EXACT SCIENCES CORP - Quarter Report: 2014 September (Form 10-Q)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

 

 

FORM 10-Q

 

x      QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended September 30, 2014

 

OR

 

o         TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

Commission File Number:

001-35092

 

EXACT SCIENCES CORPORATION

(Exact name of registrant as specified in its charter)

 

 

(608) 284-5700 (Registrant’s telephone number, including area code)

 

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

 

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 x   No o

 

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

 

 

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

 

As of October 30, 2014, the registrant had 84,250,616 shares of common stock outstanding.

 

 

Table of Contents

 

EXACT SCIENCES CORPORATION

 

INDEX

 

		Page
		Number
Part I - Financial Information
Item 1.	Financial Statements
	Condensed Consolidated Balance Sheets (unaudited) as of September 30, 2014 and December 31, 2013	3
	Condensed Consolidated Statements of Operations (unaudited) for the Three and Nine Months Ended September 30, 2014 and 2013	4
	Condensed Consolidated Statements of Comprehensive Loss (unaudited) for the Three and Nine Months Ended September 30, 2014 and 2013	5
	Condensed Consolidated Statements of Cash Flows (unaudited) for the Nine Months Ended September 30, 2014 and 2013	6
	Notes to Condensed Consolidated Financial Statements (unaudited)	7
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	21
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	32
Item 4.	Controls and Procedures	32
Part II - Other Information
Item 1.	Legal Proceedings	33
Item 1A.	Risk Factors	33
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	33
Item 3.	Defaults Upon Senior Securities	33
Item 4.	Mine Safety Disclosures	33
Item 5	Other Information	33
Item 6.	Exhibits	33
	Signatures	34
	Exhibit Index	35

 

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Part I — Financial Information

 

EXACT SCIENCES CORPORATION

Condensed Consolidated Balance Sheets

(Amounts in thousands, except share data - unaudited)

 

		September 30,			December 31,
		2014			2013
ASSETS
Current Assets:
Cash and cash equivalents		$	27,829		$	12,851
Marketable securities		183,315			120,408
Inventory		2,719			—
Prepaid expenses and other current assets		2,377			2,199
Total current assets		216,240			135,458
Property and Equipment, at cost:
Laboratory equipment		10,439			5,087
Assets under construction		1,048			2,592
Computer software and computer equipment		6,866			1,217
Leasehold improvements		5,108			5,043
Furniture and fixtures		268			268
		23,729			14,207
Less—Accumulated depreciation		(5,302		)	(3,038		)
		18,427			11,169
		$	234,667		$	146,627
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current Liabilities:
Accounts payable		$	4,635		$	761
Accrued expenses		11,128			5,806
Capital lease obligation, current portion		449			351
Lease incentive obligation, current portion		540			540
Deferred license fees, current portion		—			294
Total current liabilities		16,752			7,752
Long-term debt		1,000			1,000
Long-term accrued interest		100			84
Capital lease obligation, less current portion		—			360
Lease incentive obligation, less current portion		1,710			2,115
Commitments and contingencies
Stockholders’ Equity:
Preferred stock, $0.01 par value Authorized—5,000,000 shares, Issued and outstanding—no shares at September 30, 2014 and December 31, 2013		—			—
Common stock, $0.01 par value Authorized—100,000,000 shares, Issued and outstanding—83,164,089 and 71,071,838 shares at September 30, 2014 and December 31, 2013		832			711
Additional paid-in capital		602,642			455,239
Accumulated other comprehensive income		(6		)	125
Accumulated deficit		(388,363		)	(320,759		)
Total stockholders’ equity		215,105			135,316
		$	234,667		$	146,627

 

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

 

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EXACT SCIENCES CORPORATION

Condensed Consolidated Statements of Operations

(Amounts in thousands, except per share data)

 

		Three Months Ended September 30,						Nine Months Ended September 30,
		2014			2013			2014			2013
License fees		$	—		$	1,036		$	294		$	3,108
Operating expenses:
Research and development		9,073			6,982			23,677			20,965
General and administrative		8,994			3,686			19,810			9,962
Sales and marketing		13,217			1,615			23,839			6,676
Cost of sales		924			—			924			—
		32,208			12,283			68,250			37,603
Loss from operations		(32,208		)	(11,247		)	(67,956		)	(34,495		)
Investment income		160			103			392			220
Interest expense		(12		)	(16		)	(40		)	(53		)
Net loss		$	(32,060	)	$	(11,160	)	$	(67,604	)	$	(34,328	)
Net loss per share—basic and diluted		$	(0.39	)	$	(0.16	)	$	(0.86	)	$	(0.52	)
Weighted average common shares outstanding—basic and diluted		82,941			70,559			78,702			66,389

 

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

 

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EXACT SCIENCES CORPORATION

Condensed Consolidated Statements of Comprehensive Loss

(Amounts in thousands - unaudited)

 

		Three Months Ended September 30,						Nine Months September 30,
		2014			2013			2014			2013
Net loss		$	(32,060	)	$	(11,160	)	$	(67,604	)	$	(34,328	)
Other comprehensive loss, net of tax
Unrealized holding gain (loss) on available-for-sale investments		(95		)	101			(131		)	40
Comprehensive loss		$	(32,155	)	$	(11,059	)	$	(67,735	)	$	(34,288	)

 

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

 

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EXACT SCIENCES CORPORATION

Condensed Consolidated Statements of Cash Flows

(Amounts in thousands - unaudited)

 

		Nine Months Ended September 30,
		2014			2013
Cash flows from operating activities:
Net loss		$	(67,604	)	$	(34,328	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation of property and equipment		2,264			976
Loss on disposal of property and equipment		—			91
Stock-based compensation		8,643			5,660
Amortization of deferred license fees		(294		)	(3,108		)
Amortization of premium on short-term investments		628			458
Changes in assets and liabilities:
Prepaid expenses and other current assets		(178		)	(311		)
Inventory		(2,719		)	—
Accounts payable		3,874			(3,047		)
Accrued expenses		5,778			2,752
Lease incentive obligation		(405		)	871
Accrued interest		16			16
Net cash used in operating activities		(49,997		)	(29,970		)
Cash flows from investing activities:
Purchases of marketable securities		(141,355		)	(89,261		)
Maturities of marketable securities		77,689			45,488
Purchases of property and equipment		(9,522		)	(4,413		)
Net cash used in investing activities		(73,188		)	(48,186		)
Cash flows from financing activities:
Proceeds from sale of common stock, net of issuance costs		137,664			73,296
Proceeds from exercise of common stock options		424			1,212
Payments on capital lease obligations		(262		)	(248		)
Proceeds in connection with the Company’s employee stock purchase plan		337			261
Net cash provided by financing activities		138,163			74,521
Net increase (decrease) in cash and cash equivalents		14,978			(3,635		)
Cash and cash equivalents, beginning of period		12,851			13,345
Cash and cash equivalents, end of period		$	27,829		$	9,710
Supplemental disclosure of non-cash investing and financing activities:
Unrealized gain on available-for-sale investments		$	(131	)	$	40
Issuance of 32,269 and 30,534 shares of common stock to fund the Company’s 401(k) matching contribution for 2013 and 2012, respectively		$	456		$	354

 

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

 

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EXACT SCIENCES CORPORATION

 

Notes to Condensed Consolidated Financial Statements

(unaudited)

 

(1) ORGANIZATION AND BASIS OF PRESENTATION

 

Organization

 

Exact Sciences Corporation (together with its subsidiary, “Exact”, “we”, “us” or the “Company”) was incorporated in February 1995. Exact is a molecular diagnostics company currently focused on the early detection and prevention of colorectal cancer. The Company’s non-invasive stool-based DNA (sDNA) screening technology includes proprietary and patented methods that isolate and analyze human DNA present in stool to screen for the presence of colorectal pre-cancer and cancer.

 

Basis of Presentation

 

The accompanying condensed consolidated financial statements, which include the accounts of Exact Sciences Corporation and those of its wholly-owned subsidiary, Exact Sciences Laboratories, LLC, are unaudited and have been prepared on a basis substantially consistent with the Company’s audited financial statements and notes as of and for the year ended December 31, 2013 included in the Company’s Annual Report on Form 10-K (the “2013 Form 10-K”). These condensed financial statements are prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”) and follow the requirements of the Securities and Exchange Commission (“SEC”) for interim reporting. In the opinion of management, all adjustments (consisting only of adjustments of a normal and recurring nature) considered necessary for a fair presentation of the results of operations have been included. The results of the Company’s operations for any interim period are not necessarily indicative of the results of the Company’s operations for any other interim period or for a full fiscal year. The statements should be read in conjunction with the audited financial statements and related notes included in the 2013 Form 10-K.  Management has evaluated subsequent events for disclosure or recognition in the accompanying financial statements up to the filing of this report.

 

(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Principles of Consolidation

 

The accompanying consolidated financial statements include the accounts of the Company’s wholly-owned subsidiary, Exact Sciences Laboratories, LLC. All significant intercompany transactions and balances have been eliminated in consolidation.

 

Use of Estimates

 

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.  Actual results could differ from those estimates.

 

Cash and Cash Equivalents

 

The Company considers cash on hand, demand deposits in bank, money market funds, and all highly liquid investments with an original maturity of 90 days or less to be cash and cash equivalents. The Company had no restricted cash at September 30, 2014 and December 31, 2013.

 

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Marketable Securities

 

Management determines the appropriate classification of debt securities at the time of purchase and re-evaluates such designation as of each balance sheet date. Debt securities carried at amortized cost are classified as held-to-maturity when the Company has the positive intent and ability to hold the securities to maturity. Marketable equity securities and debt securities not classified as held-to-maturity are classified as available-for-sale. Available-for-sale securities are carried at fair value, with the unrealized gains and losses, net of tax, reported in other comprehensive loss. The amortized cost of debt securities in this category is adjusted for amortization of premiums and accretion of discounts to maturity computed under the straight-line method, which approximates the effective interest method. Such amortization is included in investment income. Realized gains and losses and declines in value judged to be other-than-temporary on available-for-sale securities are included in investment income. The cost of securities sold is based on the specific identification method. Interest and dividends on securities classified as available-for-sale are included in investment income.

 

At September 30, 2014 and December 31, 2013, the Company’s investments were comprised of fixed income investments and all were deemed available-for-sale. The objectives of the Company’s investment strategy are to provide liquidity and safety of principal while striving to achieve the highest rate of return consistent with these two objectives.  The Company’s investment policy limits investments to certain types of instruments issued by institutions with investment grade credit ratings and places restrictions on maturities and concentration by type and issuer. Investments in which the Company has the ability and intent, if necessary, to liquidate in order to support its current operations (including those with a contractual term greater than one year from the date of purchase) are classified as current. All of the Company’s investments are considered current. Realized gains were $11.1 thousand and $5.1 thousand, net of insignificant realized losses, for the nine months ended September 30, 2014 and 2013, respectively. Unrealized gains or losses on investments are recorded in other comprehensive loss.

 

We periodically review our investments in unrealized loss positions for other-than-temporary impairments. This evaluation includes, but is not limited to, significant quantitative and qualitative assessments and estimates regarding credit ratings, collateralized support, the length of time and significance of a security’s loss position, our intent not to sell the security, and whether it is more likely than not that we will have to sell the security before recovery of its cost basis. For the three months ended September 30, 2014, no investments were identified with other-than-temporary declines in value.

 

Available-for-sale securities at September 30, 2014 consisted of the following:

 

		September 30, 2014
(In thousands)		Amortized Cost			Gains in Accumulated Other Comprehensive Income			Losses in Accumulated Other Comprehensive Income			Estimated Fair Value
U.S. government agency securities		$	32,690		$	7		$	—		$	32,697
Corporate bonds		112,075			—			(10		)	112,065
Certificates of deposit		300			—			—			300
Asset backed securities		38,256			—			(3		)	38,253
Total available-for-sale securities		$	183,321		$	7		$	(13	)	$	183,315

 

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Available-for-sale securities at December 31, 2013 consisted of the following:

 

		December 31, 2013
(In thousands)		Amortized Cost			Gains in Accumulated Other Comprehensive Income			Losses in Accumulated Other Comprehensive Income			Estimated Fair Value
Corporate bonds		$	54,487		$	67		$	—		$	54,554
U.S. government agency securities		34,291			47			—			34,338
Certificates of deposit		6,558			3			—			6,561
Commercial paper		1,499			—			—			1,499
Asset backed securities		23,448			8						23,456
Total available-for-sale securities		$	120,283		$	125		$	—		$	120,408

 

Changes in Accumulated Other Comprehensive Income (Loss)

 

The amounts recognized in accumulated other comprehensive income (loss) (AOCI) for the three and nine months ended September 30, 2014 were as follows (in thousands):

 

		Three Months Ended September 30,						Nine Months Ended September 30,
		2014			2013			2014			2013
Beginning balance		$	89		$	17		$	125		$	78
Other comprehensive income (loss) before reclassifications		(99		)	104			(106		)	63
Amounts reclassified from accumulated other comprehensive income (loss)		4			(3		)	(25		)	(23		)
Net current period change in accumulated other comprehensive income (loss)		(95		)	101			(131		)	40
Ending balance		$	(6	)	$	118		$	(6	)	$	118

 

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Amounts reclassified from accumulated other comprehensive income (loss) for the three and nine months ended September 30, 2014 were as follows (in thousands):

 

		Affected Line Item in the		Three Months Ended September 30,						Nine Months Ended September 30,
Details about AOCI Components		Statement of Operations		2014			2013			2014			2013
Change in value of available-for-sale investments
Sales and maturities of available-for-sale investments		Investment income		$	4		$	(3	)	$	(25	)	$	(23	)
Total reclassifications				$	4		$	(3	)	$	(25	)	$	(23	)

 

Property and Equipment

 

Property and equipment are stated at cost and depreciated using the straight-line method over the assets’ estimated useful lives. Maintenance and repairs are expensed when incurred; additions and improvements are capitalized. The estimated useful lives of fixed assets are as follows:

 

		Estimated
Asset Classification		Useful Life
Laboratory equipment		3 - 5 years
Office and computer equipment		3 years
Leasehold improvements		Lesser of the remaining lease term or useful life
Furniture and fixtures		3 years

 

At September 30, 2014, the Company had $1.0 million of assets under construction which consisted of $0.5 million of capitalized costs related to software projects and $0.5 million of costs related to leasehold improvement projects. Depreciation will begin on these assets once they are placed into service. We expect that it will cost $1.7 million to complete the leasehold improvement projects and $0.2 million to complete the software projects, and these projects are expected to be completed in 2014.

 

Software Capitalization Policy

 

Software development costs related to internal use software are incurred in three stages of development: the preliminary project stage, the application development stage, and the post-implementation stage. Costs incurred during the preliminary project and post-implementation stages are expensed as incurred. Costs in the application development stage that meet the criteria for capitalization are capitalized and amortized using the straight-line basis over the estimated economic useful life of the software.

 

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Net Loss Per Share

 

Basic net loss per common share was determined by dividing net loss applicable to common stockholders by the weighted average common shares outstanding during the period.  Basic and diluted net loss per share are the same because all outstanding common stock equivalents have been excluded, as they are anti-dilutive due to the Company’s losses.

 

The following potentially issuable common shares were not included in the computation of diluted net loss per share because they would have an anti-dilutive effect due to net losses for each period:

 

		September 30,
(In thousands)		2014		2013
Shares issuable upon exercise of stock options		6,207		6,108
Shares issuable upon exercise of outstanding warrants (1)		75		155
Shares issuable upon the release of restricted stock awards		1,577		1,264
Shares issuable upon the vesting of restricted stock awards related to a licensing agreement		24		49
		7,883		7,576

 

(1)         At September 30, 2014, represents warrants to purchase 75,000 shares of common stock issued under a consulting agreement.  At September 30, 2013, represents warrants to purchase 80,000 shares of common stock issued under a license agreement and warrants to purchase 75,000 shares of common stock issued under a consulting agreement.

 

Revenue Recognition

 

Laboratory Service Revenue. The Company’s revenues will be generated primarily by the Cologuard test. Revenues are recognized when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the price is fixed or determinable, and collectability is reasonably assured. The Company assesses whether the fee is fixed or determinable and if the collectability is reasonably assured based on the nature of the fee charged for the laboratory services

 

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delivered and whether there are existing contractual arrangements with customers, third-party commercial payors (insurance carriers and health plans) or coverage of the test by Centers for Medicare & Medicaid Services (CMS). In addition, when evaluating collectability, the Company considers factors such as collection experience for the healthcare industry, the financial standing of customers or third-party commercial payors, and whether it has sufficient collection history to reliably estimate a payor’s individual payment patterns.

 

A significant portion of laboratory service revenues earned by the Company will be initially recognized on a cash basis because the above criteria will not have been met at the time the test results are delivered. The Company generally bills third-party payors upon generation and delivery of a test result to the ordering physician following completion of a test. As such, the Company takes assignment of benefits and risk of collection with the third-party payor. Patients may have out-of-pocket costs for amounts not covered by their insurance carrier and the Company bills the patient directly for these amounts in the form of co-pays and deductibles in accordance with their insurance carrier and health plans. Some third-party payors may not cover the Cologuard test as ordered by the physician under their reimbursement policies. Consequently, the Company pursues reimbursement on a case-by-case basis directly from the patient.

 

For laboratory services performed, where the collectability is not reasonably assured, the Company will continue to recognize revenues upon cash collection until it can reliably estimate the amount that would be ultimately collected for the Cologuard test. In order to begin to record revenue on an accrual basis in these scenarios, the Company expects to use at least several months of payment history, review the number of tests paid against the number of tests billed, and consider the payor’s outstanding balance for unpaid tests to determine whether payments are being made for a consistently high percentage of tests billed and at appropriate amounts given the contracted or historical payment amount. Cologuard became available upon FDA approval on August 11, 2014 and no revenue recognition criteria have been met for tests performed as of September 30, 2014. The national coverage decision for Cologuard was released by CMS on October 9, 2014.

 

License fees.   License fees for the licensing of product rights are recorded as deferred revenue upon receipt of cash and recognized as revenue on a straight-line basis over the license period. As more fully described in the 2013 Form 10-K, in connection with the Company’s January 2009 strategic transaction with Genzyme Corporation,  the Company deferred the initial $16.65 million in cash received at closing and amortized that up-front payment on a straight-line basis into revenue over the initial five-year collaboration period which ended in January 2014. In addition, in 2010 the Company received holdback amounts of $1.85 million, which were deferred at the time of receipt and were amortized on a straight-line basis into revenue over the then remaining term of the collaboration period.

 

In addition, the Company deferred $1.53 million premium related to common stock purchased by Genzyme and amortized that amount on a straight-line basis into revenue over the initial five-year collaboration period which ended in January 2014.

 

The Company did not recognize revenue in connection with the amortization of the up-front payments from Genzyme during the three months ended September 30, 2014. The Company recognized approximately $1.0 million in license fee revenue in connection with the amortization of the up-front payments from Genzyme during the three months ended September 30, 2013. The Company recognized approximately $0.3 million and $3.1 million in license fee revenue in connection with the amortization of up-front payments from Genzyme during each of the nine months ended September 30, 2014 and September 30, 2013, respectively.

 

Inventory

 

Inventory is stated at the lower of cost or market value (net realizable value). The Company determines the cost of inventory using the first-in, first out method (FIFO). The Company estimates the recoverability of inventory by reference to internal estimates of future demands and product life cycles, including expiration. The Company periodically analyzes its inventory levels to identify inventory that may expire prior to expected sale or has a cost basis in excess of its estimated realizable value, and records a charge to cost of sales for such inventory as appropriate. In addition, the Company’s products are subject to strict quality control and monitoring which the Company performs throughout the manufacturing process. If certain batches or units of product no longer meet quality specifications or become obsolete due to expiration, the Company records a charge to cost of sales to write down such unmarketable inventory to its estimated realizable value.

 

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Direct and indirect manufacturing costs incurred during process validation and for other research and development activities, which are not permitted to be sold, have been expensed to research and development.  Raw material inventory that was purchased in prior periods, and expensed to research and development, may still be on hand and used toward the production of commercial Cologuard, provided it has an appropriate remaining shelf life.  This inventory is expected to provide a gross margin benefit to the Company in future periods of $0.9 million if the entirety of those balances were allocated to inventory produced for resale and not allocated to research and development activities.

 

The Company has invested in its manufacturing operations to support future demand for Cologuard. Because of this investment in the future, the Company is not currently operating at normal capacity. Charges related to excess capacity are included as current period charges to cost of sales, and are not capitalized into inventory. Total excess capacity charged to cost of sales during the three and nine months ended September 30, 2014 was $0.6 million.

 

Inventory consists of the following (amount in thousands):

 

		September 30,
		2014			2013
Raw materials		$	1,052		$	—
Semi-finished and finished goods		1,667			—
Total inventory		$	2,719		$	—

 

Reclassifications

 

Certain prior period amounts have been reclassified to conform to the current period presentation in the consolidated financial statements and accompanying notes to the consolidated financial statements.

 

(3) MAYO LICENSE AGREEMENT

 

Overview

 

As more fully described in the 2013 Form 10-K, on June 11, 2009, the Company entered into a license agreement (the “License Agreement”) with MAYO Foundation for Medical Education and Research (“MAYO”). Pursuant to the License Agreement, the Company granted MAYO two common stock purchase warrants with an exercise price of $1.90 per share covering 1,000,000 and 250,000 shares of common stock, respectively. The Company is also required to make payments to MAYO for up-front fees, fees once certain milestones are reached by the Company, and other payments as outlined in the License Agreement. In addition to the license to intellectual property owned by MAYO, the Company receives product development and research and development efforts from MAYO personnel. The Company is also obligated to make royalty payments to MAYO on potential future net sales of any products developed from the licensed technology. The Company sought rights to the MAYO intellectual property for the specific purpose of developing a non-invasive, stool-based DNA screening test for colorectal cancer. At the time the license agreement was executed, the sole focus of the Company was the development of such a test. Accordingly, the Company recognized the initial payments and expenses related to the warrants at the time of the transaction and the amounts were expensed to research and development as there were no anticipated alternative future uses associated with the intellectual property.

 

Warrants

 

The warrants granted to MAYO were valued based on a Black-Scholes pricing model at the date of the grant. The warrants were granted with an exercise price of $1.90 per share of common stock. The grant to purchase 1,000,000 shares was immediately exercisable and the grant to purchase 250,000 shares vests and becomes exercisable over a four year period.

 

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MAYO exercised the warrant to purchase 1,000,000 shares through several partial exercises. As of September 2011, the warrant covering 1,000,000 shares was fully exercised.

 

MAYO exercised the warrant to purchase 250,000 shares through partial exercises, the last of which occurred in June 2014. In June 2014, MAYO exercised the remaining shares of this warrant by utilizing the cashless exercise provision contained in the warrant. As a result of this exercise for a gross amount of 80,000 shares, in lieu of paying a cash exercise price, MAYO forfeited its right with respect to 10,587 shares leaving it with a net amount of 69,413 shares. Following this exercise, all of MAYO’s warrants to purchase the Company’s common stock were fully exercised.

 

Royalty Payments

 

The Company will make royalty payments to MAYO based on a percentage of net sales of products developed from the licensed technology starting in the third year of the agreement. In 2012, minimum royalty payments were $10,000. For each year from 2013 through 2029 (the year the last patent expires), the minimum royalty payments are $25,000 per year.

 

Other Payments

 

Other payments under the License Agreement include an upfront payment of $80,000, a milestone payment of $250,000 on the commencement of patient enrollment in a human cancer screening clinical trial, and a $500,000 payment upon FDA approval of the Company’s Cologuard test.   The upfront payment of $80,000 was made in the third quarter of 2009 and expensed to research and development in the second quarter of 2009. The Company began enrollment in a human cancer screening clinical trial in June 2011 and the milestone payment of $250,000 was made and expensed to research and development in June 2011.  The Company received FDA approval for its Cologuard test in August 2014, and the milestone payment of $500,000 was made and expensed to research and development in August 2014.

 

In addition, the Company is paying MAYO for research and development efforts. During the three and nine months ended September 30, 2014, the Company made payments of $0.0 million and $0.7 million, respectively. At September 30, 2014 the Company recorded an estimated liability in the amount of $1.6 million for MAYO’s research and development efforts. During the three and nine months ended September 30, 2013, the Company made research and development payments to MAYO of $0.3 million and $0.6 million, respectively. At September 30, 2013 the Company recorded an estimated liability in the amount of $0.7 million for research and development efforts.

 

May 2012 Amendment

 

As more fully described in the 2013 Form 10-K, in May 2012 the Company expanded the relationship with MAYO through an amendment to the License Agreement. As part of the amendment, MAYO expanded the Company’s license to include all gastrointestinal cancers and diseases, and new cancer screening applications of stool- and blood-based testing.

 

As part of the amendment, the Company will also be responsible for making restricted stock grants to MAYO as certain milestones are met with respect to commercial launch of the Company’s second and third licensed products. Additionally, the Company will make milestone payments once certain sales levels are reached on licensed products. It is uncertain as to when or if these milestones will be met; therefore, the milestone payments have not been recorded as a liability. The Company evaluates the status of the milestone payments at each reporting date to determine if a liability should be recorded for the milestone payment.

 

(4) STOCK-BASED COMPENSATION

 

Stock-Based Compensation Plans

 

The Company maintains the 2010 Omnibus Long-Term Incentive Plan, the 2010 Employee Stock Purchase Plan and the 2000 Stock Option and Incentive Plan (collectively, as each has been amended, the “Stock Plans”).

 

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Stock-Based Compensation Expense

 

The Company recorded $4.1 million and $8.6 million in stock-based compensation expense during the three and nine months ended September 30, 2014 in connection with the amortization of restricted stock and restricted stock unit awards, stock purchase rights granted under the Company’s employee stock purchase plan and stock options granted to employees, non-employee consultants and non-employee directors, and warrants granted to non-employee consultants.   The Company recorded $1.8 million and $5.7 million in stock-based compensation expense during the three and nine months ended September 30, 2013 in connection with the amortization of restricted stock and restricted stock unit awards, stock purchase rights granted under the Company’s employee stock purchase plan and stock options granted to employees, non-employee consultants and non-employee directors.

 

Warrant Expense

 

Warrants to purchase 75,000 shares of common stock were issued in connection with a consulting agreement in 2009 to provide specific assistance to the Company in attaining FDA approval of Cologuard. The 75,000 warrants vested in the third quarter of 2014 upon successful FDA approval for Cologuard. The Company recorded $1.3 million, the fair value of the warrant on the vesting date as stock-based compensation expense during the third quarter of 2014 in connection with the vesting of this warrant.

 

Determining Fair Value

 

Valuation and Recognition — The fair value of each option award is estimated on the date of grant using the Black-Scholes option pricing model based on the assumptions in the table below. The estimated fair value of employee stock options is recognized to expense using the straight-line method over the vesting period.

 

Expected Term — The Company uses the simplified calculation of expected life, described in the SEC’s Staff Accounting Bulletins 107 and 110, as the Company does not currently have sufficient historical exercise data on which to base an estimate of expected life.  Using this method, the expected term is determined using the average of the vesting period and the contractual life of the stock options granted.

 

Expected Volatility — Expected volatility is based on the Company’s historical stock volatility data over the expected term of the awards.

 

Risk-Free Interest Rate — The Company bases the risk-free interest rate used in the Black-Scholes valuation model on the implied yield currently available on U.S. Treasury zero-coupon issues with an equivalent expected term.

 

Forfeitures — The Company records stock-based compensation expense only for those awards that are expected to vest.  A forfeiture rate is estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from initial estimates.  The Company’s forfeiture rate used in the nine months ended September 30, 2014 was 4.99%. The Company’s forfeiture rate used in the nine months ended September 30, 2013 was 2.76%.

 

The fair value of each restricted stock and restricted stock unit award is determined on the date of grant using the closing stock price on that day.

 

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		Three Months Ended						Nine Months Ended
		September 30,						September 30,
		2014			2013			2014			2013
Option Plan Shares
Risk-free interest rates		2.01		%	1.73		%	1.96% - 2.01%			0.94% - 1.73%
Expected term (in years)		6			6			6			6
Expected volatility		77.6		%	82.9		%	77.6% - 80.8%			82.9% - 84.0%
Dividend yield		0		%	0		%	0		%	0		%
Weighted average fair value per share of options granted during the period		$	11.37		$	10.34		$	10.05		$	8.12
ESPP Shares
Risk-free interest rates				(1)			(1)	0.10% - 0.41%			0.11% - 0.20%
Expected term (in years)				(1)			(1)	0.5 - 2			0.5 - 2
Expected volatility				(1)			(1)	42.5% - 49.5%			39.1% - 45.6%
Dividend yield				(1)			(1)	0		%	0		%
Weighted average fair value per share of stock purchase rights granted during the period				(1)			(1)	$	3.76		$	2.80

 

(1) The Company did not issue stock purchase rights under its 2010 Employee Stock Purchase Plan during the respective period.

 

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Stock Option and Restricted Stock Activity

 

A summary of stock option activity under the Stock Plans during the nine months ended September 30, 2014 is as follows:

 

							Weighted
				Weighted			Average
				Average			Remaining		Aggregate
				Exercise			Contractual		Intrinsic
Options		Shares		Price			Term (Years)		Value (1)
(Aggregate intrinsic value in thousands)
Outstanding, January 1, 2014		6,062,587		$	2.78		6.6
Granted		266,477		$	14.28
Exercised		(115,004	)	$	3.68
Forfeited		(6,625	)	$	7.99
Outstanding, September 30, 2014		6,207,435		$	3.25		5.3		100,138
Exercisable, September 30, 2014		5,446,108		$	2.14		4.9		93,895
Vested and expected to vest September 30, 2014		6,169,445		$	3.20		5.3		99,826

 

(1)         The aggregate intrinsic value of options outstanding, exercisable and vested and expected to vest is calculated as the difference between the exercise price of the underlying options and the market price of the Company’s common stock for options that had exercise prices that were lower than the $19.38 market price of the Company’s common stock at September 30, 2014.  The total intrinsic value of options exercised during the nine months ended September 30, 2014 and 2013 was $1.4 million and $1.6 million, respectively.

 

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As of September 30, 2014, there was $20.5 million of total unrecognized compensation cost related to non-vested share-based compensation arrangements granted under all Stock Plans.  Total unrecognized compensation cost will be adjusted for future changes in forfeitures.  The Company expects to recognize that cost over a weighted average period of 2.8 years.

 

A summary of restricted stock activity under the Stock Plans during the nine months ended September 30, 2014 is as follows:

 

				Weighted
		Restricted		Average Grant
		Shares		Date Fair Value
Outstanding, January 1, 2014		1,150,694		$	11.24
Granted		833,380		$	14.64
Released		(385,825	)	$	11.38
Forfeited		(21,536	)	$	12.31
Outstanding, September 30, 2014		1,576,713		$	12.99

 

(5) FAIR VALUE MEASUREMENTS

 

The FASB has issued authoritative guidance which requires that fair value should be based on the assumptions market participants would use when pricing an asset or liability and establishes a fair value hierarchy that prioritizes the information used to develop those assumptions.  Under the standard, fair value measurements are separately disclosed by level within the fair value hierarchy.  The fair value hierarchy establishes and prioritizes the inputs used to measure fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs.  Observable inputs are inputs that reflect the assumptions that market participants would use in pricing the asset or liability developed based on

 

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market data obtained from sources independent of the Company.  Unobservable inputs are inputs that reflect the Company’s assumptions about the assumptions market participants would use in pricing the asset or liability developed based on the best information available in the circumstances.

 

The three levels of the fair value hierarchy established are as follows:

 

Level 1		Quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access as of the reporting date. Active markets are those in which transactions for the asset or liability occur in sufficient frequency and volume to provide pricing information on an ongoing basis.
Level 2		Pricing inputs other than quoted prices in active markets included in Level 1, which are either directly or indirectly observable as of the reporting date. These include quoted prices for similar assets or liabilities in active markets and quoted prices for identical or similar assets or liabilities in markets that are not active.
Level 3		Unobservable inputs that reflect the Company’s assumptions about the assumptions that market participants would use in pricing the asset or liability. Unobservable inputs shall be used to measure fair value to the extent that observable inputs are not available.

 

Fixed-income securities and mutual funds are valued using a third party pricing agency. The valuation is based on observable inputs including pricing for similar assets and other observable market factors. There has been no material change from period to period.  The estimated fair value of the Company’s long-term debt based on a market approach was approximately $1.0 million as of September 30, 2014 and December 31, 2013 and represent Level 2 measurements.  When determining the estimated fair value of the Company’s long-term debt, the Company used market-based risk measurements, such as credit risk.

 

The following table presents the Company’s fair value measurements as of September 30, 2014 along with the level within the fair value hierarchy in which the fair value measurements in their entirety fall.  Amounts in the table are in thousands.

 

					Fair Value Measurement at September 30, 2014 Using:
					Quoted Prices in Active			Significant Other			Significant Unobservable
		Fair Value at			Markets for Identical Assets			Observable Inputs			Inputs
Description		September 30, 2014			(Level 1)			(Level 2)			(Level 3)
Cash and cash equivalents
Cash and money market		$	27,829		$	27,829		$	—		$	—
Available-for-Sale
Marketable securities
U.S. government agency securities		32,697			—			32,697			—
Corporate bonds		112,065			—			112,065			—
Certificates of deposit		300			—			300			—
Asset backed securities		38,253			—			38,253			—
Total		$	211,144		$	27,829		$	183,315		$	—

 

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The following table presents the Company’s fair value measurements as of December 31, 2013 along with the level within the fair value hierarchy in which the fair value measurements in their entirety fall.  Amounts in the table are in thousands.

 

					Fair Value Measurement at December 31, 2013 Using:
					Quoted Prices in Active			Significant Other			Significant Unobservable
		Fair Value at			Markets for Identical Assets			Observable Inputs			Inputs
Description		December 31, 2013			(Level 1)			(Level 2)			(Level 3)
Cash and cash equivalents
Cash and money market		$	12,851		$	12,851		$	—		$	—
Available-for-Sale
Marketable securities
Corporate bonds		54,554			—			54,554			—
U.S. government agency securities		34,338			—			34,338			—
Certificates of deposit		6,561			—			6,561			—
Commercial paper		1,499			—			1,499			—
Asset backed securities		23,456						23,456
Total		$	133,259		$	12,851		$	120,408		$	—

 

The following table summarizes the gross unrealized losses and fair values of our investments in an unrealized loss position as of September 30, 2014, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position:

 

		September 30, 2014
		Less than 12 months						12 months or greater						Total
(In thousands)		Fair Value			Gross Unrealized Loss			Fair Value			Gross Unrealized Loss			Fair Value			Gross Unrealized Loss
U.S. government agency securities		$	11,875		$	(22	)	$	—		$	—		$	11,875		$	(22	)
Corporate bonds		61,132			(69		)	—			—			61,132			(69		)
Asset backed securities		21,775			(11		)	—			—			21,775			(11		)
Total		$	94,782		$	(102	)	$	—		$	—		$	94,782		$	(102	)

 

The following summarizes contractual underlying maturities of the Company’s available-for-sale investments in debt securities at September 30, 2014 (in thousands):

 

		Due in one year or less						Due after one year through two years
Description		Cost			Fair Value			Cost			Fair Value
Marketable Securities
U.S. government agency securities		$	20,794		$	20,822		$	11,897		$	11,875
Corporate bonds		52,153			52,202			59,921			59,864
Certificates of deposit		300			300			—			—
Asset backed securities		30,219			30,220			8,038			8,032
Total		$	103,466		$	103,544		$	79,856		$	79,771

 

(6) EQUITY

 

On April 2, 2014, the Company completed an underwritten public offering of 11.5 million shares of common stock at a price of $12.75 per share to the public. The Company received approximately $137.7 million of net proceeds from the offering, after deducting the $8.9 million for the underwriting discount and other stock issuance costs paid by the Company.

 

On June 21, 2013, the Company completed an underwritten public offering for 6.3 million shares of common stock at a price of $12.35 per share to the public. The Company received approximately $73.3 million of net proceeds from the offering, after deducting $4.8 million for the underwriting discount and other stock issuance costs paid by the Company.

 

In February 2011, the Company adopted a rights agreement and subsequently distributed to our stockholders preferred stock purchase rights.  Under certain circumstances, each right can be exercised for one one-thousandth of a share of Series A Junior Participating Preferred Stock.  In general, the rights will become exercisable in the event of an announcement of an acquisition of 15% or more of our outstanding common stock or the commencement or announcement of an intention to make a tender offer or exchange offer for 15% or more of our outstanding common

 

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