectively, was owed to the Company by Fulgent Pharma as a result of this arrangement, which is recorded in Other receivable
in Other current assets in the accompanying consolidated balance sheets.
Note 15. 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 December 31, 2017, 43,600,000 RMB (or approximately $6.7 million U.S. dollars) remained to
be contributed to FF Gene Biotech by the Company under the terms of the JV Agreement, and the Company has purchased and
contributed equipment with an aggregate fair value of $2.5 million pursuant to its contribution commitment under the JV Agreement,
all of which was contributed in the year ended December 31, 2017. The Company accounted for this contribution in accordance with
Accounting Standards Codification 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 for the year ended December 31, 2017 in the accompanying consolidated
F-29
statements of operations, and recorded its contribution during the period, net of its proportionate share in the accumulated losses of FF
Gene Biotech, in the accompanying consolidated balance sheet as of December 31, 2017.
The Company has 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 the Company 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 an insignificant amount of royalties under the license
agreement for the year ended December 31, 2017.
In November 2017, FF Gene Biotech invested and formed a majority-owned subsidiary that focuses on sales and marketing for
FF Gene Biotech. The financial information of the subsidiary is consolidated in the summarized financial information for FF Gene
Biotech disclosed below.
The Company had no equity method investments as of December 31, 2016. Equity method investments as of December 31,
2017 consisted of the following:
FF Gene Biotech
Total equity method investments
Summary Financial Information
Carrying
Value
(in thousands)
$
$
1,937
1,937
Ownership
Percentage
Summary financial information for FF Gene Biotech is as follows:
Consolidated Balance Sheet Data:
Current Assets
Non-Current Assets
Current Liabilities
Non-Current Liabilities
Minority Interest
Stockholders' Equity
December 31,
2017
2016
$
(in thousands)
$
2,474
4,851
942
—
—
6,383
Consolidated Statement of Operations Data:
Net Sales
Gross Profit
Net Loss
Share of loss from investments accounted for using the equity method (1)
Years Ended December 31,
2016
2017
$
(in thousands)
90 $
10
(2,318)
(524)
30%
30%
830
4,593
119
—
—
5,304
—
—
(662)
—
(1) The Company's share of loss is based on pro-rated net loss beginning April 25, 2017, the date on which the Company entered into
the JV Agreement.
F-30
Note 16. Selected Quarterly Financial Data (Unaudited)
The tables below set forth the Company’s quarterly consolidated statements of operations data for the eight quarters ended
December 31, 2017. In the opinion of management, this quarterly data has been prepared on the same basis as the accompanying
consolidated financial statements and includes all adjustments, consisting of normal recurring adjustments, necessary for a fair
presentation of the results of operations for the periods presented. See Item 7. “Management’s Discussion and Analysis of Financial
Condition and Results of Operations,” in the report in which these consolidated financial statements are included for descriptions of
the effects of any extraordinary, unusual or infrequently occurring items recognized in any of the periods covered by this data. The
results for any one quarter are not indicative of the results to be expected in the current period or any future period.
Statement of Operations Data:
Revenue
Cost of revenue
Gross profit
Operating expenses:
Research and development
Selling and marketing
General and administrative
Total operating expenses
Operating income (loss)
Interest and other income (expense)
Income (loss) before income taxes and equity
loss in investee
Provision for income taxes
Income (loss) before equity loss in investee
Equity loss in investee
Net income (loss)
Net income (loss) per common share:
Basic
Diluted
Three Months Ended
Dec. 31,
2017
Sept.
30,
2017
June
30,
2017
Mar.
31,
2017
Dec. 31,
2016
Sept.
30,
2016
June
30,
2016
Mar.
31,
2016
(dollars in thousands, except per share data)
$ 4,281 $ 4,503 $ 4,640 $ 5,306 $ 5,854 $ 5,011 $ 3,971 $ 3,440
2,545 2,268 1,879 1,859 1,863 2,143 1,411 1,304
1,736 2,235 2,761 3,447 3,991 2,868 2,560 2,136
920
851
561
656
818 1,523
1,324 1,128
477
301
1,080 1,383
893
798
1,402 1,205 1,140 1,486 1,116 1,147
457 1,889
3,806 3,716 2,911 3,228 2,732 3,563 1,590 2,751
(615)
(2,070) (1,481)
13
145
219 1,259
57
119
970
5 (5,462)
(150)
120
851
891
(695)
97
(596)
(1,377)
(247)
(1,973) (1,336)
(415)
(921)
(172)
$ (1,624) $ (1,093) $
(30)
(110)
80
(105)
(25) $
338 1,316
(690) (4,492)
-
417
503
106
813 (1,107) (4,492)
232
-
-
-
813 $ (1,107) $ (4,492) $
232 $
-
(602)
-
(602)
-
(602)
$ (0.09) $ (0.06) $
$ (0.09) $ (0.06) $
- $
- $
0.01 $
0.01 $
0.05 $ (0.44) $ (5.49) $ (0.02)
0.05 $ (0.44) $ (5.49) $ (0.02)
F-31
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4978 Santa Anita Avenue, Temple City, California 91780