EXACT SCIENCES CORP - Quarter Report: 2014 June (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 June 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  £

 

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 July 30, 2014, the registrant had 82,934,536 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 June 30, 2014 and December 31, 2013	3
	Condensed Consolidated Statements of Operations (Unaudited) for the Three and Six Months Ended June 30, 2014 and 2013	4
	Condensed Consolidated Statements of Comprehensive Loss (Unaudited) for the Three and Six Months Ended June 30, 2014 and 2013	5
	Condensed Consolidated Statements of Cash Flows (Unaudited) for the Six Months Ended June 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	30
Item 4.	Controls and Procedures	30
	Part II - Other Information
Item 1.	Legal Proceedings	30
Item 1A.	Risk Factors	30
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	31
Item 3.	Defaults Upon Senior Securities	31
Item 4.	Mine Safety Disclosures	31
Item 5	Other Information	31
Item 6.	Exhibits	31
	Signatures	32
	Exhibit Index	33

 

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Part I — Financial Information

 

EXACT SCIENCES CORPORATION

Condensed Consolidated Balance Sheets

(Amounts in thousands, except share data - unaudited)

 

		June 30,			December 31,
		2014			2013
ASSETS
Current Assets:
Cash and cash equivalents		$	20,708		$	12,851
Marketable securities		214,089			120,408
Prepaid expenses and other current assets		3,987			2,199
Total current assets		238,784			135,458
Property and Equipment, at cost:
Laboratory equipment		8,127			5,087
Assets under construction		6,694			2,592
Office and computer equipment		1,260			1,217
Leasehold improvements		5,055			5,043
Furniture and fixtures		268			268
		21,404			14,207
Less—Accumulated depreciation		(4,383		)	(3,038		)
		17,021			11,169
		$	255,805		$	146,627
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current Liabilities:
Accounts payable		$	357		$	761
Accrued expenses		8,560			5,806
Capital lease obligation, current portion		361			351
Lease incentive obligation, current portion		540			540
Deferred license fees, current portion		—			294
Total current liabilities		9,818			7,752
Long-term debt		1,000			1,000
Long-term accrued interest		95			84
Capital lease obligation, less current portion		177			360
Lease incentive obligation, less current portion		1,845			2,115
Commitments and contingencies
Stockholders’ Equity:
Preferred stock, $0.01 par value Authorized—5,000,000 shares, Issued and outstanding—no shares at June 30, 2014 and December 31, 2013		—			—
Common stock, $0.01 par value Authorized—100,000,000 shares, Issued and outstanding—82,920,004 and 71,071,838 shares at June 30, 2014 and December 31, 2013		829			711
Additional paid-in capital		598,255			455,239
Accumulated other comprehensive income		89			125
Accumulated deficit		(356,303		)	(320,759		)
Total stockholders’ equity		242,870			135,316
		$	255,805		$	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 - unaudited)

 

		Three Months Ended June 30,						Six Months Ended June 30,
		2014			2013			2014			2013
License fees		$	—		$	1,036		$	294		$	2,072
Operating expenses:
Research and development		7,174			6,457			14,604			13,983
General and administrative		6,230			3,628			10,816			6,276
Sales and marketing		6,166			3,302			10,622			5,061
		19,570			13,387			36,042			25,320
Loss from operations		(19,570		)	(12,351		)	(35,748		)	(23,248		)
Investment income		146			55			232			117
Interest expense		(13		)	(18		)	(28		)	(37		)
Net loss		$	(19,437	)	$	(12,314	)	$	(35,544	)	$	(23,168	)
Net loss per share—basic and diluted		$	(0.24	)	$	(0.19	)	$	(0.46	)	$	(0.36	)
Weighted average common shares outstanding—basic and diluted		82,048			64,699			76,548			64,270

 

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 June 30,						Six Months June 30,
		2014			2013			2014			2013
Net loss		$	(19,437	)	$	(12,314	)	$	(35,544	)	$	(23,168	)
Other comprehensive loss, net of tax
Unrealized holding loss on available-for-sale investments		(44		)	(54		)	(36		)	(61		)
Comprehensive loss		$	(19,481	)	$	(12,368	)	$	(35,580	)	$	(23,229	)

 

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)

 

		Six Months Ended June 30,
		2014			2013
Cash flows from operating activities:
Net loss		$	(35,544	)	$	(23,168	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation of fixed assets		1,344			646
Loss on disposal of fixed asset		—			91
Stock-based compensation		4,478			3,811
Amortization of deferred license fees		(294		)	(2,072		)
Amortization of premium on short-term investments		370			270
Changes in assets and liabilities:
Prepaid expenses and other current assets		(1,788		)	(494		)
Accounts payable		(404		)	(2,568		)
Accrued expenses		3,210			1,254
Lease incentive obligation		(270		)	—
Accrued interest		11			10
Net cash used in operating activities		(28,887		)	(22,220		)
Cash flows from investing activities:
Purchases of marketable securities		(138,855		)	(71,833		)
Maturities of marketable securities		44,768			30,067
Purchases of property and equipment		(7,196		)	(1,726		)
Net cash used in investing activities		(101,283		)	(43,492		)
Cash flows from financing activities:
Proceeds from sale of common stock, net of issuance costs		137,670			73,302
Proceeds from exercise of common stock options		193			486
Payments on capital lease obligations		(173		)	(164		)
Proceeds in connection with the Company’s employee stock purchase plan		337			261
Net cash provided by financing activities		138,027			73,885
Net increase in cash and cash equivalents		7,857			8,173
Cash and cash equivalents, beginning of period		12,851			13,345
Cash and cash equivalents, end of period		$	20,708		$	21,518
Supplemental disclosure of non-cash investing and financing activities:
Unrealized loss on available-for-sale investments		$	36		$	61
Issuance of 32,266 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 June 30, 2014 and December 31, 2013.

 

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

 

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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 June 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 $7.6 thousand and $2.8 thousand, net of insignificant realized losses, for the six months ended June 30, 2014 and 2013, respectively. Unrealized gains or losses on investments are recorded in other comprehensive loss.

 

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

 

		June 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		$	48,550		$	27		$	—		$	48,577
Corporate bonds		118,696			41			—			118,737
Certificates of deposit		3,550			1			—			3,551
Asset backed securities		43,204			20			—			43,224
Total available-for-sale securities		$	214,000		$	89		$	—		$	214,089

 

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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

 

The amounts recognized in accumulated other comprehensive income (AOCI) were as follows (in thousands):

 

		Three Months Ended June 30,						Six Months Ended June 30,
		2014			2013			2014			2013
Beginning balance		$	133		$	71		$	125		$	78
Other comprehensive loss before reclassifications		(39		)	(52		)	(24		)	(48		)
Amounts reclassified from accumulated other comprehensive income		(5		)	(2		)	(12		)	(13		)
Net current period change in accumulated other comprehensive income		(44		)	(54		)	(36		)	(61		)
Ending balance		$	89		$	17		$	89		$	17

 

Amounts reclassified from accumulated other comprehensive income were as follows (in thousands):

 

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		Affected Line Item in the		Three Months Ended June 30,						Six Months Ended June 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		$	(5	)	$	(2	)	$	(12	)	$	(13	)
Total reclassifications				$	(5	)	$	(2	)	$	(12	)	$	(13	)

 

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 June 30, 2014, the Company had $6.7 million of assets under construction which consisted of $4.4 million of capitalized costs related to software projects and $2.3 million of costs related to equipment projects. Depreciation will begin on these assets once they are placed into service. We expect that it will cost $1.0 million to complete the equipment projects and $2.2 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.

 

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:

 

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		June 30,
(In thousands)		2014		2013
Shares issuable upon exercise of stock options		6,221		6,249
Shares issuable upon exercise of outstanding warrants (1)		75		155
Shares issuable upon the release of restricted stock awards		1,546		875
Shares issuable upon the vesting of restricted stock awards related to a licensing agreement		24		49
		7,866		7,328

 

(1)      At June 30, 2014, represents warrants to purchase 75,000 shares of common stock issued under a consulting agreement.  At June 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

 

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, Genzyme agreed to pay the Company a total of $18.5 million, of which $16.65 million was paid on January 27, 2009 and $1.85 million was subject to a holdback by Genzyme to satisfy certain potential indemnification obligations in exchange for the assignment and licensing of certain intellectual property to Genzyme. The Company’s on-going performance obligations to Genzyme under the Collaboration, License and Purchase Agreement (the “CLP Agreement”), as described below, including its obligation to deliver through licenses certain intellectual property improvements to Genzyme, if improvements are made during the initial five-year collaboration period, were deemed to be undelivered elements of the CLP Agreement on the date of closing. Accordingly, 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. The Company received the first holdback amount of $1.0 million, which included accrued interest due, from Genzyme during the first quarter of 2010. The Company received the second holdback amount of $0.9 million, which included accrued interest due, from Genzyme during the third quarter of 2010.  The amounts 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, Genzyme purchased 3,000,000 shares of common stock on January 27, 2009 for $2.00 per share, representing a premium of $0.51 per share above the closing price of the Company’s common stock on that date of $1.49 per share. The aggregate premium paid by Genzyme over the closing price of the Company’s common stock on the date of the transaction of $1.53 million is deemed to be a part of the total consideration for the CLP Agreement. Accordingly, the Company deferred the aggregate $1.53 million premium 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 June 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 June 30, 2013. The

 

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Company recognized approximately $0.3 million and $2.1 million in license fee revenue in connection with the amortization of up-front payments from Genzyme during each of the six months ended June 30, 2014 and June 30, 2013, respectively.

 

Reclassifications

 

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

 

(3) MAYO LICENSE AGREEMENT

 

Overview

 

On June 11, 2009, the Company entered into a license agreement (the “License Agreement”) with MAYO Foundation for Medical Education and Research (“MAYO”). Under the License Agreement, MAYO granted the Company an exclusive, worldwide license within the field (the “Field”) of stool or blood based cancer diagnostics and screening (excluding a specified proteomic target) with regard to certain MAYO patents, and a non-exclusive worldwide license within the Field with regard to certain MAYO know-how. The licensed patents cover advances in sample processing, analytical testing and data analysis associated with non-invasive, stool-based DNA screening for colorectal cancer. Under the License Agreement, the Company assumes the obligation and expense of prosecuting and maintaining the licensed patents and is obligated to make commercially reasonable efforts to bring products covered by the license to market. 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.

 

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.

 

In January of 2013, MAYO partially exercised its warrant covering 250,000 shares by utilizing the cashless exercise provision contained in the warrant. As a result of this exercise for a gross amount of 85,000 shares, in lieu of paying a cash exercise price, MAYO forfeited its right with respect to 14,008 shares leaving it with a net amount of 70,992 shares.

 

In June of 2013, MAYO partially exercised this warrant by utilizing the cashless exercise provision contained in the warrant. As a result of this exercise for a gross amount of 85,000 shares, in lieu of paying a cash exercise price, MAYO forfeited its right with respect to 12,765 shares leaving it with a net amount of 72,235 shares.

 

In June of 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.

 

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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.  It is uncertain as to when or if the FDA will approve the Company’s Cologuard test; therefore the $500,000 milestone payment has not been recorded as a liability. The Company evaluates the status of the FDA trial at each reporting date to determine if a liability should be recorded for the milestone payment.

 

In addition, the Company is paying MAYO for research and development efforts. During the three and six months ended June 30, 2014, the Company made payments of $0.2 million and $0.7 million, respectively. At June 30, 2014 the Company recorded an estimated liability in the amount of $1.0 million for research and development efforts. During the three and six months ended June 30, 2013, the Company made payments of $0.3 million and $0.5 million, respectively. At June 30, 2013 the Company recorded an estimated liability in the amount of $0.5 million for research and development efforts.

 

May 2012 Amendment

 

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 consideration for the expanded license, the Company granted MAYO 97,466 shares of restricted stock, one quarter of which vested immediately, with the remainder to vest in three equal annual installments. The Company recognized $1.0 million in research and development licensing expense during the twelve months ended December 31, 2012 in connection with the restricted stock grant. The Company sought rights to the MAYO intellectual property for the specific purpose of developing future non-invasive, stool-based DNA screening tests for gastrointestinal diseases other than colorectal cancer. The Company does not believe there are alternative future uses for the intellectual property. In addition, at the time the restricted stock grant expense was recorded for the intellectual property license, the Company believed it was unlikely that the Company would proceed with the tests for other gastrointestinal diseases until following receipt of FDA approval for the Company’s Cologuard test. Because of the significant uncertainty of receiving this FDA approval, coupled with the uncertainty associated with funding future development of tests for other gastrointestinal diseases, the Company could not conclude that commencement of any future projects related to the acquired intellectual property was reasonably expected at the time of this license agreement amendment.

 

As part of the amendment, the Company will also be responsible for making additional 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.

 

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(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”).

 

Stock-Based Compensation Expense

 

The Company recorded $2.5 million and $4.5 million in stock-based compensation expense during the three and six months ended June 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.  The Company recorded $2.8 million and $3.8 million in stock-based compensation expense during the three and six months ended June 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.

 

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 six months ended June 30, 2014 was 4.99%. The Company’s forfeiture rate used in the six months ended June 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						Six Months Ended
		June 30,						June 30,
		2014			2013			2014			2013
Option Plan Shares
Risk-free interest rates		(1)			0.94%			1.96%			0.94% - 1.15%
Expected term (in years)		(1)			6			6			6
Expected volatility		(1)			82.9%			80.8%			82.9% - 84.0%
Dividend yield		(1)			0%			0%			0%
Weighted average fair value per share of options granted during the period		(1)			$	6.55		$	9.86		$	7.66
ESPP Shares
Risk-free interest rates		0.10% - 0.41%			0.11% - 0.20%			0.10% - 0.41%			0.11% - 0.20%
Expected term (in years)		0.5 - 2			0.5 - 2			0.5 - 2			0.5 - 2
Expected volatility		42.5% - 49.5%			39.1% - 45.6%			42.5% - 49.5%			39.1% - 45.6%
Dividend yield		0%			0%			0%			0%
Weighted average fair value per share of stock purchase rights granted during the period		$	3.76		$	2.80		$	3.76		$	2.80

 

(1) The Company did not grant options under its 2010 Option Plan during the period indicated.

 

Stock Option and Restricted Stock Activity

 

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

 

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							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		233,000		$	13.96
Exercised		(69,064	)	$	2.79
Forfeited		(5,125	)	$	7.80
Outstanding, June 30, 2014		6,221,398		$	3.19		5.5		$	86,097
Exercisable, June 30, 2014		5,374,375		$	2.06		5.1		$	80,441
Vested and expected to vest, June 30, 2014		6,179,132		$	3.14		5.5		$	85,815

 

(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 $17.03 market price of the Company’s common stock at June 30, 2014.  The total intrinsic value of options exercised during the six months ended June 30, 2014 and 2013 was $0.7 million and $0.5 million, respectively.

 

As of June 30, 2014, there was $18.9 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 2.92 years.

 

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

 

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				Weighted
		Restricted		Average Grant
		Shares		Date Fair Value
Outstanding, January 1, 2014		1,150,694		$	11.24
Granted		576,794		$	13.81
Released		(166,756	)	$	8.99
Forfeited		(14,599	)	$	12.05
Outstanding, June 30, 2014		1,546,133		$	12.43

 

(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 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.

 

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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 June 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 June 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 June 30, 2014 Using:
					Quoted Prices in Active			Significant Other			Significant Unobservable
		Fair Value at			Markets for Identical Assets			Observable Inputs			Inputs
Description		June 30, 2014			(Level 1)			(Level 2)			(Level 3)
Cash and cash equivalents
Cash and money market		$	20,708		$	20,708		$	—		$	—
Available-for-Sale
Marketable securities
U.S. government agency securities		48,577			—			48,577			—
Corporate bonds		118,737			—			118,737			—
Certificates of deposit		3,551			—			3,551			—
Asset backed securities		43,224			—			43,224			—
Total		$	234,797		$	20,708		$	214,089		$	—

 

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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		$	—

 

As of June 30, 2014 and December 31, 2013 the Company held available-for-sale securities which had been in a continuous unrealized loss position for less than twelve months, the total unrealized losses of which were $51.4 thousand, as of June 30, 2014, and $7.2 thousand, as of December 31, 2013. The total fair value of the securities in a continuous unrealized loss position were $83.5 million, as of June 30, 2014 and $13.9 million as of December 31, 2013. At June 30, 2014 and December 31, 2013 there were no available-for-sale securities in a continuous loss position for greater than twelve months.

 

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

 

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		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		$	32,906		$	32,932		$	15,644		$	15,645
Corporate bonds		29,096			29,134			89,600			89,603
Certificates of deposit		3,550			3,551			—			—
Asset backed securities		33,932			33,947			9,272			9,277
Total		$	99,484		$	99,564		$	114,516		$	114,525

 

(6) EQUITY

 

On April 2, 2014, the Company completed an underwritten public offering of 11,500,000 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.

 

In February 2011, we 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 stock.  If any person or group acquires 15% or more of our common stock, our stockholders, other than the acquiror, will have the right to purchase additional shares of our common stock (in lieu of the Series A Junior Participating Preferred Stock) at a substantial discount to the then prevailing market price. The rights agreement could significantly dilute such acquiror’s ownership position in our shares, thereby making a takeover prohibitively expensive and encouraging such acquiror to negotiate with our board of directors. The ability to exercise these rights is contingent on events that the Company has determined to be unlikely at this time, and therefore this provision has not been considered in the computation of equity or earnings per share.

 

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(7) RECENT ACCOUNTING PRONOUNCEMENTS

 

In May 2014, the Financial Accounting Standards Board issued Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers. ASU 2014-09 is a comprehensive new revenue recognition model requiring a company to recognize revenue to depict the transfer of goods or services to a customer at an amount reflecting the consideration it expects to receive in exchange for those goods or services. ASU 2014-09 may be applied using either a full retrospective or a modified retrospective approach and is effective for fiscal years, and interim periods within those years, beginning after December 15, 2016, and early adoption is not permitted. We are currently evaluating the impact of this amendment on our financial position and results of operations.

 

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

 

The following discussion of the financial condition and results of operations of Exact Sciences Corporation (together with its subsidiary, “Exact,” “we,” “us”, “our” or the “Company”)  should be read in conjunction with the condensed financial statements and the related notes thereto included elsewhere in this Quarterly Report on Form 10-Q and the audited financial statements and notes thereto and Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K for the year ended December 31, 2013, which has been filed with the SEC (the “2013 Form 10-K”).

 

Forward-Looking Statements

 

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities and Exchange Act of 1934, as amended, that are intended to be covered by the “safe harbor” created by those sections.  Forward-looking statements, which are based on certain assumptions and describe our future plans, strategies and expectations, can generally be identified by the use of forward-looking terms such as “believe,” “expect,” “may,” “will,” “should,” “could,” “seek,” “intend,” “plan,” “estimate,” “anticipate” or other comparable terms.  Forward-looking statements in this Quarterly Report on Form 10-Q may address the following subjects among others: statements regarding the sufficiency of our capital resources, expected operating losses, timing and anticipated results of the FDA’s review of our pivotal clinical trial and our related FDA submissions, our ability to secure favorable reimbursement rates from Medicare and other third-party payors, our ability to establish a lab facility and secure the required certifications for that facility, timing of our launch of a commercial product, estimated markets for our products and expected revenues, expected research and development expenses, expected general and administrative expenses and our expectations concerning our business strategy.  Forward-looking statements involve inherent risks and uncertainties which could cause actual results to differ materially from those in the forward-looking statements, as a result of various factors including those risks and uncertainties described in the Risk Factors and in Management’s Discussion and Analysis of Financial Condition and Results of Operations sections of our 2013 Form 10-K and our subsequently filed Quarterly Reports on Form 10-Q.  We urge you to consider those risks and uncertainties in evaluating our forward-looking statements.  We caution readers not to place undue reliance upon any such forward-looking statements, which speak only as of the date made.  Except as otherwise required by the federal securities laws, we disclaim any obligation or undertaking to publicly release any updates or revisions to any forward-looking statement contained herein (or elsewhere) to reflect any change in our expectations with regard thereto or any change in events, conditions or circumstances on which any such statement is based.

 

Overview

 

We are a molecular diagnostics company currently focused on the early detection and prevention of colorectal cancer. We have developed an accurate, non-invasive, patient friendly screening test to meet our primary goal of becoming the market leader for early detection of colorectal pre-cancer and cancer.

 

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Our strategic roadmap to achieve this goal includes the following key components:

 

· advance our product through U.S. Food and Drug Administration (FDA) clinical approval process;

 

· commercialize an FDA-approved product that detects colorectal pre-cancer and cancer; and

 

· secure favorable reimbursement for our product from payors.

 

Our Cologuard® test is designed to detect pre-cancerous lesions or polyps, and each of the four stages of colorectal cancer and is expected to be a powerful, preventive tool.  Cologuard is a non-invasive, stool-based DNA (sDNA) screening test designed to detect DNA markers, which in published studies have been shown to be associated with colorectal cancer. In addition to DNA markers, our test includes a protein marker to detect blood in the stool utilizing an antibody-based fecal immunochemical test (FIT).

 

Colorectal cancer is the second leading cause of cancer deaths in the United States and the leading cause of cancer deaths among nonsmokers.

 

It is widely accepted that colorectal cancer is among the most preventable, yet least prevented cancers. Colorectal cancer can take up to 10-15 years to progress from a pre-cancerous lesion to metastatic cancer and death. Patients who are diagnosed early in the progression of the disease—with pre-cancerous lesions or polyps, or early-stage cancer—are more likely to have a complete recovery and to be treated less expensively. Accordingly, the American Cancer Society (ACS) recommends that all people age 50 and older undergo regular colorectal cancer screening. Of the more than 80 million people in the United States for whom routine colorectal cancer screening is recommended, nearly 47 percent have not been screened according to current guidelines. Poor compliance has meant that nearly two-thirds of colorectal cancer diagnoses are made in the disease’s late stages. The five-year survival rates for stages 3 and 4 are 67 percent and 12 percent, respectively.

 

We believe the large population of unscreened and inadequately screened patients represents a significant opportunity for a patient friendly screening test like ours. A powerful preventive tool that detects pre-cancerous polyps and early stage colorectal cancer could significantly reduce colorectal cancer deaths and the health care costs associated with the disease. Pre-cancerous polyps are present in approximately 6 percent of average risk people 50 years of age and older who undergo routine colorectal cancer screening.

 

The competitive advantages of sDNA screening provide a significant market opportunity. Assuming a 30-percent test adoption rate and a three-year screening interval, we estimate the potential U.S. market for sDNA screening to be more than $2 billion and we estimate the potential global market opportunity to be greater than $3 billion.

 

Our current focus is on seeking FDA approval for our Cologuard test. We believe obtaining FDA approval is important to building broad demand and successfully commercializing our sDNA colorectal cancer screening technology.

 

The FDA, as well as physicians and others assessing the effectiveness and value of our Cologuard test, will likely consider, among other things, our Cologuard test’s sensitivity and specificity in identifying colorectal cancer and pre-cancerous polyps. “Sensitivity” (also called the true positive rate) measures the percentage of colorectal cancer or pre-cancerous polyps that our Cologuard test correctly identifies. “Specificity” (also called the true negative rate) measures the percentage of people who our Cologuard test correctly identifies as not having colorectal cancer or pre-cancerous polyps.

 

In the first half of 2013 we completed our pivotal 10,000 patient DeeP-C study.  All patients provided a sample to be tested with our Cologuard test, and received a FIT test and a colonoscopy.

 

Top-line data from the DeeP-C study showed that our Cologuard test demonstrated 92 percent sensitivity for the detection of colorectal cancer and 42 percent sensitivity for the detection of pre-cancerous polyps, including 66 percent sensitivity for pre-cancerous polyps equal to or greater than 2 centimeters. The test achieved a specificity of 87 percent during the clinical trial.

 

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