exas_Current Folio_10Q

Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

 


 

FORM 10-Q

 

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

 

For the quarterly period ended March 31, 2019

 

OR

 

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)

 

DELAWARE

 

02-0478229

(State or other jurisdiction of

 

(I.R.S. Employer

incorporation or organization)

 

Identification Number)

 

 

 

441 Charmany Drive, Madison WI

 

53719

(Address of principal executive offices)

 

(Zip Code)

 

(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  ☒  No  ☐

 

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

 

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

 

Large accelerated filer ☒

 

Accelerated filer ☐

 

 

 

Non-accelerated filer ☐

 

Smaller reporting company ☐

 

 

 

Emerging growth company ☐

 

 

 

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

 

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

 

As of April 29, 2019, the registrant had 129,138,838 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 March 31, 2019 and December 31, 2018

3

 

 

 

 

Condensed Consolidated Statements of Operations (unaudited) for the Three Months Ended March 31, 2019 and 2018

4

 

 

 

 

Condensed Consolidated Statements of Comprehensive Loss (unaudited) for the Three Months Ended March 31, 2019 and 2018

5

 

 

 

 

Condensed Consolidated Statements of Stockholders’ Equity (unaudited) for the Three Months Ended March 31, 2019 and 2018

6

 

 

 

 

Condensed Consolidated Statements of Cash Flows (unaudited) for the Three Months Ended March 31, 2019 and 2018

7

 

 

 

 

Notes to Condensed Consolidated Financial Statements (unaudited)

8

 

 

 

Item 2. 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

31

 

 

 

Item 3. 

Quantitative and Qualitative Disclosures About Market Risk

43

 

 

 

Item 4. 

Controls and Procedures

43

 

 

 

 

Part II - Other Information

 

 

 

 

Item 1. 

Legal Proceedings

44

 

 

 

Item 1A. 

Risk Factors

44

 

 

 

Item 2. 

Unregistered Sales of Equity Securities and Use of Proceeds

45

 

 

 

Item 3. 

Defaults Upon Senior Securities

45

 

 

 

Item 4. 

Mine Safety Disclosures

45

 

 

 

Item 5 

Other Information

45

 

 

 

Item 6. 

Exhibits

46

 

 

 

 

Signatures

47

 

 

2


 

Table of Contents

Part I — Financial Information

 

EXACT SCIENCES CORPORATION

Condensed Consolidated Balance Sheets

(Amounts in thousands, except share data - unaudited)

 

 

 

 

 

 

 

 

 

    

March 31,

    

December 31,

 

 

2019

 

2018

ASSETS

 

 

 

 

 

 

Current Assets:

 

 

 

 

 

 

Cash and cash equivalents

 

$

285,200

 

$

160,430

Marketable securities

 

 

997,506

 

 

963,752

Accounts receivable, net

 

 

56,095

 

 

44,239

Inventory, net

 

 

44,269

 

 

39,148

Prepaid expenses and other current assets

 

 

24,050

 

 

20,498

Total current assets

 

 

1,407,120

 

 

1,228,067

Long-term Assets:

 

 

 

 

 

 

Property, plant and equipment, net

 

 

291,629

 

 

245,259

Goodwill and intangibles, net

 

 

45,610

 

 

46,281

Other long-term assets, net

 

 

26,189

 

 

4,415

Total assets

 

$

1,770,548

 

$

1,524,022

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

 

Current Liabilities:

 

 

 

 

 

 

Accounts payable

 

$

17,552

 

$

28,141

Accrued liabilities

 

 

143,129

 

 

100,644

Accrued interest

 

 

1,066

 

 

4,172

Debt, current portion

 

 

21

 

 

 8

Other short-term liabilities

 

 

5,889

 

 

3,204

Total current liabilities

 

 

167,657

 

 

136,169

Convertible notes, net

 

 

770,510

 

 

664,749

Long-term debt, less current portion

 

 

24,787

 

 

24,494

Other long-term liabilities

 

 

6,821

 

 

9,475

Long-term obligations

 

 

23,833

 

 

8,194

     Total liabilities

 

 

993,608

 

 

843,081

 

 

 

 

 

 

 

Commitments and contingencies

 

 

 

 

 

 

 

 

 

 

 

 

 

Stockholders’ Equity:

 

 

 

 

 

 

Preferred stock, $0.01 par value Authorized—5,000,000 shares issued and outstanding—no shares at March 31, 2019 and December 31, 2018

 

 

 —

 

 

 —

Common stock, $0.01 par value Authorized—200,000,000 shares issued and outstanding—129,083,822 and 123,192,540 shares at March 31, 2019 and December 31, 2018

 

 

1,292

 

 

1,232

Additional paid-in capital

 

 

1,894,116

 

 

1,716,894

Accumulated other comprehensive income (loss)

 

 

354

 

 

(1,422)

Accumulated deficit

 

 

(1,118,822)

 

 

(1,035,763)

Total stockholders’ equity

 

 

776,940

 

 

680,941

Total liabilities and stockholders’ equity

 

$

1,770,548

 

$

1,524,022

 

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

 

3


 

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EXACT SCIENCES CORPORATION

Condensed Consolidated Statements of Operations

(Amounts in thousands, except per share data - unaudited)

 

 

 

 

 

 

 

 

 

 

Three Months Ended March 31,

 

 

2019

 

2018

Revenue

 

$

162,043

 

$

90,296

 

 

 

 

 

 

 

Cost of sales

 

 

43,252

 

 

22,914

Gross margin

 

 

118,791

 

 

67,382

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

 

Research and development

 

 

32,016

 

 

14,935

General and administrative

 

 

64,030

 

 

35,567

Sales and marketing

 

 

90,939

 

 

53,408

Total operating expenses

 

 

186,985

 

 

103,910

Loss from operations

 

 

(68,194)

 

 

(36,528)

 

 

 

 

 

 

 

Other income (expense)

 

 

 

 

 

 

Investment income

 

 

6,655

 

 

3,673

Interest expense

 

 

(21,990)

 

 

(6,510)

Total other expense

 

 

(15,335)

 

 

(2,837)

 

 

 

 

 

 

 

Net loss before tax

 

 

(83,529)

 

 

(39,365)

 

 

 

 

 

 

 

Income tax benefit (expense)

 

 

470

 

 

(59)

 

 

 

 

 

 

 

Net loss

 

$

(83,059)

 

$

(39,424)

 

 

 

 

 

 

 

Net loss per share—basic and diluted

 

$

(0.66)

 

$

(0.33)

 

 

 

 

 

 

 

Weighted average common shares outstanding—basic and diluted

 

 

126,248

 

 

121,016

 

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 March 31,

 

 

2019

 

2018

Net loss

 

$

(83,059)

 

$

(39,424)

Other comprehensive loss, before tax:

 

 

 

 

 

 

Unrealized gain (loss) on available-for-sale investments

 

 

2,176

 

 

(1,606)

Foreign currency translation gain

 

 

120

 

 

20

Comprehensive loss, before tax

 

 

(80,763)

 

 

(41,010)

Income tax expense related to items of other comprehensive loss

 

 

(520)

 

 

 —

Comprehensive loss, net of tax

 

$

(81,283)

 

$

(41,010)

 

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

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EXACT SCIENCES CORPORATION

Condensed Consolidated Statements of Stockholders’ Equity

(Amounts in thousands, except share data - unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Common Stock

 

Additional

 

Other

 

 

 

 

Total

 

    

Number of

    

$0.01

    

Paid In

    

Comprehensive

    

Accumulated

    

Stockholders’

 

 

Shares

 

Par Value

 

Capital

 

Income (Loss)

 

Deficit

 

Equity

Balance, January 1, 2019

 

123,192,540

 

$

1,232

 

$

1,716,894

 

$

(1,422)

 

$

(1,035,763)

 

$

680,941

Equity component of convertible notes, net of issuance costs

 

 —

 

 

 —

 

 

268,390

 

 

 —

 

 

 —

 

 

268,390

Shares issued to settle convertible notes

 

2,158,991

 

 

22

 

 

182,413

 

 

 —

 

 

 —

 

 

182,435

Settlement of convertible notes

 

 —

 

 

 —

 

 

(300,768)

 

 

 —

 

 

 —

 

 

(300,768)

Exercise of common stock options

 

235,278

 

 

 2

 

 

3,648

 

 

 —

 

 

 —

 

 

3,650

Issuance of common stock to fund the Company’s 2018 401(k) match

 

86,532

 

 

 1

 

 

7,408

 

 

 —

 

 

 —

 

 

7,409

Compensation expense related to issuance of stock options and restricted stock awards

 

3,410,481

 

 

35

 

 

16,131

 

 

 —

 

 

 —

 

 

16,166

Net loss

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

(83,059)

 

 

(83,059)

Accumulated other comprehensive loss

 

 —

 

 

 —

 

 

 —

 

 

1,776

 

 

 —

 

 

1,776

Balance, March 31, 2019

 

129,083,822

 

$

1,292

 

$

1,894,116

 

$

354

 

$

(1,118,822)

 

$

776,940

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance, January 1, 2018

 

120,497,426

 

$

1,205

 

$

1,380,577

 

$

(750)

 

$

(860,614)

 

$

520,418

Equity component of convertible notes, net of issuance costs

 

 —

 

 

 —

 

 

189,456

 

 

 —

 

 

 —

 

 

189,456

Exercise of common stock options

 

420,129

 

 

 4

 

 

1,387

 

 

 —

 

 

 —

 

 

1,391

Issuance of common stock to fund the Company’s 2017 401(k) match

 

86,828

 

 

 1

 

 

4,299

 

 

 —

 

 

 —

 

 

4,300

Compensation expense related to issuance of stock options and restricted stock awards

 

862,376

 

 

 9

 

 

12,454

 

 

 —

 

 

 —

 

 

12,463

Net loss

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

(39,424)

 

 

(39,424)

Accumulated other comprehensive loss

 

 —

 

 

 —

 

 

 —

 

 

(1,586)

 

 

 —

 

 

(1,586)

Balance, March 31, 2018

 

121,866,759

 

$

1,219

 

$

1,588,173

 

$

(2,336)

 

$

(900,038)

 

$

687,018

 

 

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

 

6


 

Table of Contents

EXACT SCIENCES CORPORATION

Condensed Consolidated Statements of Cash Flows

(Amounts in thousands, except share data - unaudited)

 

 

 

 

 

 

 

 

 

 

Three Months Ended March 31,

 

    

2019

    

2018

Cash flows from operating activities:

 

 

 

 

 

 

Net loss

 

$

(83,059)

 

$

(39,424)

Adjustments to reconcile net loss to net cash used in operating activities:

 

 

 

 

 

 

Depreciation and amortization of property, plant and equipment

 

 

6,324

 

 

4,281

Loss on disposal of property, plant and equipment

 

 

82

 

 

98

Deferred tax benefit

 

 

(520)

 

 

 —

Stock-based compensation

 

 

16,166

 

 

12,463

Loss on settlement of convertible notes

 

 

10,558

 

 

 —

Non-cash lease expense

 

 

845

 

 

 —

Amortization of liabilities

 

 

8,420

 

 

4,543

Amortization of premium on short-term investments

 

 

(1,306)

 

 

(515)

Amortization of intangible assets

 

 

810

 

 

612

Changes in assets and liabilities:

 

 

 

 

 

 

Accrued interest

 

 

(3,106)

 

 

1,407

Accounts receivable, net

 

 

(11,856)

 

 

(8,156)

Inventory, net

 

 

(5,121)

 

 

(6,353)

Prepaid expenses and other current assets

 

 

(3,552)

 

 

(2,812)

Accounts payable

 

 

(10,589)

 

 

(3,861)

Accrued liabilities

 

 

7,891

 

 

(623)

Other short-term liabilities

 

 

(60)

 

 

(29)

Other long-term liabilities

 

 

(2,092)

 

 

 —

Long-term obligations

 

 

18,492

 

 

(153)

Other long-term assets

 

 

(22,734)

 

 

 —

Net cash used in operating activities

 

 

(74,407)

 

 

(38,522)

Cash flows from investing activities:

 

 

 

 

 

 

Purchases of marketable securities

 

 

(262,887)

 

 

(628,502)

Maturities of marketable securities

 

 

232,615

 

 

81,161

Purchases of property, plant and equipment

 

 

(10,657)

 

 

(15,328)

Internally developed software

 

 

(140)

 

 

(62)

Net cash used in investing activities

 

 

(41,069)

 

 

(562,731)

Cash flows from financing activities:

 

 

 

 

 

 

Proceeds from issuance of convertible notes, net

 

 

729,536

 

 

671,091

Proceeds from exercise of common stock options

 

 

3,650

 

 

1,391

Payments on settlement of convertible notes

 

 

(493,355)

 

 

 —

Proceeds from construction loan

 

 

295

 

 

 —

Payments on mortgage payable

 

 

 —

 

 

(45)

Net cash provided by financing activities

 

 

240,126

 

 

672,437

 

 

 

 

 

 

 

Effects of exchange rate changes on cash and cash equivalents

 

 

120

 

 

20

 

 

 

 

 

 

 

Net increase in cash and cash equivalents

 

 

124,770

 

 

71,204

Cash and cash equivalents, beginning of period

 

 

160,430

 

 

77,491

Cash and cash equivalents, end of period

 

$

285,200

 

$

148,695

Supplemental disclosure of non-cash investing and financing activities:

 

 

 

 

 

 

Property, plant and equipment acquired but not paid

 

$

42,119

 

$

12,513

Unrealized gain (loss) on available-for-sale investments, before tax

 

$

2,176

 

$

(1,606)

Issuance of 86,532 and 86,828 shares of common stock to fund the Company’s 401(k) matching contribution for 2018 and 2017, respectively

 

$

7,409

 

$

4,300

Issuance of 2,158,991 shares of common stock upon settlement of convertible notes

 

$

182,435

 

$

 —

Retirement of equity component of convertible notes settled

 

$

(300,768)

 

$

 —

Interest paid

 

$

5,214

 

$

48

 

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

 

7


 

Table of Contents

EXACT SCIENCES CORPORATION

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

(1) ORGANIZATION AND BASIS OF PRESENTATION

 

Organization

 

Exact Sciences Corporation (together with its subsidiaries, “Exact,” or the “Company”) was incorporated in February 1995. Exact is a molecular diagnostics company currently focused on the early detection and prevention of some of the deadliest forms of cancer. The Company has developed an accurate, non-invasive, patient-friendly screening test called Cologuard® for the early detection of colorectal cancer and pre-cancer and is currently working on the development of additional tests for other types of cancer, with the goal of becoming a leader in cancer screening and diagnostics.

 

Basis of Presentation

 

The accompanying condensed consolidated financial statements, which include the accounts of Exact Sciences Corporation and those of its wholly owned subsidiaries and variable interest entities, 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, 2018 included in the Company’s Annual Report on Form 10-K (the “2018 Form 10-K”). These condensed consolidated 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 2018 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 condensed consolidated financial statements include the accounts of the Company’s wholly owned subsidiaries and variable interest entities. See Note 7 for the discussion of financing arrangements involving certain entities that are variable interest entities that are included in the Company’s condensed consolidated financial statements. All significant intercompany transactions and balances have been eliminated in consolidation.

References to “Exact”, “we”, “us”, “our”, or the “Company” refer to Exact Sciences Corporation and its wholly owned subsidiaries.

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 March 31, 2019 or December 31, 2018.

8


 

Table of Contents

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 income. 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. 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 March 31, 2019 and December 31, 2018, the Company’s marketable securities 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 $0.1 million and $30,000, net of insignificant realized losses, for the three months ended March 31, 2019 and 2018, respectively, and are included in investment income.

 

The Company periodically reviews 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, the Company’s intent not to sell the security, and whether it is more likely than not that the Company will have to sell the security before recovery of its cost basis. For the three months ended March 31, 2019, no investments were identified with other-than-temporary declines in value.

 

Available-for-sale securities at March 31, 2019 consisted of the following:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

March 31, 2019

 

    

 

 

    

Gains in Accumulated

    

Losses in Accumulated

    

 

 

 

 

 

 

 

Other Comprehensive

 

Other Comprehensive

 

Estimated Fair

(In thousands)

 

Amortized Cost

 

Income (Loss) (1)

 

Income (Loss) (1)

 

Value

Corporate bonds

 

$

445,236

 

$

516

 

$

(83)

 

$

445,669

Asset backed securities

 

 

308,764

 

 

325

 

 

(122)

 

 

308,967

U.S. government agency securities

 

 

198,943

 

 

141

 

 

(32)

 

 

199,052

Commercial paper

 

 

6,000

 

 

 —

 

 

(1)

 

 

5,999

Certificates of deposit

 

 

37,784

 

 

36

 

 

(1)

 

 

37,819

Total available-for-sale securities

 

$

996,727

 

$

1,018

 

$

(239)

 

$

997,506

 


(1)

Gains and losses in accumulated other comprehensive income (loss) are reported before tax impact.

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Table of Contents

Available-for-sale securities at December 31, 2018 consisted of the following:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2018

 

    

 

 

    

Gains in Accumulated

    

Losses in Accumulated

    

 

 

 

 

 

 

 

Other Comprehensive

 

Other Comprehensive

 

Estimated Fair

(In thousands)

 

Amortized Cost

 

Income (Loss) (1)

 

Income (Loss) (1)

 

Value

Corporate bonds

 

$

392,973

 

$

33

 

$

(719)

 

$

392,287

Asset backed securities

 

 

277,537

 

 

30

 

 

(568)

 

 

276,999

U.S. government agency securities

 

 

250,606

 

 

43

 

 

(178)

 

 

250,471

Commercial paper

 

 

12,158

 

 

 —

 

 

(7)

 

 

12,151

Certificates of deposit

 

 

31,875

 

 

 —

 

 

(31)

 

 

31,844

Total available-for-sale securities

 

$

965,149

 

$

106

 

$

(1,503)

 

$

963,752

 


(1)

Gains and losses in accumulated other comprehensive income (loss) are reported before tax impact.

 

Changes in Accumulated Other Comprehensive Income (Loss)

The amount recognized in accumulated other comprehensive income (loss) (“AOCI”) for the three months ended March 31, 2019 were as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accumulated

 

 

Cumulative

 

Unrealized

 

Other

 

 

Translation

 

Gain (Loss)

 

Comprehensive

(In thousands)

    

Adjustment

    

on Securities

    

Income (Loss)

Balance at December 31, 2018

 

$

(25)

 

$

(1,397)

 

$

(1,422)

Other comprehensive income (loss) before reclassifications

 

 

120

 

 

2,051

 

 

2,171

Amounts reclassified from accumulated other comprehensive loss

 

 

 —

 

 

125

 

 

125

Net current period change in accumulated other comprehensive loss, before tax

 

 

120

 

 

2,176

 

 

2,296

Income tax expense related to items of other comprehensive income

 

 

 —

 

 

(520)

 

 

(520)

Balance at March 31, 2019

 

$

95

 

$

259

 

$

354

 

The amounts recognized in AOCI for the three months ended March 31, 2018 were as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accumulated

 

 

Cumulative

 

Unrealized

 

Other

 

 

Translation

 

Gain (Loss)

 

Comprehensive

(In thousands)

    

Adjustment

    

on Securities

    

Income (Loss)

Balance at December 31, 2017

 

$

(61)

 

$

(689)

 

$

(750)

Other comprehensive loss before reclassifications

 

 

20

 

 

(1,630)

 

 

(1,610)

Amounts reclassified from accumulated other comprehensive loss

 

 

 —

 

 

24

 

 

24

Net current period change in accumulated other comprehensive loss

 

 

20

 

 

(1,606)

 

 

(1,586)

Balance at March 31, 2018

 

$

(41)

 

$

(2,295)

 

$

(2,336)

 

Amounts reclassified from AOCI for the three months ended March 31, 2019 and 2018 were as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Affected Line Item in the

 

Three Months Ended March 31,

 

Details about AOCI Components (In thousands)

 

Statements of Operations

 

2019

 

2018

 

Change in value of available-for-sale investments

 

 

 

 

 

 

 

 

 

Sales and maturities of available-for-sale investments

 

Investment income

 

$

125

 

$

24

 

Total reclassifications

 

 

 

$

125

 

$

24

 

 

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Property, Plant and Equipment

 

Property and equipment are stated at cost and depreciated using the straight-line method over the assets’ estimated useful lives. Land is stated at cost and does not depreciate. Maintenance and repairs are expensed when incurred; additions and improvements are capitalized. The estimated useful lives of property and equipment are as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

Estimated

 

March 31,

 

December 31,

(In thousands)

 

Useful Life

 

2019

 

2018

Property, plant and equipment

 

 

 

 

 

 

 

 

 

Land

 

 

(1)

 

$

4,466

 

$

4,466

Leasehold and building improvements

 

 

(2)

 

 

59,759

 

 

38,895

Land improvements

 

 

15 years

 

 

1,766

 

 

1,530

Buildings

 

 

30 years

 

 

7,928

 

 

7,928

Computer equipment and computer software

 

 

3 years

 

 

37,658

 

 

36,969

Laboratory equipment

 

 

3 - 10 years

 

 

45,111

 

 

37,518

Furniture and fixtures

 

 

3 years

 

 

8,481

 

 

8,353

Assets under construction

 

 

(3)

 

 

190,143

 

 

167,462

Property, plant and equipment, at cost

 

 

 

 

 

355,312

 

 

303,121

Accumulated depreciation

 

 

 

 

 

(63,683)

 

 

(57,862)

Property, plant and equipment, net

 

 

 

 

$

291,629

 

$

245,259


(1)

Not depreciated.

(2)

Lesser of remaining lease term, building life, or useful life.

(3)

Not depreciated until placed into service.

 

Depreciation expense for the three months ended March 31, 2019 and 2018 was $6.3 million and $4.3 million, respectively.

 

At March 31, 2019, the Company had $190.1 million of assets under construction which consisted of $35.7 million related to laboratory equipment, $143.5 million related to leasehold and building improvements, and $10.9 million related to computer equipment and computer software projects. Depreciation will begin on these assets once they are placed into service. The Company expects to incur an additional $14.7 million to complete the laboratory equipment, $105.2 million to complete the building projects, and $2.8 million to complete the computer equipment and computer software projects. These projects are expected to be completed throughout 2019, 2020 and 2021. The Company assesses its long-lived assets, consisting primarily of property, plant and equipment, for impairment when material events and changes in circumstances indicate that the carrying value may not be recoverable. There were no impairment losses for the periods ended March 31, 2019 and December 31, 2018.

 

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 incurred during the application development stage that meet the criteria for capitalization are capitalized and amortized, when the software is ready for its intended use, using the straight-line basis over the estimated useful life of the software.

 

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Patent Costs, Intangible Assets and Goodwill

 

Goodwill and Intangible assets consisted of the following:

 

 

 

 

 

 

 

 

 

 

March 31,

 

December 31,

(In thousands)

    

2019

    

2018

Finite-lived intangible assets

 

 

 

 

 

 

Finite-lived intangible assets

 

$

33,083

 

$

33,058

Less: Accumulated amortization

 

 

(4,917)

 

 

(4,107)

Finite-lived intangible assets, net

 

 

28,166

 

 

28,951

Internally developed technology in process

 

 

165

 

 

51

Total finite-lived intangible assets, net

 

 

28,331

 

 

29,002

Goodwill

 

 

17,279

 

 

17,279

Goodwill and intangible assets, net

 

$

45,610

 

$

46,281

 

Finite-Lived Intangible Assets

 

The following table summarizes the net-book-value and estimated remaining life of the Company’s finite-lived intangible assets as of March 31, 2019:

 

 

 

 

 

 

 

 

 

 

 

 

Weighted

 

 

Net Balance at

 

Average

 

 

March 31,

 

Remaining

(In thousands)

    

2019

    

Life (Years)

Trade name

 

$

677

 

 

14.6

Customer relationships

 

 

2,611

 

 

14.6

Patents

 

 

18,413

 

 

9.4

Acquired developed technology

 

 

5,960

 

 

13.6

Internally developed technology

 

 

505

 

 

2.4

Total

 

$

28,166

 

 

 

 

As of March 31, 2019, the estimated future amortization expense associated with the Company’s finite-lived intangible assets for each of the five succeeding fiscal years is as follows:

 

 

 

 

 

(In thousands)

    

 

    

2019

 

$

2,401

2020

 

 

3,201

2021

 

 

3,100

2022

 

 

2,956

2023

 

 

2,953

Thereafter

 

 

13,555

 

 

$

28,166

 

The Company reviews long-lived assets, including property and equipment and identifiable intangibles for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future undiscounted net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell. There were no impairment losses for periods ended March 31, 2019 and December 31, 2018.

 

Patent costs, which have historically consisted of related legal fees, are capitalized as incurred, only if the Company determines that there is some probable future economic benefit derived from the transaction. A capitalized patent is amortized over its estimated useful life, beginning when such patent is approved. Capitalized patent costs are expensed upon disapproval, upon a decision by the Company to no longer pursue the patent or when the related intellectual

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property is either sold or deemed to be no longer of value to the Company. Other than the transactions discussed below, the Company determined that all patent costs incurred during the three months ended March 31, 2019 and 2018 should be expensed and not capitalized as the future economic benefit derived from the transactions cannot be determined.

 

Under a technology license and royalty agreement entered into with MDx Health (“MDx”), dated July 26, 2010 (as subsequently amended, the “MDx License Agreement”), the Company was required to pay MDx milestone-based royalties on sales of products or services covered by the licensed intellectual property. Once the achievement of a milestone occurred or was considered probable, an intangible asset and corresponding liability was reported in goodwill and intangible assets and accrued liabilities, respectively. The liability was relieved once the milestone was achieved and payment made. The intangible asset is being amortized over the estimated ten-year useful life of the licensed intellectual property through 2024, and such amortization is reported in cost of sales. Payment for all remaining milestones under the MDx License Agreement was made as part of the Royalty Buy-Out agreement outlined below.

 

Effective April 2017, the Company and MDx entered into a royalty buy-out agreement (“Royalty Buy-Out Agreement”), which terminated the MDx License Agreement.  Pursuant to the Royalty Buy-Out Agreement, the Company paid MDx a one-time fee of $8.0 million in exchange for an assignment of certain patents covered by the MDx License Agreement and the elimination of all ongoing royalties and other payments by the Company to MDx under the MDx License Agreement.  Also included in the Royalty Buy-Out Agreement is a mutual release of liabilities, which includes all amounts previously accrued under the MDx License Agreement.  Concurrently with entering into the Royalty Buy-Out Agreement, the Company entered into a patent purchase agreement (“Patent Purchase Agreement”) with MDx under which it paid MDx an additional $7.0 million in exchange for the assignment of certain other patent rights that were not covered by the MDx License Agreement. The total $15.0 million paid by the Company pursuant to the Royalty Buy-Out Agreement and Patent Purchase Agreement, net of liabilities relieved of $6.6 million, was recorded as an intangible asset and is being amortized over the estimated remaining useful life of the licensed intellectual property through 2024, and such amortization is reported in cost of sales. The $6.6 million of liabilities relieved were related to historical milestones and accrued royalties under the MDx License Agreement.

 

As of March 31, 2019, and December 31, 2018, an intangible asset of $7.4 million and $7.7 million, respectively, related to historical milestone payments made under the MDx License Agreement and intangible assets acquired as part of the Royalty Buy-Out Agreement and Patent Purchase Agreement is reported in net goodwill and intangible assets on the Company’s condensed consolidated financial statements.  Amortization expense was $0.3 million and $0.3 million for the three months ended March 31, 2019 and 2018, respectively. 

 

In December 2017, the Company entered into an asset purchase agreement (the “Armune Purchase Agreement”) with Armune BioScience, Inc. (“Armune”), pursuant to which the Company acquired intellectual property and certain other assets underlying Armune’s APIFINY®, APIFINY® PRO and APIFINY® ACTIVE SURVEILLANCE prostate cancer diagnostic tests. The Company has utilized the Armune assets in its research and development program. The total consideration was comprised of an up-front cash payment of $12.0 million and $17.5 million in contingent payment obligations that will become payable upon the Company’s achievement of development and commercial milestones using the acquired intellectual property. The satisfaction of these milestones is subject to many risks and is therefore uncertain.  The Company will not record the contingent consideration until it is probable that the milestones will be met.  There is no other consideration due to Armune beyond the milestone payments and the Company is not subject to future royalty obligations should a product be developed and commercialized. In connection with the Armune Purchase Agreement, Armune terminated a license agreement pursuant to which it licensed certain patent rights and know-how from the Regents of the University of Michigan (“University of Michigan”), and the Company entered into a license agreement with the University of Michigan with respect to such patent rights and know-how, as well as certain additional intellectual property rights. Pursuant to the Company’s agreement with the University of Michigan, it is required to pay the University of Michigan a low single-digit royalty on its net sales of products using the licensed intellectual property.

 

The Company accounted for the transaction as an asset acquisition under GAAP. The asset is comprised of a portfolio of biomarkers, related technology and know-how, which is a group of complementary assets concentrated in a single identifiable asset.  The transaction costs directly related to the asset acquisition were added to the asset in accordance with GAAP.  As such, the collective asset value from the acquisition resulted in an intangible asset of $12.2 million.  The intellectual property asset, which includes related transaction costs, is being amortized on a straight-line

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basis over the period the Company expects to be benefited, which is in line with the legal life of the patents acquired.  The Company capitalized these costs as there is a reasonable expectation that the assets acquired will be used in an alternative manner in the future, that is not contingent on future development subsequent to acquisition, and the Company anticipates there to be economic benefit from these alternative uses.  For the three months ended March 31, 2019 and 2018, the Company recorded amortization expense of $0.2 million and $0.2 million, respectively. At March 31, 2019 and December 31, 2018, the net balance of $11.1 million and $11.3 million, respectively, is reported in net goodwill and intangible assets in the Company’s condensed consolidated balance sheet.

 

In 2017, the Company acquired all of the equity interests of Sampleminded, Inc. (“Sampleminded”). As a result of the acquisition, the Company recorded an intangible asset of $1.0 million, which was comprised of developed technology acquired of $0.9 million, customer relationships of $0.1 million, and non-compete agreements of $32,000. The intangible assets acquired are being amortized over the remaining useful life, which was determined to be eight years for developed technology acquired, three years for customer relationships, and five years for non-compete agreements. For the three months ended March 31, 2019 and 2018, the Company recorded amortization expense of $36,000 and $36,000, respectively. At March 31, 2019 and December 31, 2018 the net balance of $0.7 million and $0.8 million, respectively, is reported in net intangible assets in the Company’s condensed consolidated balance sheets. 

 

As more fully described in the 2018 Form 10-K, during the fourth quarter of 2018, the Company completed a full acquisition of Biomatrica, Inc.  (“Biomatrica”, and the “Biomatrica Acquisition”). As a result of the Biomatrica Acquisition, the Company recorded an intangible asset of $8.8 million which was comprised of acquired developed technology of $5.4 million, customer relationships of $2.7 million, and trade names of $0.7 million. The intangible assets acquired are being amortized over the remaining useful life, which was determined to be fifteen years for the acquired developed technology, fifteen years for the customer relationships, and fifteen years for the trade names. For the three months ended March 31, 2019, the Company recorded amortization expense of $0.1 million. At March 31, 2019 and December 31, 2018, the net balance of $8.5 million and $8.7 million, respectively, is reported in net goodwill and intangible assets in the Company’s condensed consolidated balance sheets.

 

Goodwill

In 2018, the Company recognized goodwill of $15.3 million from the acquisition of Biomatrica. Goodwill is reported in net goodwill and intangible assets in the Company’s condensed consolidated balance sheet. The Company evaluates goodwill impairment on an annual basis, or more frequently should an event or change in circumstance occur that indicate the carrying amount is in excess of the fair value. There were no impairment losses for the periods ended March 31, 2019 and December 31, 2018.

 

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 is the same because all outstanding common stock equivalents have been excluded, as they are anti-dilutive as a result of 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:

 

 

 

 

 

 

 

 

March 31,

(In thousands)

    

2019

    

2018

Shares issuable upon exercise of stock options

 

2,482

 

3,284

Shares issuable upon the release of restricted stock awards

 

4,216

 

6,315

Shares issuable upon conversion of convertible notes

 

12,197

 

9,148

 

 

18,895

 

18,747

 

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Revenue Recognition

 

The Company’s revenue is primarily generated by screening services using its Cologuard test, and the service is completed upon delivery of a patient’s test result to the ordering physician.  The Company accounts for revenue in accordance with Accounting Standards Codification (“ASC”) Topic 606, Revenue from Contracts with Customers (“ASC 606”), which it adopted on January 1, 2018, using the modified retrospective method, which it elected to apply to all contracts. Application of the modified retrospective method did not impact amounts previously reported by the Company, nor did it require a cumulative effect adjustment upon adoption, as the Company’s method of recognizing revenue under ASC 606 was analogous to the method utilized immediately prior to adoption.  Accordingly, there is no need for the Company to disclose the amount by which each financial statement line item was affected as a result of applying the new standard and an explanation of significant changes.

 

The core principle of ASC 606 is that the Company recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the Company expects to be entitled in exchange for those goods or services. The Company recognizes revenue from its Cologuard test in accordance with that core principle, and key aspects considered by the Company include the following:

 

Contracts

 

The Company’s customer is the patient. However, the Company does not enter into a formal reimbursement contract with a patient, as formal reimbursement contracts, including national coverage determination for Cologuard, are established with payers.  Accordingly, the Company establishes a contract with a patient in accordance with other customary business practices.

 

·

Approval of a contract is established via the order submitted by the patient’s physician and the return of a sample by the patient.

·

The Company is obligated to perform its laboratory services upon receipt of a sample from a patient, and the patient and/or applicable payer are obligated to reimburse the Company for services rendered based on the patient’s insurance benefits.

·

Payment terms are a function of a patient’s existing insurance benefits, including the impact of coverage decisions with CMS and applicable reimbursement contracts established between the Company and payers, unless the patient is a self-pay patient, whereby the Company requires payment from the patient prior to the Company shipping a collection kit to the patient.

·

Once the Company delivers a patient’s test result to the ordering physician the contract with a patient has commercial substance, as the Company is legally able to collect payment and bill an insurer and/or patient, depending on payer contract status or patient insurance benefit status.

·

The Company’s consideration is deemed to be variable, and the Company considers collection of such consideration to be probable to the extent that it is unconstrained.

 

Performance obligations

 

A performance obligation is a promise in a contract to transfer a distinct good or service (or a bundle of goods or services) to the customer.  The Company’s contracts have a single performance obligation, which is satisfied upon rendering of services, which culminates in the delivery of a patient’s Cologuard test result to the ordering physician. The duration of time between sample receipt and delivery of a valid test result to the ordering physician is typically less than two weeks. Accordingly, the Company elects the practical expedient and therefore, the Company does not disclose the value of unsatisfied performance obligations.

 

Transaction price

 

The transaction price is the amount of consideration that the Company expects to collect in exchange for transferring promised goods or services to a customer, excluding amounts collected on behalf of third parties (for example, some sales taxes). The consideration expected from a contract with a customer may include fixed amounts, variable amounts, or both.

 

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The consideration derived from the Company’s contracts is deemed to be variable, though the variability is not explicitly stated in any contract. Rather, the implied variability is due to several factors, such as the amount of contractual adjustments, any patient co-payments, deductibles or patient compliance incentives, the existence of secondary payers and claim denials. 

 

The Company estimates the amount of variable consideration using the expected value method, which represents the sum of probability-weighted amounts in a range of possible consideration amounts. When estimating the amount of variable consideration, the Company considers several factors, such as historical collections experience, patient insurance eligibility and payer reimbursement contracts.  

 

The Company limits the amount of variable consideration included in the transaction price to the unconstrained portion of such consideration. In other words, the Company recognizes revenue up to the amount of variable consideration that is not subject to a significant reversal until additional information is obtained or the uncertainty associated with the additional payments or refunds is subsequently resolved.  Differences between original estimates and subsequent revisions, including final settlements, represent changes in the estimate of variable consideration and are included in the period in which such revisions are made. Revenue recognized from changes in transaction prices was $1.5 million and $8.5 million for the three months ended March 31, 2019 and 2018, respectively.

 

The Company monitors its estimates of transaction price to depict conditions that exist at each reporting date. If the Company subsequently determines that it will collect more consideration than it originally estimated for a contract with a patient, it will account for the change as an increase in the estimate of the transaction price (i.e., an upward revenue adjustment) in the period identified. Similarly, if the Company subsequently determines that the amount it expects to collect from a patient is less than it originally estimated, it will generally account for the change as a decrease in the estimate of the transaction price (i.e., a downward revenue adjustment), provided that such downward adjustment does not result in a significant reversal of cumulative revenue recognized.  

 

When the Company does not have significant historical experience or that experience has limited predictive value, the constraint over estimates of variable consideration may result in no revenue being recognized upon delivery of a patient’s Cologuard test result to the ordering physician, with recognition, generally occurring at the date of cash receipt.

 

Allocate transaction price

 

The entire transaction price is allocated entirely to the performance obligation contained within the contract with a patient.

 

Point in time recognition

 

The Company’s single performance obligation is satisfied at a point in time, and that point in time is defined as the date a patient’s successful test result is delivered to the patient’s ordering physician. The Company considers this date to be the time at which the patient obtains control of the promised Cologuard test service. 

 

Disaggregation of Revenue

 

The following table presents the Company’s revenues disaggregated by revenue source for the three months ended March 31, 2019 and 2018, respectively:

 

 

 

 

 

 

 

 

 

 

Three Months Ended March 31,

(In thousands)

    

2019

    

2018

Medicare Parts B & C

 

$

82,917

 

$

52,475

Commercial

 

 

73,351

 

 

34,834

Other

 

 

5,775

 

 

2,987

Total

 

$

162,043

 

$

90,296

 

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Contract Balances

 

The timing of revenue recognition, billings and cash collections results in billed accounts receivable and deferred revenue on the condensed consolidated balance sheets. Generally, billing occurs subsequent to delivery of a patient’s test result to the ordering physician, resulting in an account receivable. However, the Company sometimes receives advance payment from a patient, particularly a self-pay patient, before a Cologuard test result is completed, resulting in deferred revenue. The deferred revenue balance is relieved upon delivery of the applicable patient’s test result to the ordering physician. Changes in accounts receivable and deferred revenue were not materially impacted by any other factors.

 

Deferred revenue balances are reported in other short-term liabilities in the Company’s condensed consolidated balance sheets and were $0.4 million and $0.5 million as of March 31, 2019 and December 31, 2018, respectively.

 

Revenue recognized for the three months ended March 31, 2019 and 2018, which was included in the deferred revenue balance at the beginning of each period was $0.1 million and $0.1 million, respectively.

 

Practical Expedients

 

The Company does not adjust the transaction price for the effects of a significant financing component, as at contract inception, the Company expects the collection cycle to be one year or less.

 

The Company expenses sales commissions when incurred because the amortization period would have been one year or less. These costs are recorded within sales and marketing expenses in the Company’s condensed consolidated statements of operations.  

 

The Company incurs certain other costs that are incurred regardless of whether a contract is obtained. Such costs are primarily related to legal services and patient communications (e.g. compliance reminder letters).  These costs are expensed as incurred and recorded within general and administrative expenses in the Company’s condensed consolidated statements of operations.

 

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 net realizable value and records a charge to cost of sales for such inventory, as appropriate. In addition, the materials used in performing Cologuard tests 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 net realizable value.

 

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 in the Company’s condensed consolidated statements of operations. 

 

Inventory consisted of the following:

 

 

 

 

 

 

 

 

 

 

March 31,

 

December 31,

(In thousands)

    

2019

    

2018

Raw materials

 

$

15,266

 

$

12,761

Semi-finished and finished goods

 

 

29,003

 

 

26,387

Total inventory

 

$

44,269

 

$

39,148

 

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Table of Contents

Foreign Currency Translation

 

For the Company’s international subsidiaries, the local currency is the functional currency. Assets and liabilities of these subsidiaries are translated into United States dollars at the period-end exchange rate or historical rates, as appropriate. Condensed consolidated statements of operations are translated at average exchange rates for the period. The cumulative translation adjustments resulting from changes in exchange rates are included in the Company’s condensed consolidated balance sheet as a component of accumulated other comprehensive loss in total Exact Sciences Corporation’s stockholders’ equity. Transaction gains and losses are included in the Company’s condensed consolidated statement of operations.

 

Reclassifications

 

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

 

(3) MAYO LICENSE AGREEMENT

 

Overview

 

As more fully described in the 2018 Form 10-K, in June 2009 the Company entered into a license agreement with Mayo Foundation for Medical Education and Research (“Mayo”). The Company’s license agreement with Mayo was amended and restated in February 2015 and further amended in January 2016, October 2017, and January 2019. Under the license agreement, Mayo granted the Company an exclusive, worldwide license to certain Mayo patents and patent applications, as well as a non-exclusive, worldwide license with regard to certain Mayo know-how. The scope of the license, as amended, covers any screening, surveillance or diagnostic test or tool for use in connection with any type of cancer, pre-cancer, disease or condition.

 

Pursuant to the Company’s agreement with Mayo, the Company is required to pay Mayo a low-single-digit royalty on the Company’s net sales of products using the licensed Mayo intellectual property, with minimum annual royalty fees of $25,000 each year through 2033, the year the last patent expires. The January 2016 amendment to the Mayo license agreement established various low-single-digit royalty rates on net sales of current and future products and clarified how net sales will be calculated. As part of the October 2017 amendment, the royalty rate on the Company’s net sales of Cologuard increased and, if in the future, improvements are made to the Cologuard product, the royalty rate may further increase, but pursuant to the terms of the January 2016 and October 2017 amendment, the rate remains a low-single-digit percentage of net sales.

 

In addition to royalties, the Company is required to pay Mayo cash of $0.2 million, $0.8 million and $2.0 million upon each product using the licensed Mayo intellectual property reaching $5.0 million, $20.0 million and $50.0 million in cumulative net sales, respectively.

 

As part of the February 2015 amendment and restatement of the license agreement, the Company agreed to pay Mayo an additional $5.0 million, payable in five annual installments, through 2019. The Company paid Mayo the annual installment of $1.0 million in the first quarter of each of 2015, 2016,  2018, and 2019. The Company paid Mayo the 2017 installment in December 2016. The Company records the $1.0 million installments to prepaid expenses and other current assets and amortizes each installment over a twelve-month period commencing on February 1 of each year. For the three months ended March 31, 2019 and 2018 the Company has recorded $0.3 million and $0.3 million in amortization of the installments, respectively.

 

In addition, the Company is paying Mayo for research and development efforts. As part of the Company’s research collaboration with Mayo, the Company incurred charges of $1.1 million for the three months ended March 31, 2019. The Company made payments of $1.8 million for the three months ended March 31, 2019. The Company recorded an estimated liability of $1.2 million for research and development efforts as of March 31, 2019. The Company incurred charges of $1.3 million for the three months ended March 31, 2018. The Company made payments of $1.8 million for the three months ended March 31, 2018. The Company recorded an estimated liability of $1.3 million for research and development efforts as of March 31, 2018.  

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(4) PFIZER PROMOTION AGREEMENT

 

In August 2018, the Company entered into a Promotion Agreement (“Promotion Agreement”) with Pfizer Inc. (“Pfizer”). Under the terms of the Promotion Agreement, Pfizer will promote Cologuard and provide certain sales, marketing, analytical and other commercial operations support services. The Company and Pfizer committed in the Promotion Agreement to invest specified amounts in the advertising and promotion of Cologuard.

 

The Company agreed to pay Pfizer for promotion, sales and marketing costs incurred on behalf of the Company.  The Company incurred charges of $17.6 million for promotion, sales and marketing services performed by Pfizer on behalf of the Company during the three months ended March 31, 2019. The Company recorded a liability of $17.6 million and $0.5 million for promotion, sales and marketing services performed by Pfizer on behalf of the Company in accrued liabilities in the Company’s condensed consolidated balance sheets as of March 31, 2019 and December 31, 2018, respectively. These costs are recorded in sales and marketing in the Company’s condensed consolidated statements of operations.

 

The Company also agreed to pay Pfizer a service fee based on incremental gross profits over specified baselines during the term and royalties for Cologuard related revenues for a specified period after the expiration or termination of the Promotion Agreement. The initial term of the Promotion Agreement runs through December 31, 2021. The Company incurred charges of $19.2 million for this service fee during the three months ended March 31, 2019. The Company recorded a liability of $24.0 million and $4.8 million for the service fee earned by Pfizer as of March 31, 2019 and December 31, 2018, respectively, in accrued liabilities in the Company’s condensed consolidated balance sheets. These costs are recorded in sales and marketing in the Company’s condensed consolidated statements of operations.

 

(5) STOCK-BASED COMPENSATION

 

Stock-Based Compensation Plans

 

The Company maintains the 2010 Omnibus Long-Term Incentive Plan (As Amended and Restated Effective July 27, 2017), the 2010 Employee Stock Purchase Plan, the 2015 Inducement Award Plan, the 2016 Inducement Award Plan and the 2000 Stock Option and Incentive Plan (collectively, the “Stock Plans”).

 

Stock-Based Compensation Expense

 

The Company records stock-based compensation expense in connection with the amortization of restricted stock and restricted stock unit awards (“RSUs”), 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 $16.2 million in stock-based compensation expense during the three months ended March 31, 2019. The Company recorded $12.5 million in stock-based compensation expense during the three months ended March 31, 2018.  

 

In connection with the April 2018 transition of the Company’s former Chief Operating Officer, the Company accelerated the vesting of 69,950 shares under his previously unvested stock options and 54,350 shares under his previously unvested restricted stock units whereby such unvested stock options and unvested restricted stock units vested on December 31, 2018. It was determined that the continuing service to be provided by the Company’s Chief Operating Officer to the Company through December 31, 2018 was substantive and, as a result, the Company recognized the additional non-cash stock-based compensation expense for the modified awards evenly over the transition term of April 25, 2018 through December 31, 2018. During the transition period in 2018, the Company recorded $3.9 million of non-cash stock-based compensation expense for the modified awards.

 

In February 2019, the Company issued performance-based equity awards to certain employees which vest upon the achievement of certain performance goals, including financial performance targets and operational milestones. Determining the appropriate amount to expense based on the anticipated achievement of the stated goals requires judgment, including forecasting future financial results. The estimate of the timing of the expense recognition is revised periodically based on the probability of achieving the goals and adjustments are made as appropriate. The cumulative impact of any revision is reflected in the period of the change. If the financial performance targets or operational milestones are not achieved, the award does not vest, so no compensation cost is recognized and any previously recognized stock-based compensation expense is reversed. 

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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. The fair value of each market measure-based award is estimated on the date of grant using a Monte Carlo simulation pricing model. The fair value of service-based awards for each restricted stock unit award is determined on the date of grant using the closing stock price on that day. The estimated fair value of these awards is recognized to expense using the straight-line method over the vesting period. The Black-Scholes and Monte Carlo pricing models utilize the following assumptions:

 

Expected Term – Expected life of an option award is the average length of time over which the Company expects employees will exercise their options, which is based on historical experience with similar grants. Expected life of a market measure-based award is based on the applicable performance period.

 

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 and Monte Carlo valuation models on the implied yield currently available on U.S. Treasury zero-coupon issues with an equivalent expected term.

 

Forfeitures - The Company records the effects of actual forfeitures at the time they occur.

 

The fair value of each option and market measure-based award is based on the assumptions in the following table:

 

 

 

 

 

 

 

 

Three Months Ended

 

 

March 31,

 

    

2019