SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
ý QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2003
OR
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File Number: 000-32179
EXACT SCIENCES CORPORATION
(Exact name of registrant as specified in its charter)
DELAWARE |
| 02-0478229 |
(State or other jurisdiction of |
| (I.R.S. Employer |
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100 Campus Drive, Marlborough, Massachusetts |
| 01752 |
(Address of principal executive offices) |
| (Zip Code) |
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(508) 683-1200 | ||
(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 ý No o
Indicate by checkmark whether or the registrant is an accelerated filer (as defined in the Exchange Act Rule 12b-2).
Yes ý No o
As of July 28, 2003, the Registrant had 19,146,688 shares of Common Stock outstanding.
EXACT SCIENCES CORPORATION
INDEX
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Part I - Financial Information | ||
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Item 1. | Condensed Consolidated Financial Statements |
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| Condensed Consolidated Balance Sheets as of December 31, 2002 and | |
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| Notes to Condensed Consolidated Financial Statements (Unaudited) | |
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Management’s Discussion and Analysis of Financial Condition and | ||
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EXACT SCIENCES CORPORATION
Condensed Consolidated Balance Sheets
(Amounts in thousands - unaudited)
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| December 31, |
| June 30, |
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ASSETS |
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Current Assets: |
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Cash and cash equivalents |
| $ | 17,439 |
| $ | 14,736 |
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Marketable securities |
| 26,407 |
| 12,386 |
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Prepaid expenses |
| 1,110 |
| 1,454 |
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Total current assets |
| 44,956 |
| 28,576 |
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Property and Equipment, at cost: |
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Laboratory equipment |
| 3,427 |
| 3,931 |
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Office and computer equipment |
| 1,278 |
| 1,323 |
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Leasehold improvements |
| 823 |
| 1,549 |
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Furniture and fixtures |
| 272 |
| 299 |
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| 5,800 |
| 7,102 |
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Less—Accumulated depreciation and amortization |
| (3,544 | ) | (4,447 | ) | ||
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| 2,256 |
| 2,655 |
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Patent Costs and Other Assets, net |
| 2,874 |
| 2,738 |
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| $ | 50,086 |
| $ | 33,969 |
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LIABILITIES AND STOCKHOLDERS’ EQUITY |
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Current Liabilities: |
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Accounts payable |
| $ | 1,157 |
| $ | 688 |
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Accrued expenses |
| 2,466 |
| 2,389 |
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Deferred licensing fees, current portion |
| 1,621 |
| 1,621 |
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Total current liabilities |
| 5,244 |
| 4,698 |
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Deferred Licensing Fees, less current portion |
| 6,493 |
| 5,683 |
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Stockholders’ Equity: |
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Common stock |
| 191 |
| 191 |
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Additional paid-in capital |
| 117,256 |
| 117,549 |
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Treasury stock |
| (12 | ) | (12 | ) | ||
Notes receivable |
| (699 | ) | (643 | ) | ||
Deferred compensation |
| (1,977 | ) | (1,362 | ) | ||
Unrealized gain on marketable securities |
| 57 |
| 49 |
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Accumulated deficit |
| (76,467 | ) | (92,184 | ) | ||
Total stockholders’ equity |
| 38,349 |
| 23,588 |
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| $ | 50,086 |
| $ | 33,969 |
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The accompanying notes are an integral part of these condensed consolidated financial statements.
3
EXACT SCIENCES CORPORATION
Condensed Consolidated Statements of Operations
(Amounts in thousands, except per share data, unaudited)
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| Three Months Ended June 30, |
| Six Months Ended June 30, |
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| 2002 |
| 2003 |
| 2002 |
| 2003 |
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Revenue |
| $ | 40 |
| $ | 406 |
| $ | 79 |
| $ | 814 |
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Cost of revenues |
| 2 |
| — |
| 2 |
| 3 |
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Gross margin |
| 38 |
| 406 |
| 77 |
| 811 |
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Operating Expenses: |
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Research and development |
| 5,066 |
| 4,592 |
| 10,109 |
| 9,605 |
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Selling, general and administrative |
| 2,534 |
| 3,494 |
| 4,823 |
| 6,608 |
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Stock-based compensation (1) |
| 544 |
| 330 |
| 1,112 |
| 658 |
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| 8,144 |
| 8,416 |
| 16,044 |
| 16,871 |
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Loss from operations |
| (8,106 | ) | (8,010 | ) | (15,967 | ) | (16,060 | ) | ||||
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Interest income |
| 231 |
| 126 |
| 506 |
| 293 |
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Net loss |
| $ | (7,875 | ) | $ | (7,884 | ) | $ | (15,461 | ) | $ | (15,767 | ) |
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Net loss per share - basic and diluted: |
| $ | (0.43 | ) | $ | (0.42 | ) | $ | (0.85 | ) | $ | (0.84 | ) |
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Weighted average common shares outstanding: |
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Basic and diluted |
| 18,376 |
| 18,801 |
| 18,271 |
| 18,764 |
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(1) The following summarizes the departmental allocation of stock-based compensation: |
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Research and development |
| $ | 117 |
| $ | 82 |
| $ | 258 |
| $ | 163 |
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Selling, general and administrative |
| 427 |
| 248 |
| 854 |
| 495 |
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Total |
| $ | 544 |
| $ | 330 |
| $ | 1,112 |
| $ | 658 |
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The accompanying notes are an integral part of these condensed consolidated financial statements.
4
EXACT SCIENCES CORPORATION
Condensed Consolidated Statements of Cash Flows
(Amounts in thousands - unaudited)
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| Six Months Ended June 30, |
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| 2002 |
| 2003 |
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Cash Flows from Operating Activities: |
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Net loss |
| $ | (15,461 | ) | $ | (15,767 | ) |
Adjustments to reconcile net loss to net cash used in operating activities: |
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Depreciation |
| 659 |
| 903 |
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Amortization |
| 248 |
| 442 |
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Non-cash stock-based compensation expense |
| 1,112 |
| 658 |
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Amortization of deferred licensing fees |
| (76 | ) | (810 | ) | ||
Changes in assets and liabilities: |
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Prepaid expenses |
| (462 | ) | (343 | ) | ||
Accounts payable |
| 251 |
| (469 | ) | ||
Deferred license fees |
| 15,000 |
| — |
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Accrued expenses |
| 578 |
| (27 | ) | ||
Net cash provided by (used in) operating activities |
| 1,849 |
| (15,413 | ) | ||
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Cash Flows from Investing Activities: |
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Sale of marketable securities |
| — |
| 14,013 |
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Purchases of property and equipment |
| (873 | ) | (1,302 | ) | ||
Increase in patent costs and other assets |
| (127 | ) | (306 | ) | ||
Net cash provided by (used in) investing activities |
| (1,000 | ) | 12,405 |
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Cash Flows from Financing Activities: |
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Proceeds from exercise of common stock options and stock purchase plan |
| 77 |
| 250 |
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Repayment of notes receivable |
| 195 |
| 55 |
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Purchase of treasury shares |
| (4 | ) | — |
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Net cash provided by financing activities |
| 268 |
| 305 |
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Net Increase (Decrease) in Cash and Cash Equivalents |
| 1,117 |
| (2,703 | ) | ||
Cash and Cash Equivalents, beginning of period |
| 56,843 |
| 17,439 |
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Cash and Cash Equivalents, end of period |
| $ | 57,960 |
| $ | 14,736 |
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The accompanying notes are an integral part of these condensed consolidated financial statements.
5
EXACT SCIENCES CORPORATION
Notes to Condensed Consolidated Financial Statements
(Unaudited)
(1) ORGANIZATION
EXACT Sciences Corporation (the “Company”) was incorporated on February 10, 1995. The Company applies proprietary genomics technologies to the early detection of several types of common cancers. The Company has selected colorectal cancer as the first application of its technology platform. The Company is currently devoting a majority of its efforts towards research and development primarily related to the completion of several large in-process multi-centered clinical studies and towards the commercial availability of PreGen-Plus™, its proprietary, non-invasive PreGen™ technology for the early detection of colorectal cancer in the average-risk population.
(2) BASIS OF PRESENTATION
The condensed consolidated financial statements included herein have been prepared by the Company, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). In the opinion of management, the unaudited condensed consolidated financial statements have been prepared on the same basis as the audited consolidated financial statements and include all adjustments (consisting only of normal recurring accruals) necessary for a fair presentation of interim period results. Certain information and footnote disclosures normally included in the financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. The Company believes, however, that its disclosures are adequate to make the information presented not misleading. The results of operations for the three and six months ended June 30, 2003 are not necessarily indicative of the results to be expected for the full fiscal year. The accompanying condensed consolidated financial statements should be read in conjunction with the Company’s Form 10-K for the fiscal year ended December 31, 2002, which was filed with the Securities and Exchange Commission on March 28, 2003.
(3) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The consolidated financial statements include the accounts of the Company’s wholly owned subsidiary, EXACT Sciences Securities Corporation, a Massachusetts securities corporation. All significant intercompany transactions and balances have been eliminated in consolidation.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States 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 all highly liquid investments with maturities of 90 days or less at the time of acquisition to be cash equivalents. Cash equivalents primarily consist of money market funds at December 31, 2002 and June 30, 2003.
Marketable Securities
The Company accounts for its investments in marketable securities in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 115, “Accounting for Certain Investments in Debt and Equity 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 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.
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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 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.
All of the Company’s investments are comprised of fixed income investments and all are deemed available-for-sale. The objectives of this portfolio 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.
Patent Costs
Patent costs, which consist of related legal fees and purchases of intellectual property, are capitalized as incurred and are amortized beginning when patents are approved over an estimated useful life of five years.
The Company applies SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets and for Long-Lived Assets, which requires the Company to continually evaluate whether events or circumstances have occurred that indicate that the estimated remaining useful life of long-lived assets and certain identifiable intangibles and goodwill may warrant revision or that the carrying value of these assets may be impaired.
Net Loss Per Share
Basic and diluted net loss per share is presented in conformity with SFAS No. 128, Earnings per Share, for all periods presented. In accordance with SFAS No. 128, 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, less shares subject to repurchase. Basic and diluted net loss per share are the same because all outstanding common stock equivalents have been excluded as they are anti-dilutive. Stock options to purchase 2,892,954 and 3,676,176 common shares, unvested restricted common shares of 490,635 and 228,178 and outstanding warrants to purchase common shares of 1,000,000, have therefore been excluded from the computations of diluted weighted average shares outstanding for the three months and six ended June 30, 2002 and 2003, respectively.
Revenue Recognition
The Company’s revenue for the three and six months ended June 30, 2002 and 2003 is primarily comprised of amortization of up-front technology license fees associated with the Company’s two strategic alliance agreements with Laboratory Corporation of America® Holdings (“LabCorp®”) which is being amortized on a straight-line basis over the respective license periods (Note 3). Fees for the licensing of product rights on initiation of strategic agreements are recorded as deferred revenue upon receipt and recognized as revenue on a straight-line basis over the license period. As such, the Company is amortizing the first payment of $15 million from LabCorp, net of the $6.6 million value of the warrant, and will amortize the second payment of $15 million, as license fee revenue over the remaining exclusive license period. Revenue from milestone and other performance-based payments, as well as per-test royalty fees on each test performed will be recognized as revenue when earned and collection of the receivable is probable.
The Company also recognizes revenue from performing tests in its facility upon delivery of the results to the prescribing physician provided there is persuasive evidence of an agreement, the fee is fixed or determinable and collection of the receivable is probable.
Clinical Study Accrual
The Company accrued the estimated cost of patient recruitment associated with its large multi-center clinical study as patients enrolled in the trial. These patient recruitment costs consisted primarily of payments made to the clinical centers, investigators and patients for participating in the Company’s clinical study. The Company concluded its patient recruitment for the clinical study at the end of the first quarter of 2003. As actual or expected costs become known, they may differ from estimated costs previously accrued, at which point this clinical study accrual would be adjusted accordingly.
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Comprehensive Income
SFAS No. 130, Reporting Comprehensive Income, establishes presentation and disclosure requirements for comprehensive income (loss). For the Company, comprehensive loss consists of net loss and the change in unrealized gains and losses on marketable securities. Comprehensive loss for the three months ended June 30, 2002 and 2003 would have been $7,875,000 and $7,860,000, respectively, and $15,461,000 and $15,775,000 for the six months ended June 30, 2002 and 2003, respectively.
Accounting for Stock-Based Compensation
The Company accounts for its stock-based compensation plan under Accounting Principal Bulletin Opinion (“APB”) No. 25, Accounting for Stock Issued to Employees. SFAS No. 123, Accounting for Stock-Based Compensation, establishes the fair-value-based method of accounting for stock-based compensation plans. The Company has adopted the disclosure-only alternative for options granted to employees and directors under SFAS No. 123, which requires disclosure of the pro forma effects on earnings as if SFAS No. 123 had been adopted, as well as certain other information. Options granted to scientific advisory board members and other non-employees are recorded at fair value based on the fair value measurement criteria of SFAS No. 123. Compensation expense, computed using the Black-Scholes option pricing model, of $11,000 and $22,000 was recorded in the accompanying consolidated statements of operations for the three months ended June 30, 2002 and 2003, respectively, and $47,000 and $44,000 for the six months ended June 30, 2002 and 2003, respectively.
The Company has computed the pro forma disclosures required under SFAS No. 123 for all stock options granted to employees and directors of the Company as of June 30, 2002 and 2003 using the Black-Scholes option pricing model prescribed by SFAS No. 123.
The effect of applying SFAS No. 123 would be as follows:
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| Six Months Ended June 30, |
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| 2002 |
| 2003 |
| 2002 |
| 2003 |
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Net loss as reported |
| $ | (7,875 | ) | $ | (7,884 | ) | $ | (15,461 | ) | $ | (15,767 | ) |
Add: Stock-based compensation included in reported net loss |
| 544 |
| 330 |
| 1,112 |
| 658 |
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Deduct: Total stock-based employee compensation determined under SFAS 123 for all awards |
| (1,381 | ) | (1,685 | ) | (2,762 | ) | (3,368 | ) | ||||
Pro forma net loss |
| $ | (8,712 | ) | $ | (9,239 | ) | $ | (17,111 | ) | $ | (18,477 | ) |
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Basic and diluted net loss per share: |
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As reported |
| $ | (0.43 | ) | $ | (0.42 | ) | $ | (0.85 | ) | $ | (0.84 | ) |
Pro forma - SFAS 123 |
| $ | (0.47 | ) | $ | (0.49 | ) | $ | (0.94 | ) | $ | (0.98 | ) |
(3) STRATEGIC ALLIANCE AGREEMENT
On June 26, 2002, the Company entered into a license agreement with LabCorp for an exclusive, long-term strategic alliance between the parties to commercialize PreGen-Plus, the Company’s proprietary, non-invasive DNA-based technology for the early detection of colorectal cancer in the average-risk population. Pursuant to this agreement, the Company licensed to LabCorp all U.S. and Canadian patents and patent applications owned by the Company relating to its PreGen technology. The license is exclusive for a five-year period, followed by a non-exclusive license for the life of the patents. In return for the license, LabCorp has agreed to pay the Company certain up-front, milestone and performance-based payments, and a per-test royalty fee. LabCorp made an initial payment of $15 million upon the signing of the agreement, and a second payment of $15 million is to be made upon the commercial launch of PreGen-Plus. In addition, the Company may be eligible for milestone payments from LabCorp totaling up to $30 million based upon Company deliverables related to scientific acceptance, reimbursement approval and technology improvements and up to $15 million based upon the achievement of significant LabCorp revenue thresholds. In addition to these payments, the Company will receive a royalty fee for each PreGen-Plus test performed by LabCorp. In conjunction with the strategic alliance, the Company has issued to LabCorp a warrant to purchase 1,000,000 shares of its common stock, exercisable over a three-year period at an exercise
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price of $16.09 per share. The Company assigned a value to the warrant of $6.6 million under the Black-Scholes option-pricing model which has been recorded as a reduction in the initial up-front deferred license fee of $15 million.
The Company will amortize the first two payments of $15 million, net of the $6.6 million value of the warrant, as license fee revenue over the remaining exclusive license period. Any subsequent milestone and performance-based payments, as well as the royalty fee on each test performed by LabCorp, will be recorded as revenue when earned and collection is probable.
(4) SUPPLY AGREEMENTS
The Company has entered into several agreements with various suppliers and manufacturers for components utilized in the Company’s Effipure™ technology for the recovery of DNA from biological samples. The Effipure technology, formerly known as Hybrigel™, is expected to be incorporated into the commercial version of PreGen-Plus assay. Accordingly, the Company expects to sell these components to LabCorp in connection with the commercialization of PreGen-Plus.
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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 should be read in conjunction with the financial statements and the related notes thereto included elsewhere in this 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, 2002, which has been filed with the Securities and Exchange Commission. Except for the historical information contained herein, the following discussion contains forward-looking statements made pursuant to the safe harbor provisions of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Some of the forward-looking statements can be identified by the use of forward-looking terms such as “believes,” “expects,” “may,” “will,” “should,” “could,” “seek,” “intends,” “plans,” “estimates,” “anticipates” or other comparable terms. Forward-looking statements involve inherent risks and uncertainties, certain of which are beyond our control. A number of important factors could cause actual results to differ materially from those in the forward-looking statements. We urge you to consider the risks and uncertainties described in “Factors That May Affect Future Results” in this Form 10-Q and in the other documents filed with the SEC in evaluating our forward-looking statements. We have no plans to update our forward-looking statements to reflect events or circumstances after the date of this report. We caution readers not to place undue reliance upon any such forward-looking statements, which speak only as of the date made.
Overview
We apply proprietary genomic technologies to the early detection of common cancers. We have selected colorectal cancer screening as the first application of our PreGen technologies platform. Since our inception on February 10, 1995, our principal activities have included:
• researching and developing our PreGen technologies for colorectal cancer screening;
• conducting clinical studies to validate our colorectal cancer screening tests;
• negotiating licenses for intellectual property of others;
• developing relationships with opinion leaders in the scientific and medical communities;
• conducting market studies and analyzing alternative approaches for commercializing our PreGen technologies;
• hiring research and clinical personnel;
• hiring management and other support personnel;
• raising capital;
• licensing our proprietary PreGen technologies to LabCorp; and
• working with LabCorp on activities necessary to prepare for commercial launch of PreGen-Plus.
On June 26, 2002, we entered into a license agreement with LabCorp for an exclusive, long-term strategic alliance to commercialize PreGen-Plus, our proprietary, non-invasive technology for the early detection of colorectal cancer in the average-risk population. Pursuant to the license agreement, we agreed to license to LabCorp all U.S. and Canadian patents and patent applications owned by us relating to our PreGen technologies for the detection of colorectal cancer in an average-risk population. The license is exclusive for a five-year period, followed by a non-exclusive license for the life of the patents. In return for the license, LabCorp has agreed to pay us certain up-front, milestone and performance-based payments, and a per-test royalty fee. LabCorp made an initial payment of $15 million upon the signing of the agreement, and a second payment of $15 million is to be made upon the commercial launch of PreGen-Plus. In addition, we may be eligible for milestone payments from LabCorp totaling up to $30 million based upon Company deliverables related to scientific acceptance, reimbursement approval and technology improvements and up to $15 million upon the achievement of significant LabCorp revenue thresholds. In addition to these payments, the Company will receive a royalty fee for each PreGen-Plus test performed by LabCorp. In conjunction with the strategic alliance, the Company has issued to LabCorp a warrant to purchase 1,000,000 shares of its common stock, exercisable over a three-year period at an exercise price of $16.09 per share. The Company assigned a value to the warrant of $6.6 million under the Black-Scholes option-pricing model, which has been recorded as a reduction in the initial up-front deferred license fee of $15 million.
We have generated no material operating revenues since our inception, and do not expect any technology licensing or product revenues until at least the second half of 2003, after the commercialization of PreGen-Plus. As of June 30, 2003, we had an accumulated deficit of approximately $92.2 million. Our losses have historically resulted from costs incurred in conjunction with our research and development initiatives, and more recently, costs associated with selling, general and administrative expenses as we hire additional personnel, initiate marketing programs and build our infrastructure to support the commercial launch of PreGen-Plus, our average-risk colorectal cancer test, and to support future growth.
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Research and development expenses include costs related to scientific and laboratory personnel, clinical studies and reagents and supplies used in the development of our PreGen technologies. There are two large in-process clinical studies that comprise the majority of our research and development expense for the three and six months ended June 30, 2002 and 2003.
In the third quarter of 2001, we initiated our blinded multi-center clinical study, which includes approximately 5,500 asymptomatic, age 50 and older, patients from over 80 academic and community-based practices. We concluded patient enrollment in this clinical study at the end of the first quarter of 2003 and expect that study data will be available in the fourth quarter of 2003. The goal of this clinical study will be to provide additional data supporting the superiority of tests utilizing our Pre-Gen technology versus the most widely used brand of fecal occult blood testing (“FOBT’), Hemoccult II®, in detecting colorectal cancer in this average-risk population.
In October 2001, we initiated a clinical study in collaboration with the Mayo Clinic in which our PreGen technologies are the subject of an independent study by the Mayo Clinic for which the Mayo Clinic received a $4.9 million grant from the National Cancer Institute of the National Institutes of Health. This three-year study will involve approximately 4,000 patients at average risk for developing colorectal cancer, and will compare the results of our non-invasive, DNA-based screening technology with those of FOBT, a common first-line colorectal cancer screening option. The Mayo Clinic has indicated that it expects enrollment in this clinical study to be completed sometime in 2004.
Selling, general and administrative expenses consist primarily of non-research personnel salaries, office expenses and professional fees. We expect selling, general and administrative expenses to increase in 2003 from 2002 levels as we hire additional sales and marketing personnel and implement marketing and sales initiatives in conjunction with LabCorp to support the commercialization of PreGen-Plus.
Stock-based compensation expense, a non-cash expense, primarily represents the difference between the exercise price and fair value of common stock on the date of grant for certain options granted prior to our initial public offering. The stock-based compensation expense is being amortized over the vesting period of the applicable options, which is generally 60 months. Currently, we expect to recognize stock-based compensation expense related to employee, consultant and director options of approximately $1.2 million, $600,000 and $200,000 during the years ended December 31, 2003, 2004 and 2005, respectively.
Significant Accounting Policies
Financial Reporting Release No. 60, which was recently issued by the Securities and Exchange Commission, requires all registrants to discuss critical accounting policies or methods used in the preparation of the financial statements. The notes to the consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2002, which has been filed with the Securities and Exchange Commission, includes a summary of the significant accounting policies and methods used in the preparation of our consolidated financial statements.
Further, we have made a number of estimates and assumptions that affect reported amounts of assets, liabilities, revenues and expenses, and actual results may differ from those estimates. The areas that require the greatest degree of management judgment are the assessment of the recoverability of long-lived assets, primarily intellectual property and the accrual of costs related to patient recruitment for our multi-center clinical study.
Patent costs, which consist of related legal fees and purchases of intellectual property, are capitalized as incurred and are amortized beginning when patents are issued in the United States over an estimated useful life of five years. Capitalized patent costs are expensed upon disapproval or upon a decision by us to no longer pursue the patent, or the related intellectual property is deemed to be no longer of value to us.
We accrued the estimated cost of patient recruitment associated with our large multi-center clinical study as patients were enrolled in the trial. These costs consisted primarily of payments made to the clinical centers, investigators and patients for participating in the Company’s clinical study. We concluded our patient recruitment for the this clinical study at the end of the first quarter of 2003. As actual or expected costs become known, they may differ from estimated costs previously accrued, at which point this clinical study accrual would be adjusted accordingly.
We believe that full consideration has been given to all relevant circumstances that we may be subject to, and the financial statements accurately reflect our best estimate of the results of operations, financial position and cash flows for the periods presented.
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Results of Operations
Revenue. Revenue increased to $406,000 for the three months ended June 30, 2003 from $40,000 for the three months ended June 30, 2002. Revenue increased to $814,000 for the six months ended June 30, 2003 from $79,000 for the six months ended June 30, 2002. This revenue is primarily composed of amortization of up-front technology license fees associated with agreements signed with LabCorp that are being amortized on a straight-line basis over the license period.
Cost of revenues. Cost of revenues for the six months ended June 30, 2003 and 2002 of $3,000 and $2,000, respectively, represents the estimated cost of performing commercial colorectal screening tests at our facilities.
Research and development expenses. Research and development expenses, excluding departmental allocations of stock-based compensation, decreased to $4.6 million for the three months ended June 30, 2003 from $5.1 million for the three months ended June 30, 2002 as decreases in clinical study expenses of $1.5 million were offset by increases of $267,000 in personnel-related expenses, $139,000 in professional fees and expenses, $526,000 in laboratory expenses, and $111,000 related to the leasing of additional laboratory space. Research and development expenses, excluding departmental allocations of stock-based compensation, decreased to $9.6 million for the six months ended June 30, 2003 from $10.1 million for the six months ended June 30, 2002 as decreases in clinical study expenses of $2.7 million were offset by increases of $630,000 in personnel-related expenses, $401,000 in professional fees and expenses, $951,000 in laboratory expenses, and $172,000 related to the leasing of additional laboratory space. Clinical study expenses decreased primarily due to lower professional fees and patient recruitment costs for our blinded multi-center clinical study, which concluded its patient recruitment at the end of March 2003. The increase in the expenses noted above were primarily attributable to an increase in the number of tests being performed in support of the two large in-process clinical studies and other research and development initiatives undertaken to further develop our PreGen technologies in support of the anticipated commercialization of PreGen-Plus.
Selling, general and administrative expenses. Selling, general and administrative expenses, excluding departmental allocations of stock-based compensation, increased to $3.5 million for the three months ended June 30, 2003 from $2.5 million for the three months ended June 30, 2002. The increase for the three month period was attributable primarily to increases of $430,000 in personnel-related expenses, $477,000 in professional fees and expenses and $52,000 in office-related expenses. Selling, general and administrative expenses, excluding departmental allocations of stock-based compensation, increased to $6.6 million for the six months ended June 30, 2003 from $4.8 million for the six months ended June 30, 2002. The increase for the six month period was attributable primarily to increases of $950,000 in personnel-related expenses, $749,000 in professional fees and expenses and $85,000 in office-related expenses. These expenses increased primarily due to increases in marketing and sales personnel and programs in preparation for the commercialization of PreGen-Plus.
Stock-based compensation. Stock-based compensation, which is a non-cash expense, decreased to $330,000 for the three months ended June 30, 2003 from $544,000 for the three months ended June 30, 2002. Stock-based compensation decreased to $658,000 for the six months ended June 30, 2003 from $1.1 million for the six months ended June 30, 2002. Stock-based compensation decreased due to the accelerated method of amortization being utilized to amortize this non-cash expense.
Interest income. Interest income decreased to $126,000 for the three months ended June 30, 2003 from $231,000 for the three months ended June 30, 2002. Interest income decreased to $293,000 for the six months ended June 30, 2003 from $506,000 for the six months ended June 30, 2002. This decrease was due to lower interest rates on our investments, as well as an overall decrease in our average cash, cash equivalents and marketable securities balances.
Liquidity and Capital Resources
We have financed our operations since inception primarily through private sales of preferred stock, the completion of an initial public offering of our common stock in February 2001 and cash received in connection with our second strategic alliance with LabCorp in June 2002. As of June 30, 2003, we had approximately $27.1 million in cash, cash equivalents and marketable securities available to fund our operations.
Net cash used in operating activities was $15.4 million for the six months ended June 30, 2003 and provided $1.8 million for the six months ended June 30, 2002. Excluding the impact of the up-front deferred licensing fee of $15 million from LabCorp, net cash used in operating activities would have been $13.2 million for the six months ended June 30, 2002. This increase was primarily due to the increase in our selling and administrative expenses and the timing of payments associated with our large multi-center clinical study.
Net cash provided by investing activities was $12.4 million for the six months ended June 30, 2003 and used $1 million in investing activities for the six months ended June 30, 2002. For the six months ended June 30, 2003, $14.0 million of marketable
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securities matured and were invested in cash and cash equivalents. For each of these periods, we continued to invest in our intellectual property portfolio and the expansion of our laboratory space and equipment to support our two large in-process clinical studies.
Net cash provided by financing activities was $305,000 for the six months ended June 30, 2003 and $268,000 for the six months ended June 30, 2002. For the six months ended June 30, 2003, this was primarily due to the issuance of common stock under our employee stock option and purchase plans. For the six months ended June 30, 2002, this was primarily due to the repayment of note receivables.
We expect that cash, cash equivalents and short-term investments on hand at June 30, 2003, together with the additional milestone and royalty payments expected to be received from LabCorp, will be sufficient to fund our operations for the foreseeable future. Our future capital requirements include, but are not limited to, continuing our research and development programs, supporting our clinical study efforts, supporting our marketing efforts associated with the commercialization of PreGen-Plus and capital expenditures primarily associated with leasehold improvements and other moving costs related to new facility and purchases of additional laboratory equipment of approximately $1.0 million. As of June 30, 2003, we had the following fixed obligations and commitments:
Remaining six months of 2003 |
| $ | 1,427,000 |
|
Fiscal Year: |
|
|
| |
2004 |
| 2,402,000 |
| |
2005 |
| 1,778,000 |
| |
2006 |
| 1,907,000 |
| |
2007 |
| 1,569,000 |
| |
Thereafter |
| 6,672,000 |
| |
Total lease payments |
| $ | 15,755,000 |
|
Our future capital requirements will depend on many factors, including the following:
• the success of our clinical studies;
• the scope of and progress made in our research and development activities; and
• the successful commercialization of Pre-Gen Plus.
Factors That May Affect Future Results
We operate in a rapidly changing environment that involves a number of risks, some of which are beyond our control. This discussion highlights some of the risks which may affect future operating results.
We may never successfully commercialize any of our products or services or earn a profit.
We have incurred losses since we were formed. From our date of inception on February 10, 1995 through June 30, 2003, we have accumulated a total deficit of approximately $92.2 million. We do not expect to have any operating revenue from the licensing of our products and services until at least the second half of 2003. Even after we begin selling our products and services, we expect that our losses will continue and increase as a result of continuing research and development expenses, as well as increased sales and marketing expenses. We cannot assure you that the revenue from any of our products or services will be sufficient to make us profitable.
Dependence on our strategic relationship with LabCorp.
We have a long-term, strategic alliance agreement with LabCorp whereby we license certain of our PreGen technologies to LabCorp that are required for the commercialization of PreGen-Plus, our proprietary, non-invasive DNA-based technology for the early detection of colorectal cancer in the average-risk population. The license to LabCorp is exclusive within the United States and Canada for a five-year term followed by a non-exclusive license for the life of the underlying patents. LabCorp has the ability to terminate this agreement for, among other things, a material breach by us. If LabCorp were to terminate the agreement, or fail to meet its obligations under the agreement, we would incur significant delays and expense in the commercialization of PreGen-Plus and we cannot guarantee that we would be able to enter into a similar agreement to commercialize this technology. Further, if we do not
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achieve certain milestones, or LabCorp does not achieve certain revenue and performance thresholds within the time periods prescribed in the agreement, we may not fully realize the expected benefits of the agreement to us.
Because our revenue will be substantially dependent upon LabCorp’s commercial sales of PreGen-Plus, we are actively working together with LabCorp to create and execute an operational and business plan for commercializing PreGen-Plus. Efforts include assay validation, technology transfer and licensing; contracting with manufacturers and suppliers; physician education and demand; broad-based reimbursement initiatives; advocacy development; and sales force training. Additionally, there are a number of significant initiatives that LabCorp must accomplish prior to commercialization if we are to be successful including the creation of an adequate distribution infrastructure for sample movement, the build-out of adequate laboratory space, the hiring and training of personnel, the establishment of supply agreements with vendors, and the licensing of certain third-party technologies used with the PreGen-Plus assay as it is currently configured. Once completed, LabCorp will also need to process an adequate number of stool samples at their facilities to validate test results. Failure to adequately complete any of these initiatives, or to do so in a timely manner, could impact the timing and success of the commercialization of PreGen-Plus.
In addition, LabCorp may decide to delay the commercialization of PreGen-Plus despite the achievement of the aforementioned initiatives, or may decide that the commercialization of PreGen-Plus is no longer appropriate to its business. Should that occur, we cannot assure you that we would be able to license our PreGen technology to another clinical reference laboratory or otherwise successfully commercialize the technology.
Our business would suffer if we are unable to license certain technologies or obtain raw materials or if certain of our licenses were terminated.
The current configuration of PreGen-Plus that we expect to commercialize with LabCorp requires access to certain technologies and supply of raw materials for which we or LabCorp will need to enter into licensing and supply agreements prior to commercialization. While we believe that we or LabCorp can enter into agreements for such technologies and raw materials on favorable terms and conditions, no assurances can be given that we or LabCorp will be able to accomplish this objective on a timely basis, if at all. If we or LabCorp are unable to obtain these technologies and raw materials on acceptable terms, the PreGen-Plus assay will need to be re-configured which could significantly delay its commercialization.
We license certain technologies from Roche Molecular Systems, Inc. and Genzyme Corporation that are key to our PreGen technologies, which LabCorp must also secure for the commercialization of PreGen Plus. Our Roche license for the polymerase chain reaction (“PCR) technology, which relates to a gene amplification process used in almost all genetic testing, is a non-exclusive license through 2004, the date on which the patents that we utilize expire. Roche may terminate the license upon notice if we fail to pay royalties, submit certain reports or breach any other material term of the license agreement. Our Genzyme license is a non-exclusive license to use the Apc and p53 genes, methods for the detection of target nucleic acid by analysis of stool and other methodologies relating to the genes in connection with our products and services through 2013, the date on which the term of the patent that we utilize expires. Genzyme may terminate the license upon notice if we fail to pay milestone payments and royalties, achieve a certain level of sales, or submit certain reports. In addition, if we fail to use reasonable efforts to make products and services based on these patents available to the public or fail to request FDA clearance for a diagnostic test kit as required by the agreement, Genzyme may terminate the license. If either Roche or Genzyme were to terminate the licenses, and if we, were, at the time of license termination, generating material revenue from tests performed at our Company’s facility, we would incur significant delays and expense to change a portion of our testing methods and we cannot guarantee that we would be able to change our testing methods without affecting the performance characteristics of our tests. If LabCorp is unable to secure the necessary licensing rights to the Roche and Genzyme technologies, commercialization of the PreGen-Plus assay could be delayed or prevented altogether and our revenues could be materially and adversely affected.
Dependence on collaborative relationships.
In addition to our dependence on LabCorp for the commercialization of PreGen-Plus, if any other party with which we, or LabCorp, have established, or will establish, licensing, supply, or collaborative agreements were unable to satisfy its contractual obligations to us or LabCorp, there can be no assurance that substantially similar agreements could be negotiated and executed with other third parties on acceptable terms, if at all, or that any such new agreements would be successful. While we believe such third parties will meet their contractual responsibilities under current and future agreements, there can be no assurance that this will be the case or that such future agreements will in fact be negotiated and entered into. There can be no assurance that any of our current contractual arrangements between us and third parties, us and LabCorp, or between our strategic partners and other third parties, will be continued, entered into, or not breached or terminated early, or that we or our strategic partners will be able to enter into any future relationships necessary to the commercial launch and on-going commercial sales of PreGen-Plus or necessary to our realization of material revenues. The failure to do so could have a material adverse effect on our business, results of operations and financial condition. Further, LabCorp or any other strategic partner may commercialize technologies or products for colorectal cancer outside of their relationship with us that compete directly with our PreGen technologies, and such technologies or products may prove to be
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more effective and cost-efficient than our PreGen technologies. Because our revenue will be dependent upon our and LabCorp’s successful commercial introduction of PreGen-Plus, failure to successfully maintain our relationship with LabCorp or any other strategic partner would have a material adverse effect on our operations and ability to generate operating revenue.
If our clinical studies do not prove the superiority of our PreGen technologies, we and our partners may never sell our products and services.
In the third quarter of 2001, we initiated a large multi-center clinical study that includes approximately 5,500 patients with average-risk profiles. In October 2001, we also signed a Clinical Trial Agreement with the Mayo Clinic in which our PreGen technologies is the subject of an independent study by Mayo Clinic for which Mayo Clinic received a $4.9 million grant from the National Cancer Institute of the National Institutes of Health. This three-year study will involve approximately 4,000 patients at average-risk for developing colorectal cancer and, similar to our multi-center clinical study, will compare the results of our PreGen technologies with those of the Hemoccult II and Hemoccult Sensa®, two brands of FOBT, common first-line colorectal cancer screening options. The results of these clinical studies may not be favorable or show that tests using our PreGen technologies are sufficiently superior to Hemoccult II and Hemoccult Sensa. In that event, we may have to devote significant financial and other resources to further research and development. In addition, we may experience reluctance or refusal on the part of third-party payors to pay for tests using our PreGen technologies which could slow the demand and/or commercialization of these tests, or commercialization may never occur. Our clinical studies to date have primarily included samples from higher-risk or symptomatic patients. The results from these earlier studies may not be representative of the results we obtain from any future studies, including our multi-center clinical study, which will include samples from only average-risk patients.
Scarcity of raw materials and components.
We rely on contract manufacturers and suppliers for certain components for our PreGen technologies. We believe that there are relatively few manufacturers that are currently capable of supplying commercial quantities of the raw materials and components necessary for the current configuration of the PreGen-Plus assay, including our Effipure technology, that is intended for commercialization. Although we have identified suppliers that we believe are capable of supplying these raw materials and components in sufficient quantity today, there can be no assurance that we, or LabCorp, will be able to enter into agreements with such suppliers on a timely basis on acceptable terms, if at all. Furthermore, PreGen-Plus has never been offered on a commercial scale, and there can be no assurance that the raw materials and components necessary to meet demand will be available in sufficient quantities or on acceptable terms, if at all. If we, or LabCorp, should encounter delays or difficulties in securing the necessary raw materials and components for PreGen-Plus, we may need to reconfigure our assay which would result in delays in commercialization or an interruption in sales which could materially adversely impact our revenues.
Ability to support demand.
The market launch and commercialization of PreGen-Plus will require the Company and LabCorp to implement certain increases in scale and related manufacturing and process improvements, and to establish an internal quality assurance program to support commercial testing. No assurance can be given that these increases in scale, related improvements and quality assurance program will be successfully implemented, and failure to do so could result in a delay of market launch, higher cost of testing or an inability to meet market demand. Since PreGen-Plus has never been offered on a commercial scale, there can be no assurance that LabCorp will be able to perform tests on a timely basis at a level consistent with demand. If LabCorp encounters difficulty meeting market demand for PreGen-Plus, there could be substantial interruption in LabCorp’s continued ability to offer PreGen-Plus commercially and our revenue could be materially and adversely affected.
Long-term commercial viability of PreGen-Plus may be jeopardized if we are not able to lower costs through automating and simplifying key operational processes.
Currently, colorectal cancer screening tests using our PreGen technologies are expensive because they are labor-intensive and use highly complex processes and expensive reagents. In order to generate significant profits and make our PreGen technologies more commercially attractive, we will need to reduce substantially the costs of tests using our PreGen technologies through significant automation of key operational processes and other cost savings procedures. If we, or LabCorp, fail to create and improve PreGen technologies that sufficiently reduce costs, tests using our PreGen technologies either may not be commercially viable or may generate little, if any, profitability for our partners, or for us.
If Medicare and other third-party payors, including managed care organizations, do not provide adequate reimbursement for our products and services, it is unlikely that most clinical reference laboratories will use our products or license our PreGen technologies to perform cancer screening tests.
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Most clinical reference laboratories will not perform colorectal cancer screening tests using our PreGen technologies unless they are adequately reimbursed by third-party payors such as Medicare and managed care organizations. There is significant uncertainty concerning third-party reimbursement for the use of any test incorporating new technology. Reimbursement by a third-party payor may depend on a number of factors, including a payor’s determination that tests using our PreGen technologies are sensitive for colorectal cancer, not experimental or investigational, medically necessary, appropriate for the specific patient and cost-effective. While we have had some success in obtaining reimbursement from a limited number of third-party payors for tests performed in-house, to date, we have not secured any broad-based policy-level reimbursement approval for tests using our PreGen technologies from any third-party payor, nor do we expect any such approvals in the immediate future.
Reimbursement by Medicare will require a review that may be lengthy and which may be performed under the provisions of a National Coverage Decision process. The Federal Balanced Budget Act of 1997 provides for adding new technologies to the colorectal cancer screening benefit, such as ours, with such frequency and payment limits as the Secretary of Health and Human Services (“HHS”) determines appropriate. We cannot guarantee that the Secretary of HHS will act to approve tests based on our PreGen technologies on a timely basis, or at all. While the current procedural terminology codes facilitate Medicare reimbursement, the level of any eventual Medicare reimbursement is unknown at this time.
Since policy-level reimbursement approval is required from each payor individually, seeking such approvals is a time-consuming and costly process. If we are unable to obtain adequate reimbursement approval from Medicare and private payors, our ability to generate revenue from our PreGen technologies will be limited.
If we are unable to convince medical practitioners to order tests using our PreGen technologies, our revenue and profitability may be limited.
If we fail to convince medical practitioners to order tests using our PreGen technologies, we will not be able to create sufficient demand for products using our PreGen technologies in sufficient volume for us to become profitable. We will need to make thought-leading gastroenterologists and primary care physicians aware of the benefits of tests using our PreGen technologies through published papers, presentations at scientific conferences and favorable results from our clinical studies. Our failure to be successful in these efforts would make it difficult for us to convince medical practitioners to order colorectal cancer screening tests using our PreGen technologies for their patients.
We may experience limits on our revenue and profitability if only a small number of people decide to be screened for colorectal cancer using our PreGen technologies.
Even if our PreGen technologies are superior to alternative colorectal cancer screening technologies, adequate third-party reimbursement is obtained and medical practitioners order tests using our PreGen technologies, an immaterial number of people may decide to be screened for colorectal cancer. Despite the availability of current colorectal cancer screening methods as well as the recommendations of the American Cancer Society that all Americans age 50 and above be screened for colorectal cancer, most of these individuals decide not to complete a colorectal cancer screening test. If only a small portion of the population decides to utilize colorectal cancer screening tests using our PreGen technologies, we will, despite our efforts, experience limits on our revenue and profitability.
If we or our partners fail to comply with FDA requirements, we may be limited or restricted in our ability to market our products and services and may be subject to stringent penalties.
The FDA does not actively regulate laboratory tests that have been developed and used by the laboratory to conduct in-house testing. The FDA does regulate specific reagents and certain components, some of which are used with our PreGen technologies that react with a biological substance including those designed to identify a specific DNA sequence or protein. For instance, a key component of our PreGen Technologies includes our Effipure technology for the recovery of DNA from biological samples. The FDA’s regulations provide that most such reagents, which the FDA refers to as analyte specific reagents (“ASRs”), are exempt from the FDA’s pre-market review requirements. We believe that ASRs that we may provide currently fall within these exemptions. However, if the FDA were to decide to more actively regulate in-house developed laboratory tests, or significantly change the regulations for ASRs, the commercialization of our products and services could be impacted by being delayed, halted or prevented. If the FDA were to view any of our actions as non-compliant, it could initiate enforcement action such as a regulatory warning letter and possible imposition of penalties. Moreover, while we believe that Effipure qualifies as an analyte specific reagent, and is therefore exempt from the FDA’s pre-market review requirements, there can be no assurance that the FDA or other regulatory bodies will agree with our assessment and the commercialization of our products and services could be impacted by being delayed, halted or prevented altogether. Finally, any ASRs that we may provide will be subject to a number of FDA requirements, including compliance with the FDA’s Quality System Regulation, which establishes extensive regulations for quality assurance and control as well as manufacturing procedures. Failure to comply with these regulations could result in enforcement action for us, our partners, or our contract
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manufacturers. Adverse FDA action in any of these areas could significantly increase our expenses and limit our revenue and profitability.
We may be subject to substantial costs and liability or be prevented from selling our screening tests for cancer as a result of litigation or other proceedings relating to patent rights.
Third parties may assert infringement or other intellectual property claims against our licensors, our licensees, our suppliers, our strategic partners, or us. We pursue an aggressive patent strategy that we believe provides us with a competitive advantage in the early detection of colorectal cancer and other common cancers. As of June 30, 2003, we have 29 issued patents and 30 pending patent applications in the United States and we also have 12 issued foreign patents and 108 pending foreign patent applications. Because the U.S. Patent & Trademark Office maintains patent applications in secrecy until a patent application publishes or the patent is issued, others may have filed patent applications for technology covered by our pending applications. There may be third-party patents, patent applications and other intellectual property relevant to our technologies that may block or compete with our technologies. Even if third-party claims are without merit, defending a lawsuit may result in substantial expense to us and may divert the attention of management and key personnel. In addition, we cannot provide assurance that we would prevail in any of these suits or that the damages or other remedies if any, awarded against us would not be substantial. Claims of intellectual property infringement may require that we, or our strategic partners, enter into royalty or license agreements with third parties that may not be available on acceptable terms, if at all. These claims may also result in injunctions against the further development and use of our PreGen technologies, which would have a material adverse effect on our business, financial condition and results of operations.
Also, patents and applications owned by us may become the subject of interference proceedings in the United States Patent and Trademark Office to determine priority of invention, which could result in substantial cost to us, as well as a possible adverse decision as to the priority of invention of the patent or patent application involved. An adverse decision in an interference proceeding may result in the loss of rights under a patent or patent application subject to such a proceeding.
Additionally, a third-party has asserted claims of patent infringement against certain entities that are anticipated suppliers of materials necessary to the PreGen-Plus assay as it is currently configured. Although to date, no legal proceedings have been initiated against us, if any third party, including the third party discussed above, is successful in challenging the supply of materials needed for the PreGen-Plus assay as it is currently configured, commercialization of our PreGen technologies may be significantly delayed, sales of the PreGen-Plus assay may become interrupted, and our revenue may become impacted.
If we become subject to additional regulations from the U.S. Department of Transportation (“ DOT”), or other international regulatory agencies, for the transport of diagnostic specimens, it could increase the cost of transporting stool specimens and limit revenue growth.
On August 14, 2002, the DOT issued revised Hazardous Materials Regulations for the packaging and transport of infectious materials, including diagnostic specimens. In anticipation of the application of these regulations to our current specimen container and transport system, we submitted an exemption request to the DOT to minimize the changes that would be necessary for our specimen collection system, while still providing an equivalent level of safety. On February 13, 2003, the DOT issued a formal determination that stool samples intended for clinical research or diagnostic purpose would not be deemed an infectious substance subject to the Hazardous Materials Regulations. While this decision is favorable to us and our partners, we cannot be certain that the DOT, or other international regulatory agencies, will not more actively regulate or restrict the transportation of stool samples, such as those used in our diagnostic tests.
Other companies may develop and market novel or improved methods for detecting colorectal cancer, which may make our PreGen technologies less competitive, or even obsolete.
The market for colorectal cancer screening is large, approximating 80 million Americans age 50 and above, and has attracted competitors, some of which have significantly greater resources than we have. Currently, we face competition from alternative procedures-based detection technologies such as flexible sigmiodoscopy, colonoscopy, virtual colonoscopy, a new procedure being performed in which a radiologist views the inside of the colon through a scanner, as well as existing and improved traditional screening tests such as FOBT. In addition, some competitors are developing serum-based tests, or screening tests based on the detection of proteins or nucleic acids produced by colon cancer. These and other companies may also be working on additional methods of detecting colon cancer that have not yet been announced. We may be unable to compete effectively against these competitors either because their test is superior or because they may have more expertise, experience, financial resources and stronger business relationships.
The loss of key members of our senior management team could adversely affect our business.
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Our success depends largely on the skills, experience and performance of key members of our senior management team, including Don M. Hardison, our President and Chief Executive Officer, John A. McCarthy, Jr., our Executive Vice President, Chief Operating Officer, Chief Financial Officer and Treasurer, and Anthony P. Shuber, our Executive Vice President and Chief Technology Officer. Anthony P. Shuber, together with Stanley N. Lapidus, our Chairman, has been critical to the development of our technologies and business. Although Messrs. Hardison, McCarthy and Shuber have each signed a non-disclosure and assignment of intellectual property agreement and a non-compete agreement, they have no employment agreements currently in place. We also have a severance agreement with each of Messrs. Hardison, McCarthy and Shuber that provides for twelve months severance under certain circumstances. The efforts of each of these persons will be critical to us as we continue to develop our technologies and our testing process and as we transition to a company with commercialized products and services. If we were to lose one or more of these key employees, we may experience difficulties in competing effectively, developing our technologies and implementing our business strategies.
If we are unable to protect our intellectual property effectively, we may be unable to prevent third parties from using our PreGen technologies, which would impair our competitive advantage.
We rely on patent protection as well as a combination of trademark, copyright and trade secret protection, and other contractual restrictions to protect our proprietary PreGen technologies, all of which provide limited protection and may not adequately protect our rights or permit us to gain or keep any competitive advantage. If we fail to protect our intellectual property, we will be unable to prevent third parties from using our PreGen technologies and they will be able to compete more effectively against us.
As of June 30, 2003, we have 29 issued patents and 30 pending patent applications in the United States and we also have 12 issued foreign patents and 108 pending foreign patent applications. We cannot assure you that any of our currently pending or future patent applications will result in issued patents, and we cannot predict how long it will take for such patents to be issued. Further, we cannot assure you that other parties will not challenge any patents issued to us, or that courts or regulatory agencies will hold our patents to be valid or enforceable.
A third-party institution has asserted co-inventorship rights with respect to one of our issued patents relating to pooling patient samples in connection with our loss of heterozygosity detection method. We cannot guarantee you that we will be successful in defending this or other challenges made in connection with our patents and patent applications. Any successful third-party challenge to our patents could result in co-ownership of such patents with a third party or the unenforceability or invalidity of such patents. In addition, we and a third-party institution have filed a joint patent application that is co-owned by us and that third-party institution relating to the use of various DNA markers, including one of our detection methods, to detect cancers of the lung, pancreas, esophagus, stomach, small intestine, bile duct, naso-pharyngeal, liver and gall bladder in stool under the Patent Cooperation Treaty. This patent application designates the United States, Japan, Europe and Canada. Co-ownership of a patent allows the co-owner to exercise all rights of ownership, including the right to use, transfer and license the rights protected by the applicable patent.
In addition to our patents, we rely on contractual restrictions to protect our proprietary technology. We require our employees and third parties to sign confidentiality agreements and employees to sign agreements assigning to us all intellectual property arising from their work for us. Nevertheless, we cannot guarantee that these measures will be effective in protecting our intellectual property rights.
We cannot guarantee that the patents issued to us will be broad enough to provide any meaningful protection nor can we assure you that one of our competitors may not develop more effective technologies, designs or methods to test for colorectal cancer or any other common cancer without infringing our intellectual property rights or that one of our competitors might not design around our proprietary PreGen technologies.
We may incur substantial costs to protect and enforce our patents.
We have pursued an aggressive patent strategy designed to maximize our patent protection against third parties in the U.S. and in foreign countries. We have filed patent applications that cover the methods we have designed to detect colorectal cancer and other cancers, as well as patent applications that cover our testing process. In order to protect or enforce our patent rights, we may initiate actions against third parties. Any actions regarding patents could be costly and time-consuming, and divert our management and key personnel from our business. Additionally, such actions could result in challenges to the validity or applicability of our patents.
If we lose the support of our key scientific collaborators, it may be difficult to establish tests using our PreGen technologies as a standard of care for colorectal cancer screening, which may limit our revenue growth and profitability.
We have established relationships with leading scientists, including members of our scientific advisory board, and research and academic institutions, such as the Mayo Clinic and John Hopkins University that we believe are key to establishing tests using our PreGen technologies as a standard of care for colorectal cancer screening. If our collaborators determine that colorectal cancer
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screening tests using our PreGen technologies are not superior to available colorectal cancer screening tests or that alternative technologies would be more effective in the early detection of colorectal cancer, we would encounter significant difficulty establishing tests using our PreGen technologies as a standard of care for colorectal cancer screening, which would limit our revenue growth and profitability.
Our inability to apply our proprietary PreGen technologies successfully to detect other common cancers may limit our revenue growth and profitability.
While, to date, we have focused substantially all of our research and development efforts on colorectal cancer, we have used our PreGen technologies to detect cancers of the lung, pancreas, esophagus, stomach and gall bladder. As a result, we intend to devote personnel and financial resources in the future to extending our PreGen technology platform to the development of screening tests for these common cancers. To do so, we may need to overcome technological challenges to develop reliable screening tests for these cancers. There can be no assurance that our PreGen technologies will be capable of reliably detecting cancers, beyond colorectal cancer, with the sensitivity and specificity necessary to be clinically and commercially useful for such other cancers, or that we can develop such technologies. We may never realize any benefits from our research and development activities.
Changes in healthcare policy could subject us to additional regulatory requirements that may delay the commercialization of our tests and increase our costs.
Healthcare policy has been a subject of discussion in the executive and legislative branches of the federal and many state governments. We developed our commercialization strategy for PreGen-Plus based on existing healthcare policies. Changes in healthcare policy, if implemented, could substantially delay the use of PreGen-Plus, increase costs, and divert management’s attention. We cannot predict what changes, if any, will be proposed or adopted or the effect that such proposals or adoption may have on our business, financial condition and results of operations.
Our inability to raise additional capital on acceptable terms in the future may limit our growth.
If our capital resources become insufficient to meet future requirements, we will have to raise additional funds to continue the development and commercialization of our PreGen technologies. Our inability to raise capital would seriously harm our business and development efforts. In addition, we may choose to raise additional capital due to market conditions or strategic considerations even if we believe we have sufficient funds for our current or future operations. These funds may not be available on favorable terms, or at all. If adequate funds are not available on attractive terms, we may have to restrict our operations significantly or obtain funds by entering into agreements on unattractive terms. Further, to the extent that additional capital is raised through the sale of equity or convertible debt securities, the issuance of these securities could result in dilution to our stockholders.
Conviction of Arthur Andersen LLP.
Prior to July 17, 2002, Arthur Andersen LLP (“Arthur Andersen”) served as the Company’s independent auditors. On March 14, 2002, Arthur Andersen was indicted on federal obstruction of justice charges arising from the government’s investigation of Enron Corporation and on June 15, 2002, Arthur Andersen was found guilty. Arthur Andersen informed the SEC that it would cease practicing before the SEC by August 31, 2002, unless the SEC determined that another date was appropriate. On May 7, 2002, the Company dismissed Arthur Andersen and retained Ernst & Young LLP as its independent auditors for its fiscal year ended December 31, 2002. SEC rules require the Company to present historical audited financial statements in various SEC filings, such as registration statements, along with Arthur Andersen’s consent to the Company’s inclusion of Arthur Andersen’s audit report in those filings. Since the Company’s former engagement partner and audit manager have left Arthur Andersen and in light of the announced cessation of Arthur Andersen’s SEC practice, the Company will not be able to obtain the consent of Arthur Andersen to the inclusion of Arthur Andersen’s audit report in the Company’s relevant current and future filings. The SEC recently has provided regulatory relief designed to allow companies that file reports with the SEC to dispense with the requirement to file a consent of Arthur Andersen in certain circumstances, but purchasers of securities sold under the Company’s registration statements, which were not filed with the consent of Arthur Andersen to the inclusion of Arthur Andersen’s audit report will not be able to sue Arthur Andersen pursuant to Section 11(a)(4) of the Securities Act of 1933 and therefore the purchasers’ right of recovery under that section may be limited as a result of the lack of the Company’s ability to obtain Arthur Andersen’s consent.
Certain provisions of our charter, by-laws and Delaware law may make it difficult for you to change our management and may also make a takeover difficult.
Our corporate documents and Delaware law contain provisions that limit the ability of stockholders to change our management and may also enable our management to resist a takeover. These provisions include a staggered board of directors, limitations on persons authorized to call a special meeting of stockholders and advance notice procedures required for stockholders to make nominations of candidates for election as directors or to bring matters before an annual meeting of stockholders. These
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provisions might discourage, delay or prevent a change of control or in our management. These provisions could also discourage proxy contests and make it more difficult for you and other stockholders to elect directors and cause us to take other corporate actions. In addition, the existence of these provisions, together with Delaware law, might hinder or delay an attempted takeover other than through negotiations with our board of directors.
Our stock price may be volatile.
The market price of our stock is likely to be highly volatile and could fluctuate widely in price in response to various factors, many of which are beyond our control, including:
• technological innovations or new products and services by us or our competitors;
• clinical trial results relating to our tests or those of our competitors;
• reimbursement decisions by Medicare and other managed care organizations;
• FDA regulation of our products and services;
• the establishment of collaborative partnerships;
• health care legislation;
• intellectual property disputes and other litigation;
• additions or departures of key personnel;
• a delay, or anticipated delay, in commercialization of our PreGen technologies; and
• sales of our common stock.
Because we are a company with no operating revenue expected until at least the second half of 2003, you may consider one of these factors to be material. Our stock price may fluctuate widely as a result of any of the above.
In addition, the Nasdaq National Market and the market for biotechnology companies in particular, have experienced significant price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of those companies.
Future sales by our existing stockholders could depress the market price of our common stock.
If our existing stockholders sell a large number of shares of our common stock, the market price of our common stock could decline significantly. Moreover, the perception in the public market that our existing stockholders might sell shares of common stock could adversely affect the market price of our common stock.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
The Company’s exposure to market risk is principally confined to its cash, cash equivalents and marketable securities. We invest our cash, cash equivalents and marketable securities in securities of the U.S. governments and its agencies and in investment-grade, highly liquid investments consisting of commercial paper, bank certificates of deposit and corporate bonds, all of which are currently invested in the U.S and are classified as available-for-sale. We place our cash equivalents and marketable securities with high-quality financial institutions, limit the amount of credit exposure to any one institution and have established investment guidelines relative to diversification and maturities designed to maintain safety and liquidity.
Based on a hypothetical ten percent adverse movement in interest rates, the potential losses in future earnings, fair value of risk-sensitive financial instruments, and cash flows are immaterial, although the actual effects may differ materially from the hypothetical analysis.
Item 4. Controls And Procedures
As of the end of the period covered by this report, the Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s President and Chief Executive Officer and Executive Vice President, Chief Operating Officer, Chief Financial Officer and Treasurer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures, as defined in Exchange Act Rule 15d-15(e). Based upon that evaluation, the Company’s President and Chief Executive Officer and Executive Vice President, Chief Operating Officer, Chief Financial Officer and Treasurer concluded that the Company’s disclosure controls and procedures are effective in enabling the Company to record, process, summarize and report information required to be included in the Company’s periodic SEC filings within the required time period. There have been no changes in the Company's internal control over financial reporting that occurred during the Company's last fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting.
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Item 4. Submission of Matters to a Vote of Security Holders
On June 12 2003, at our annual meeting of stockholders, the stockholders elected as Class III directors, each to serve for a three-year term, the following individuals: Stanley N. Lapidus (14,974,758 shares for; 76,581 shares withheld), Sally W. Crawford (14,974,758 shares for, and 76,581 shares withheld and Edwin M. Kania Jr. (14,808,407 shares for; 242,932 shares withheld). The term of office for each of Don M. Hardison, Richard W. Barker, Ph.D., William H. Helman, Connie Mack, III, Lance Willsey, M.D., and Patrick J. Zenner as a director of the Company continued following the annual meeting. Subsequent to the annual meeting, William H. Helman resigned as director of the Company. There were no disagreements with the Company on any matter relating to the Company’s operations, policies or practices.
A proposal to ratify Ernst & Young LLP as the Company’s independent auditors for fiscal year 2003 was approved (15,045,670 shares for, 5,219 shares withheld).
Our policy governing transactions in our securities by directors, officers and employees permits our officers, directors and certain other persons to enter into trading plans complying with Rule 10b5-1 under the Securities Exchange Act of 1934, as amended. We anticipate that, as permitted by Rule 10b5-1 and our policy governing transactions in our securities, some or all of our officers, directors and employees may establish trading plans in the future. We intend to disclose the names of executive officers and directors who establish a trading plan in compliance with Rule 10b5-1 and the requirements of our policy governing transactions in our securities in our future quarterly and annual reports on Form 10-Q and 10-K filed with the Securities and Exchange Commission. However, we undertake no obligation to update or revise the information provided herein, including for revision or termination of an established trading plan, other than in such quarterly and annual reports.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit Number |
| Description |
10.1* |
| Services, Manufacturing and Supply Agreement dated as of April 7, 2003, by and between the Company and Discovery Labware, Inc. |
31.1 |
| Certification Pursuant to 18 U.S.C Section 1350, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
31.2 |
| Certification Pursuant to 18 U.S.C Section 1350, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
32.1 |
| Certification Pursuant to 18 U.S.C Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
32.2 |
| Certification Pursuant to 18 U.S.C Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
* Confidential Treatment requested for certain portions of this Agreement.
(b) Reports on Form 8-K.
During the quarter ended June 30, 2003, we furnished three reports on Form 8-K. The first report, dated April 24, 2003, announced a conference call to discuss our first quarter financial results and the second report, dated April 28, 2003, furnished our first quarter results press release as an exhibit. The third report, dated May 13, 2003, amended the report on Form 8-K dated April 28, 2003. We filed no other reports on Form 8-K during the quarter ended June 30, 2003.
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Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| EXACT SCIENCES CORPORATION | ||||
|
| ||||
Date: July 28, 2003 |
| By: | /s/ Don M. Hardison. |
| |
| Don M. Hardison | ||||
| President, Chief Executive Officer and Director | ||||
|
| ||||
|
| ||||
Date: July 28, 2003 |
| By: | /s/ John A. McCarthy, Jr. |
| |
| John A. McCarthy, Jr. | ||||
| Executive Vice President, Chief Operating Officer, Chief | ||||
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Exhibit |
| Description |
|
|
|
10.1* |
| Services, Manufacturing and Supply Agreement dated as of April 7, 2003, by and between the Registrant and Discovery Labware, Inc. |
|
|
|
31.1 |
| Certification Pursuant to 18 U.S.C Section 1350, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
|
|
|
31.2 |
| Certification Pursuant to 18 U.S.C Section 1350, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
|
|
|
32.1 |
| Certification Pursuant to 18 U.S.C Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
|
|
|
32.2 |
| Certification Pursuant to 18 U.S.C Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
* Confidential Treatment requested for certain portions of this Agreement.
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