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Edited Transcript of EXAS earnings conference call or presentation 27-Apr-17 2:00pm GMT

Thomson Reuters StreetEvents

Q1 2017 Exact Sciences Corp Earnings Call

MADISON May 1, 2017 (Thomson StreetEvents) -- Edited Transcript of Exact Sciences Corp earnings conference call or presentation Thursday, April 27, 2017 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Jeffrey T. Elliott

Exact Sciences Corporation - CFO

* Kevin T. Conroy

Exact Sciences Corporation - Chairman of the Board, CEO and President

* Maneesh K. Arora

Exact Sciences Corporation - COO, SVP and Director

* Megan Reiss

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Conference Call Participants

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* Anne Edelstein

BofA Merrill Lynch, Research Division - Research Analyst

* Brian David Weinstein

William Blair & Company L.L.C., Research Division - Partner and Healthcare Analyst

* Bruce David Jackson

Lake Street Capital Markets, LLC, Research Division - Senior Healthcare Research Analyst

* Catherine Walden Ramsey Schulte

Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst

* Christopher William Lewis

Roth Capital Partners, LLC, Research Division - Senior Research Analyst

* Douglas Anthony Schenkel

Cowen and Company, LLC, Research Division - MD and Senior Research Analyst

* Isaac Ro

Goldman Sachs Group Inc., Research Division - VP

* Kevin Kim Ellich

Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst

* Mark Anthony Massaro

Canaccord Genuity Limited, Research Division - Senior Analyst

* Puneet Souda

Leerink Partners LLC, Research Division - Associate

* Raymond Alexander Myers

The Benchmark Company, LLC, Research Division - Research Analyst

* Samuel Brandon Couillard

Jefferies LLC, Research Division - Equity Analyst

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Presentation

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Operator [1]

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Good morning. My name is Dishan, and I'll be your conference operator today. At this time, I would like to welcome everyone to the Exact Sciences Corporation's First Quarter 2017 Earnings Call. (Operator Instructions) Thank you. I would now like to turn the call over to Megan Reiss, Investor Relations Analyst. The floor is yours.

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Megan Reiss, [2]

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Thank you, Dishan, and thank you all for joining us for Exact Sciences First Quarter 2017 Conference Call. On the call today are Kevin Conroy, the company's Chairman and CEO; Maneesh Arora, our Chief Operating Officer; and Jeff Elliott, our Chief Financial Officer. Exact Sciences issued a news release earlier this morning detailing our first quarter financial results. If you have not seen it, please go to our website at exactsciences.com.

Following the safe harbor statement, Kevin will provide an overview of the company's first quarter performance. Next, Jeff will provide a summary of our first quarter 2017 financial results. Then Kevin will provide an update on our corporate priorities.

During today's call, we will make forward-looking statements based on current expectations. Our actual results may differ materially from such statements. Descriptions of the risk and uncertainties associated with Exact Sciences are included in our SEC filings, which can be accessed through our website.

It's now my pleasure to introduce the company's Chairman and CEO, Kevin Conroy.

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Kevin T. Conroy, Exact Sciences Corporation - Chairman of the Board, CEO and President [3]

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Thank you for joining us this morning. Exact Sciences had a strong first quarter with 100,000 completed Cologuard tests, $48.4 million in revenue and 10,000 new ordering providers.

This morning, we will discuss the details of our first quarter performance, the large market opportunity that remains for Cologuard and the investments we're making in the business to maximize our ability to capture that opportunity.

We're proud of the impact that Cologuard is having on patients' lives. Since Cologuard was launched 2.5 years ago, more than 450,000 people have been screened for colon cancer with Cologuard. An estimated 45% of those people had never been screened previously. Today, Cologuard is FDA approved, covered by Medicare and included in major screening guidelines and quality measures. It is covered for 78% of the target population and continues to enjoy high patient and provider satisfaction rates. We've never been more confident in the long-term growth of Cologuard and Exact Sciences. Our goal is to change the standard of care for colon cancer screening. This will take time and require further investments in people and our infrastructure.

To discuss our first quarter financial review, I'd like to introduce Exact Sciences Chief Financial Officer, Jeff Elliott.

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Jeffrey T. Elliott, Exact Sciences Corporation - CFO [4]

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Thank you, Kevin, and good morning, everyone. I'll take you through our financials and then review our guidance.

First quarter results exceeded our expectations with revenue of $48.4 million, up 37% sequentially, and Cologuard volume of 100,000 completed tests, up 22% sequentially.

During the quarter, additional payers met the company's criteria for accrual basis revenue recognition. The one-time impact of this shift contributed about $4.3 million of revenue. Please refer to our 10-Q filings for more details on this change.

The commercial team did an outstanding job executing during the quarter. We also benefited from the mild winter weather experienced in much of the country this year. First quarter ASP increased to $485 per test, up $53 sequentially. Excluding the accrual change, ASP would have been $442 per test, an improvement of $10 sequentially on strong cash collections. While we continue to expect some quarter-to-quarter fluctuations in our ASP due to payer mix changes, the accrual shift should reduce the variability.

First quarter cost of sales totaled $170 per test, flat sequentially. During the quarter, we experienced improved volume leverage and efficiency in our lab and manufacturing operations, allowing us to offset scale of investments. The first quarter improvement in ASP and stable cost per test lifted gross margin to 65%, up 400 basis points sequentially. The accrual shift contributed 300 basis points of this lift. We remain comfortable with our long-term margin trajectory.

First quarter operating expense totaled $66.9 million, increased sequentially by $7.8 million due to higher TV advertising spending, headcount additions and our national sales meeting. R&D was a bit lighter than we had expected, primarily due to timing. On a per test basis, operating expense improved 7% sequentially. First quarter cash utilization totaled $36.4 million, higher sequentially by about $10 million due primarily to the increase in operating expense. We ended the quarter with cash and cash equivalents of $275 million.

Turning to our guidance. This year, we expect revenue of $195 million to $205 million, and Cologuard volume of at least 470,000 completed tests. Implied in this guidance is an annual ASP of $415 to $435 a test. While still early in the year, we've raised our ASP assumption based on the strong first quarter performance, along with an estimated $10 to $12 a test full year benefit from the accrual shift, partially offset by a growing mix of commercial volumes. For the second quarter, we expect Cologuard volume of at least 115,000 completed tests. We are optimistic about the future of Cologuard. The test enjoys a $14 billion total addressable market, assuming 80 million Americans indicated for colon cancer screening and a 3-year interval reimbursed by CMS and other payers. Our long-term goal is to capture at least 30% of that market for $4 billion of revenue a year. To support that growth, we will invest to [steel] our business in the coming quarters. Highlight areas include our lab, manufacturing and IT. Cologuard's growth is helping fund much of that investment. I'm also pleased to announce that we recently acquired from MDxHealth the intellectual property rights around the NDRG4 marker used in Cologuard and certain other technologies. In connection with these transactions, we've terminated our previous license agreement with MDx. We acquired these assets for $15 million, which includes amounts previously accrued under the license agreement. These acquisitions reflect our confidence in the future of Cologuard, and we expect the investment will have a positive impact on our gross margin going forward.

I will now turn the call back to Kevin.

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Kevin T. Conroy, Exact Sciences Corporation - Chairman of the Board, CEO and President [5]

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Thanks, Jeff. Despite Cologuard's success today, it has captured about 2% share of the 80 million Americans in the U.S. colon cancer screening market since Cologuard was launched. This share is calculated using the total number of Cologuard tests over the last 36 months divided by the target population. We believe that we can capture at least 30% market share over time. To reach that target, we are continuing to educate health care providers about Cologuard and its benefits.

During the first quarter, 10,000 providers ordered their initial Cologuard tests, bringing us to 70,000 total providers. This includes about 56,000 of the over 200,000 active primary care providers in the United States. We are confident that new customers will continue to adopt Cologuard at a strong pace. We completed 100,000 Cologuard tests during the first quarter. Based on published prevalence rates, we estimate Cologuard helped detect approximately 450 early-stage cancers and over 600 total cancers during the quarter. That equates to a --- to 5 colon cancers every day at the earliest, most treatable stages. Cologuard is making an impact on patients' lives. Cologuard is a colon cancer screening test that is backed by a customer care and compliance service, which supports patient completion of our test. Cologuard's compliance rate remained at 67% during the first quarter. This compliance rate is significantly higher than the published compliance rates of colonoscopy and the FIT test. While this is consistent with the last 2 quarters, ongoing payer mix shift could cause the rate to drift lower temporarily.

As we look to the future, we see a path to 8 million or more Cologuard tests per year. We are investing in people and infrastructure to enable that growth. In the coming quarters, we'll expand our current lab and manufacturing capacity to 2 million tests per year, and establish additional space for our customer care team and other functions. The marketing, the manufacturing, lab and customer support teams have done a remarkable job handling the significant increase in volume. Similarly, our commercial team has been highly effective, and we want to congratulate them for increasing Cologuard test volume. A year ago, we asked the sales force to shift their focus to calling on an entire office. By embracing this shift, the team is driving increased adoption of Cologuard within our existing customer base. This intentional refocus is paying dividends. We've made this progress while the size of our field sales force has remained constant. Despite the success we've had and our base of ordering providers growing significantly, we will expand our sales force enabling our reps to reach more providers and accelerate Cologuard's growth. Our national television campaign has been a very effective complement to our sales force. We will refresh the ad content to ensure the campaign's success as it airs throughout the year.

Let's turn to insurance coverage now. The number of lives covered for Cologuard increased to almost 197 million in the first quarter. About 78% of Cologuard's addressable market is now covered. Our market access team is performing well and now focused on turning these positive coverage decisions into contracts, allowing patients to access Cologuard as an in-network benefit. It is important to note that it typically takes about a year to execute a payer contract following a positive coverage decision. It then often takes another year to educate providers and patients of the change.

Cologuard was recently added to the Medicare Advantage Star Ratings program. Medicare Advantage plans are eligible to receive quality credit for Cologuard tests completed since 2014, which can help increase their Star Rating. Star Ratings determine Medicare Advantage bonus amounts, which can meaningfully affect the financial performance of MA plans, systems and health care providers. It takes time for payers, health care systems and providers to respond to the new quality measures, so we expect a modest benefit from inclusion this year, with a larger benefit in the future.

Turning to our pipeline. We are fortunate to have a productive partnership with Mayo Clinic. Earlier this month, we collaborated to present promising data at AACR's annual meeting from our joint work on a blood-based lung cancer screening test or lung cancer test. The key takeaways from the studies, which were presented at AACR, include biomarkers in plasma that achieved high accuracy for all types and stages of lung cancer. Using 2 modeling approaches, a panel of 4 biomarkers demonstrated sensitivity of 91% to 96%, at a specificity of 90% to 94%. A test developed using these biomarkers could potentially identify high-risk lung nodules discovered on imaging, and in the long term, provide another screening option for lung cancer. We expect continued productivity from our collaboration with Mayo Clinic. Our goal is to save lives and save money for the overall health care system.

We're now happy to answer your questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from the line of Brian Weinstein with William Blair.

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Brian David Weinstein, William Blair & Company L.L.C., Research Division - Partner and Healthcare Analyst [2]

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So when we think about where you guys are right now, you have a lot of room still to go, obviously, with penetration. But if we -- we're kind of segmenting things into sort of like early adopters. How far through the early adopters are we at this point? And how does your sales and marketing strategy change going forward to get to the next level, because you're obviously penetrating things very, very quickly here?

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Kevin T. Conroy, Exact Sciences Corporation - Chairman of the Board, CEO and President [3]

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Yes, we are approximately 20% to 25% penetrated among primary care physicians and their assistants -- their physician assistants and nurses who are active in the offices. That is a good start. Obviously, we have a long way to go, and we've seen inconsistent weekly adoption. Over the long-term, the --- we believe the rational approach to screening is screening in the first instance with a noninvasive test and having positive results go to colonoscopy. And over time, we believe we'll be effective at changing the standard of care to Cologuard upfront and colonoscopy as a second test. Again, we don't believe that the FIT test is the right approach, given that the sensitivity difference for curable stage cancers is 94% for Cologuard and only 70% for the FIT test. We also believe that as time goes on, that the resources utilized by colonoscopy are better used as a reflex test to a positive Cologuard test, and that's where we're driving. We're now talking about 5, 10, even 15 years of growth as we work hard to make that shift, and we are at the very, very early part of that opportunity.

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Brian David Weinstein, William Blair & Company L.L.C., Research Division - Partner and Healthcare Analyst [4]

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Okay. And you mentioned that when you gave your total number of physicians that had signed up, I think there was 14,000 that were kind of outside of the primary care physician realm. Are you targeting these people? Or are they just coming in through the TV campaign? And is this an area that you would want to spend additional money and the time to go and target, and I'm assuming that we're talking like OB/GYNs, but is there any effort on that side?

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Kevin T. Conroy, Exact Sciences Corporation - Chairman of the Board, CEO and President [5]

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It's really a mix, Brian, of GIs, OB/GYNs and other specialists who not only order Cologuard, but continue to order it, despite the fact that we are not actively targeting those physicians. So they have patients, who they see, that are coming to them and asking for Cologuard, and we think that's promising. The area of focus is going to continue to be on primary care providers and their offices.

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Brian David Weinstein, William Blair & Company L.L.C., Research Division - Partner and Healthcare Analyst [6]

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Okay. Last question from me...

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Kevin T. Conroy, Exact Sciences Corporation - Chairman of the Board, CEO and President [7]

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Let me just add. So there is an opportunity over time, we think, to focus a little more intently in the GI space and the OB/GYN space, but that would happen down the road, not immediately.

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Brian David Weinstein, William Blair & Company L.L.C., Research Division - Partner and Healthcare Analyst [8]

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Okay. And last question for me. Can you guys talk about how some of the spending that you're doing now kind of factors into what the long-term financial model looks like? I mean, can you give us some idea about, as we look out several years, what your target margin structure was -- is going to look like for the company? There's been changes and a lot of good stuff going on over the last few years. So how is the long-term model sort of changed in light of maybe some increased spending and, also, product success?

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Jeffrey T. Elliott, Exact Sciences Corporation - CFO [9]

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Yes. Thanks for the question, Brian. So when you think about investments I would just say there that -- we feel very good about our positioning today, and we will make those, the prudent investments to up the scale of the business. We're only at 2% share, and over time we talked about getting to at least 30%. So we'll make the investments required to make that happen. At this point, we're not prepared to share the level of details around specific investments or amounts. As far as the long-term margin trajectory, we feel very good about our ability to get the gross margin to at least 70%. So I don't think anything's changed there. But we -- as time goes on, we've gained confidence in our ability to get to that level.

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Operator [10]

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And your next question comes from the line of Doug Schenkel with Cowen & Company.

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Douglas Anthony Schenkel, Cowen and Company, LLC, Research Division - MD and Senior Research Analyst [11]

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My first question is on really order rates. The completed order rate per physician went up from something like 1.38 in the fourth quarter to 1.43 in the first quarter by our math, and I know there are some error bars around those numbers, but directionally things improved, and that was in spite of the fact that first of all, Q1 can be slower seasonally, and second, you've added 20,000 new physicians or new practices over the last couple of quarters, and historically, the ramp and penetration of new practices takes time. So loss of adds can actually be a drag on this metric. So with those observations in mind, I have 3 questions: One, how did the Q1 order rate per physician come in relative to your expectations? Two, are new physicians ordering more frequently earlier on than they have in the past and if so why? And third, are you doing anything different this year than you have in the past to really focus on getting the order rate per practice up a little bit more quickly than has occurred historically?

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Kevin T. Conroy, Exact Sciences Corporation - Chairman of the Board, CEO and President [12]

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Doug, we have not -- we calculate the reorder rate differently than the simple math of the total number of providers in the quarter and the total number of tests completed, because we're actually using the actual order rate. It is an area of focus to call on an office, a total office call, to drive a change in the mindset around colon cancer screening, and that we have seen a pickup over the last 3 or 4 quarters, fairly consistent in the utilization rate among our customer base. This is something that we keep a close eye on, and we think that it -- over the long term, that we have a lot of room to grow here. But it's really being driven by the sales force's efforts to educate the entire office staff and the effectiveness of the television ed, and we expect that to continue over the long haul with clearly some variations quarter-to-quarter.

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Douglas Anthony Schenkel, Cowen and Company, LLC, Research Division - MD and Senior Research Analyst [13]

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Okay. Just to drill in a little bit more there, Kevin. Is that tracking ahead of plan or to plan? And again, I guess, the other important part of that question is, are new practices ramping more quickly than they have in the past, which could be for a variety of reasons, some of which you just mentioned.

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Kevin T. Conroy, Exact Sciences Corporation - Chairman of the Board, CEO and President [14]

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Yes -- you know, Doug, we're not just prepared to provide that level of detail at this point. It is something that internally we, again, keep a close eye on, but it is not something that -- it's not a number that we're putting out there publicly, and probably won't, as we look into the future.

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Douglas Anthony Schenkel, Cowen and Company, LLC, Research Division - MD and Senior Research Analyst [15]

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Okay, understood. One more quick one on -- regarding your second quarter guidance, we can get to 115,000 tests with no real change in orders per physician, compliance rates or practice additions per week, at least relative to your Q1 metrics. Is there any reason you're thinking you might lose momentum on any of these metrics? Or are you just being mindful of the fact that it's early in the year?

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Jeffrey T. Elliott, Exact Sciences Corporation - CFO [16]

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Thanks for the question, Doug. We're --- we feel good about the results in the first quarter. We gave you the guidance for the second quarter and for the full year. So we feel good about the positioning right now. We're not trying to signal anything about the momentum of the business. We look forward to talking to you about the second quarter in July. It is early in the second quarter, so I think I'll just -- I'll leave it at that.

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Operator [17]

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And your next question comes from the line of Brandon Couillard with Jefferies.

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Samuel Brandon Couillard, Jefferies LLC, Research Division - Equity Analyst [18]

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Kevin, could you give us an update on sort of the status of where you guys are in terms of trying to convert, shift more of the ordering to electronic from fax?

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Kevin T. Conroy, Exact Sciences Corporation - Chairman of the Board, CEO and President [19]

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I'll pass that over to Maneesh.

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Maneesh K. Arora, Exact Sciences Corporation - COO, SVP and Director [20]

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Sure, Brandon. We're pleased with the progress. I think that once last year we were included in the NCQA metrics and then, inclusion in the Stars metrics more recently. What that has done is, a lot of folks that had said, "Hey, this isn't as much of a priority," health systems who -- honestly for us to get this rate up meaningfully, we need to be able to partner with those health systems to make investments on their side for HL7 and changing their processes. And we have gotten just a different tone from those partners and those health systems. So the team that -- account management team that is working with those systems has done a fantastic job and we've seen more interest. So we have seen an uptick in electronic orders, but we have a long way to go. And this isn't a problem that's unique to Exact Sciences. It's a problem that's prevalent across the industry. We are pleased with the progress, but if we think about one of the key drivers that could be a material accelerator, it is going to be getting more physicians able to order electronically, and we still have the vast majority of our orders coming via fax. So it's a major priority for us this year. We are making progress.

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Samuel Brandon Couillard, Jefferies LLC, Research Division - Equity Analyst [21]

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And a 2 part question for Jeff. Number 1, could you give us the impact of -- to gross margins from your acquisition of that MDxHealth marker? And then how should we think about the OpEx or cash burn, as we move over the course of the year?

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Jeffrey T. Elliott, Exact Sciences Corporation - CFO [22]

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Yes. Thanks, Brandon. We're not going to get into the details of the MDx impact on gross margins other than saying that, if you look at our past filings, what we've said is that the --- the royalty there was in the low single digits as a percent of revenue. If you look ahead to the second quarter, overall cost per test, we expect about a $5 a test improvement compared to the first quarter. Part of that will be from MDx, part of that will be from volume leverage and part of that would be from ongoing cost controls, partially offset by some investments in the business. So about a $5 overall test -- per test improvement sequentially. I think the next question was on OpEx. There we're forecasting somewhere about a $5 million to $6 million increase versus the first quarter, with selling and marketing roughly flat, G&A up a little bit and most of the increase, really, coming from R&D. Part of that R&D increase would be timing, some of the first quarter spending flipped to the second quarter. In addition, we are making some continued investments in the pipeline, which will drive R&D a bit higher.

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Operator [23]

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And your next question comes from the line of Anne Edelstein with Bank of America.

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Anne Edelstein, BofA Merrill Lynch, Research Division - Research Analyst [24]

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Can you walk us through the MDx patent valuation exercise? Just because the $15 million purchase price seems low relative to your stated expectations for test volume growth going forward. So are there any other stipulations that we should be aware of for modeling?

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Jeffrey T. Elliott, Exact Sciences Corporation - CFO [25]

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Yes. Thanks for the question, Anne. We're not prepared to get into the details around that. $15 million is, as outlined in the filings, is what we paid but -- and I gave you the impact on cost per test, but we're not going to get into the details of that. We think it is -- we do think it is a fair valuation. And we also -- MDx put out a press release last night announcing a partnership, an R&D partnership, between the companies, but we're not prepared to get into the valuation exercise that we went through.

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Anne Edelstein, BofA Merrill Lynch, Research Division - Research Analyst [26]

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Okay. And then can you quantify the impact of, colorectal cancer screening months in March, given that you had the ads running this year but not last year? And also, speak to the benefit that you saw from more mild weather? I'm not really sure how that impacts -- how that would have benefited volumes? And then, finally, was there any impact to volume in your transition from cash to accrual-based revenue recognition?

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Jeffrey T. Elliott, Exact Sciences Corporation - CFO [27]

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See -- Ann, thanks for the question. Let me take that --- that last one first on the accrual shift. That had absolutely no impact on the volumes in the first quarter, that simply impacted the ASP. And really, the go forward, the full year impact of that is $10 to $12 a test.

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Maneesh K. Arora, Exact Sciences Corporation - COO, SVP and Director [28]

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And, Ann, this is Maneesh. I'll take the front half of that. And so -- obviously, we --- we're pleased with the results in the first quarter, as evidenced by the results and our increase in our estimates for the full year. And I think that's just -- that's a function of the mild weather, and also the fact that year-over-year we have seen another year of stability and a growing awareness and a growing customer base. So we are still -- the key thing is there are 80 million people, and as more people -- close to 1/4 of a million last year are getting screened, as they communicate with their friends, with their physicians, we see the commercial strategy at its very, very early stages just starting to work. I think that's evidenced in the increase in the estimates and in our outlook for the business for the year.

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Jeffrey T. Elliott, Exact Sciences Corporation - CFO [29]

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As far as the impact on -- from winter weather, there's no way to precisely quantify the exact impact. But we do know that in days where there are snowstorms, we do see a modest negative impact in parts of the country. And I think it's pretty clear that the winter weather was relatively mild for the country as a whole. So there was some modest impact, really impossible to quantify, but I thought about mentioning that today.

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Operator [30]

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And your next question comes from the line of Puneet Souda with Leerink Partners.

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Puneet Souda, Leerink Partners LLC, Research Division - Associate [31]

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So just if I could understand, I mean, what's your expectation as we go forward into the year for the doc ads? I mean, it was a run rate of 700, 750. So as you increased the spend on the TV ad and the return that you're getting on the patient ask, any color you can provide there would be helpful. And I just wanted to sort of understand also if you could provide any color on, if this --- the TV ads are changing the click rates that you're getting online and any distribution there of Facebook and Google versus the TV ad that you're getting? Any color there would be appreciated.

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Kevin T. Conroy, Exact Sciences Corporation - Chairman of the Board, CEO and President [32]

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Sure. So the one thing that's really important to note about the TV ad, and we've mentioned in the prepared remarks that we're going to be refreshing, but this -- the ad has been now running for a full year, and it's -- there's pretty well evidence that ads do have wearout, and so we will be making investments to refresh the campaign. But it's really, really difficult for us to -- it's --- this early in the year to say, "We're going to see a material change." We want to make sure, we're monitoring it really closely. So, obviously, we look closely every week at the new doc ad rate. It's really impossible for us to measure click throughs. What we can see is orders and new physicians, and we're making investments in refreshing the ad. Too early in the year to get more visibility or provide more visibility.

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Puneet Souda, Leerink Partners LLC, Research Division - Associate [33]

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Okay. And then, just one last one on --- some of the patients who had started in early in 2014, they're going to be coming up for a repeat of the test. As you have conversations and the sales force has those conversations with the accounts where you're deep, help us understand what those conversations are educating you in terms of the timing that these folks are going to be coming back? Anything there would be helpful.

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Kevin T. Conroy, Exact Sciences Corporation - Chairman of the Board, CEO and President [34]

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Yes. So no, I think it's great. I think we are still in kind of the first round of Cologuard, because Cologuard is indicated every 3 years. What's really important though is, in addition to the fact that there are 80 million Americans, there were a 100,000 patients that were tested with Cologuard in 2015 that will be due for screening in 2019 -- or 2018, excuse me. And so we will be actively outreaching to those physicians to promote those patients getting screened. This year, we're still in a cycle that we haven't gotten to that 3 years yet, but it is going to be an important part of the future trajectory.

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Operator [35]

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And your next question comes from the line of Catherine Schulte with Robert Baird.

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Catherine Walden Ramsey Schulte, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [36]

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When you think about the impressive volume [be it] this quarter, what were the main drivers there? I mean, when you gave guidance in late February with a 5-week turnaround, it seems like you had visibility into pretty much all of first quarter orders. So was the upside there mainly a result of more people returning their kits than you anticipated?

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Jeffrey T. Elliott, Exact Sciences Corporation - CFO [37]

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Thanks for the question, Catherine. We gave the compliance rate on the call about 67%, so that hasn't changed over the last few quarters. As far as the details of why we end up beating the guidance we put out there, let's just say we feel good about the whole overall condition of the business right now. When we give guidance in any quarter, there -- you may have visibility into orders, but there's still a long ways to go as far as getting the kits back and processing them in the lab. So it's not that we know exactly where our quarter is going to land at any point when we give guidance.

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Catherine Walden Ramsey Schulte, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [38]

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Okay. And then for the lab and manufacturing expansion to get to 2 million tests per year for your capacity. Can you talk a little bit more about the timing there, and what kind of investment that will require?

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Jeffrey T. Elliott, Exact Sciences Corporation - CFO [39]

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Yes. So the investments required to get the lab and operations up to 2 million tests a year, those are already underway, and we expect in the relatively near term to be at that level of capacity. As far as the level of investment, we're not prepared to share those details but I think it's safe to say we will make the prudent investments to scale the business. We're not just focused on getting to 2 million, we're focused on getting to at least a 30% share of this market. So we will continue to make the required investments to make that happen.

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Operator [40]

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And your next question comes from the line of Isaac Ro with Goldman Sachs.

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Isaac Ro, Goldman Sachs Group Inc., Research Division - VP [41]

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I just want to come back to the margin question. If I think about what you guys have said in the past about where gross margin would get to scale, it seems like you guys are kind of already in that range and yet, obviously, we're very early in the market adoption of the technology, and you also have the new tailwind here from the patent. So I'm curious if you can give us a sense of just again at a peak capacity, optimal market penetration kind of run rate, what gross margin can be? And I appreciate that's a longer-term question, and you don't want to necessarily give a ton of guidance, but I'll take any direction there because it seems to be an important swing factor to handicapping how and when you guys get to profitability.

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Jeffrey T. Elliott, Exact Sciences Corporation - CFO [42]

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Yes. Thanks for the question, Isaac. So if you'd look at the progress we've made on gross margin in recent quarters, we feel really good about the trajectory that we're on. I think it's important to note, in this quarter it's 65%. There was a few points of that were because of this accrual change. So really 62% on the basis that we had used in the prior quarter, so --- but even that is really good improvement. Long term, we think we can get it to at least 70% gross margin, with both ASP improving and the cost per test coming down. I think we've said historically, we see a path to get the cost per test down to the $125 range, and we continue to feel good about our ability to make that happen.

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Isaac Ro, Goldman Sachs Group Inc., Research Division - VP [43]

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Got it. And then just a follow-up on the long-term opportunity. Appreciate the math you guys took us through in the slides with regards to where this product can ultimately go. It's sort of 2-part question there. One is, if I think about the remaining payers who don't yet have coverage, can you just give us a sense if there's any appreciable percentage of covered lives where you're not in active discussions for coverage at this point? And then secondly, if I think about, once you guys get past that sort of single-digit penetration range, you get to more significant numbers. Did you guys assume any kind of change in the pricing construct? It just seems to me that as you approach a really significant percentage of the market, Medicare might say, hey, this is a pretty big line item in the context of what Medicare pays for diagnostics in the aggregate?

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Kevin T. Conroy, Exact Sciences Corporation - Chairman of the Board, CEO and President [44]

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So there's kind of 2 parts to that question. The most significant -- we're not going to comment on any individual payers. But rest assured, we are in active dialogue and conversations with every payer that has covered about a contract and anyone that is not --- that has not issued positive coverage. So we are having those conversations. I'll turn it back to Kevin to talk about the pricing question.

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Jeffrey T. Elliott, Exact Sciences Corporation - CFO [45]

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All right. So the Medicare price in the future will be determined statutorily under the PAMA Act, and that will be based off the median price of the commercial payers. So there is a mechanism for that price to move and it's by statute, not by any other method. But the bigger point there is that by screening people --- well, right now Medicare pays about 75% of the nearly $20 billion in treating colon cancer. Colon cancer is one of the most expensive cancers to treat, and Medicare is paying the price for that. We think, over time, the total cost comes down that Medicare pays when you look at screening and treatment combined and obviously, the human impact is significant.

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Operator [46]

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And your next question comes from the line of Kevin Ellich with Craig-Hallum.

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Kevin Kim Ellich, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [47]

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A lot of my questions have been answered, but just wondering if you could give us some takeaways from your TV advertising, and have you been able to refine that message? It appears to us that we've seen an uptick in the number of ads in the last couple of months. Should we expect that to continue? Thoughts on that front.

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Jeffrey T. Elliott, Exact Sciences Corporation - CFO [48]

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Sure. So we stated earlier, we're really pleased with the effect that the TV ad is having, and the real insight there when the ad was developed was around colon cancer, today for the last 20 years, just being a hassle and how Cologuard really fits in with people's lives. And it makes it really, really easy and approachable, a topic that's difficult to discuss. So you will see enhancements, but that message is really resonating with patients, and it's causing them to act and talk to physicians. So you can expect to see consistency for the rest of the year on both the messaging with a campaign refresh.

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Kevin Kim Ellich, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [49]

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Got you. And then, I might have missed this, but when you guys were talking about the Medicare Stars inclusion in your prepared remarks, have you been able to notice an impact already based on the inclusion? Or is it too soon for that?

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Jeffrey T. Elliott, Exact Sciences Corporation - CFO [50]

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It's really too soon. I mean, one of the things that it's important to take away from Kevin's remarks are the fact that, when changes happen, for them to actually get operationalized over the long term -- this is a long-term gain, and it'll take some time. We expect a modest impact to this year, but the real impact will be in 2018 and in the future.

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Kevin Kim Ellich, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [51]

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Obviously. And then lastly, you gave some good commentary on insurance coverage. We saw Aetna come in. And the number of covered lives, 197 million in Q1, 78% covered. Just wondering how much of that is in-network versus out-of-network, as you said it takes about a year to turn that into contract?

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Jeffrey T. Elliott, Exact Sciences Corporation - CFO [52]

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So the vast majority of it today, because most of this coverage is relatively new, is not in network. We do have a number of contracts. We're not going to speak to the specifics of it, but it does take time, and that's what we're working on this year is getting it, getting every contract -- for everyone that has positive coverage, getting a contract that's in-network.

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Operator [53]

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And your next question comes from the line of Mark Massaro with Canaccord Genuity.

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Mark Anthony Massaro, Canaccord Genuity Limited, Research Division - Senior Analyst [54]

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My first one is on the cash utilization. It picked up a little in the quarter. And I know in the press release you talked about a higher TV ad spend and personnel additions. Is there any way you could parse out what -- if you were to take the full uptick in cash utilization, just to parse out, maybe in buckets, TV versus sales and marketing versus maybe headcount in your R&D, that would be helpful.

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Jeffrey T. Elliott, Exact Sciences Corporation - CFO [55]

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Yes. Thanks for the question, Mark. We're not going to get into that level of granularity, but I think it's safe to say that the $8 million sequential increase in OpEx drove most of that sequential increase in cash burn. There were a few things on the balance sheet, but the most part is the increase in OpEx. And you can see, I think if you look at the P&L line items, you can get a pretty good sense on the biggest factors. The Q has some additional details as far as which -- what buckets drove that increase.

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Mark Anthony Massaro, Canaccord Genuity Limited, Research Division - Senior Analyst [56]

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Great. And maybe a question for Kevin. Kevin, can you just speak to what we maybe can be looking for throughout the course of 2017 in terms of data, beyond lung nodules, you had excellent data at AACR. But as we think about your development of liver and pancreatic and perhaps other cancerous states, is it too soon to maybe expect something at ASCO? Or should we be thinking out later in the year?

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Kevin T. Conroy, Exact Sciences Corporation - Chairman of the Board, CEO and President [57]

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It's likely to be later in the year. The focus right now is on continuing to get data across a number of different cancers, sensitivity and specificity, kind of proof-of-concept data through our collaboration with the Mayo Clinic. We --- our relationship with the Mayo Clinic has deepened across a number of different investigators in their oncology groups, from breast cancer to liver cancer to colon cancer and beyond, it's --- and that is the area of focus. I think this is going to drive just a host of publications, presentations, abstracts as you look out over the next couple of years. And so we're excited to be able to present that data. But we don't have clarity right now in terms of the specific conferences that we'll be presenting at this year.

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Operator [58]

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And your next question comes from the line of Raymond Myers with Benchmark.

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Raymond Alexander Myers, The Benchmark Company, LLC, Research Division - Research Analyst [59]

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Congratulations on achieving your reimbursement goals in 2016, and now achieving very significant revenue so early in 2017. So we think next to thinking about, when might you anticipate Exact Sciences becoming profitable? How far in the future is that?

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Jeffrey T. Elliott, Exact Sciences Corporation - CFO [60]

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Yes, thanks for the question, Ray. You know, when we look out over the next 5 years, we do see a very clear path to profitability with Cologuard and the balance sheet that we have today. As far as specific timing, we're not prepared to get into that level of detail today. But it's safe to say that within that 5-year model, we do see a very clear path to profitability.

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Raymond Alexander Myers, The Benchmark Company, LLC, Research Division - Research Analyst [61]

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Okay. And next, can you tell us how many direct salespeople are you employing now?

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Kevin T. Conroy, Exact Sciences Corporation - Chairman of the Board, CEO and President [62]

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We have in the past provided a great deal of clarity around that, and we --- going forward, we'll probably provide less clarity. Our philosophy, as we look through this year, is as we -- if we continue to overdeliver, we'll probably take some portion of that and put it into our commercial organization to ensure the long-term growth of Cologuard. And we know the commercial team is doing a tremendous job. One thing that I think is worth noting is that the commercial team has been intact for about 2 years. The leadership within the commercial team is very strong. The reps are very strong. And so now we feel more confident about the ability to add both inside sales professionals and people directly in the field and see productivity, in part because of the strong training, the strong management leadership and also the peer-to-peer support that is occurring. Maneesh and the entire commercial team have created this culture of just a burning desire to change the screening paradigm, and a proof point of this is that 40 -- now 45% of people who have received a Cologuard test today, 45% have never been screened before. I think that's a testament to what the commercial organization is doing, and it justifies an expansion of that team.

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Raymond Alexander Myers, The Benchmark Company, LLC, Research Division - Research Analyst [63]

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Okay, great. And part of the reason I asked the question was to understand where the sales and marketing spend level might flatten out. How high do you think that will get over the next few years?

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Kevin T. Conroy, Exact Sciences Corporation - Chairman of the Board, CEO and President [64]

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Well, Ray, there is an opportunity over time. We have talked about this, to add additional products that would help make the call point more productive, and over time build a franchise calling on primary care physicians. So it's hard to say where that would flatten out. The goal, obviously, is to become profitable, make that a very, very efficient and impactful sales force with a conversation that physicians want to have. We do get a fair amount of time with physicians and their office staff, and that will provide us with a unique advantage in that primary care office as we look at our business over the coming years.

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Raymond Alexander Myers, The Benchmark Company, LLC, Research Division - Research Analyst [65]

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Great. And just one last question if I could. After Cologuard, which indication do you expect has the potential to be commercialized next?

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Kevin T. Conroy, Exact Sciences Corporation - Chairman of the Board, CEO and President [66]

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What we have talked about initially is the lung cancer test that would first help distinguish between benign lung nodules and lung cancer. There are a host of opportunities, and it's a good question. The team right now is working on the very important decision as to where we will make the next investment in significant clinical trials and market development. And that decision, we're leaning towards the lung nodule test, but we are also looking at other opportunities based upon the data that we get from the collaboration with the Mayo Clinic.

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Operator [67]

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And your next question comes from the line of Chris Lewis with Roth Capital Partners.

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Christopher William Lewis, Roth Capital Partners, LLC, Research Division - Senior Research Analyst [68]

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Just wanted to go back to ASPs for a second. If I do the math, it implies ASPs, it looks like of around $410 over kind of each quarter over the remainder of the year to get to the midpoint for $425 for the full year. If I take away the one-time accrual this quarter and just look at where second half of '16 ASPs were, it looks like it was above that implied level over the remainder of this year. So can you kind of help us understand the puts and takes of your ASP assumptions in the guidance?

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Jeffrey T. Elliott, Exact Sciences Corporation - CFO [69]

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Sure. We would be happy to, Chris. So the full year guidance implies a range of $415 to $435 a test. At the midpoint, I think it's important to note that that's $17 above the full year 2016 level. We do continue to expect improvement over time, but we are experiencing a rapid growth in the commercial mix on our business, which does put a temporary downward impact on the overall rate, and the midpoint of the range is also $7 above the time lagged ASP that we talk about in our 10-Q. That time lag figure is basically how much we collect on a trailing 12-month basis and we calculate that after a 6-month lag period to allow us to collect. So when you think about the full year impact, we're still guided to a really nice increase, both above the 2016 level and the time lag level. But the growing mix of commercial can put some downward pressure, and let's just face it, it is early in the year. And we're focused on a really nice level of improvement for the full year.

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Christopher William Lewis, Roth Capital Partners, LLC, Research Division - Senior Research Analyst [70]

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Got you. Are there other payers in the mix that you expect will transition to accrual from cash basis over the remainder of this year? And have you accounted for that in the guidance?

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Kevin T. Conroy, Exact Sciences Corporation - Chairman of the Board, CEO and President [71]

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Sure. So the change that we made in the first quarter was, we did shift the remainder -- really the vast majority of the remainder of all payers over to an accrual basis, really based on the experience we have, the predictability we've now gained. So we're essentially at a full accrual basis now.

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Christopher William Lewis, Roth Capital Partners, LLC, Research Division - Senior Research Analyst [72]

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Okay, great. And Kevin, maybe just one for you. You highlighted a goal to get to 30% penetration of the addressable market on a patient perspective over time from, I think, the 2% level you pointed out today. Looking at it from a provider perspective, you talked about 20% to 25% current penetration of the primary care base. Can you kind of share with us what you see as a rated -- reasonable penetration rate, just within that provider base over time?

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Kevin T. Conroy, Exact Sciences Corporation - Chairman of the Board, CEO and President [73]

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Sure, Chris. We think over time that you get to at least 75% of those providers, and the 200,000 number is a number that is derived from people who are actively prescribing statins in the primary care segment. So there are actually more primary care physicians than that 200,000-plus. On top of that you have physician assistants and nurse practitioners et cetera that could drive that north. So it may be that we're actually less penetrated. We'll see how this plays out over time. We do know -- and I think looking at it, this, from a higher level, that when you looked at colonoscopy, when you looked at the adoption of the FIT test, those trajectories were measured in over a decade, and it's just a consistent uptake over time. It is -- a --- we believe that Cologuard has a long period of time. It takes a long time for other potential market entrants to develop the evidence and to get into the guidelines, and to get into the USPSTF guidelines, and to get FDA approval and, importantly, Medicare coverage. So we believe we have a long period of time to continue to invest and to make a difference in colon cancer screening, and we're excited about that opportunity.

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Operator [74]

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And your next question comes from the line of Kevin Ellich with Craig-Hallum.

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Kevin Kim Ellich, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [75]

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I just had one quick follow-up, forgot to ask when I was on before. On the balance sheet, accounts receivable almost doubled sequentially. Was that primarily or all completely due to the shift to accrual accounting?

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Jeffrey T. Elliott, Exact Sciences Corporation - CFO [76]

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Yes, the accrual shift that we had, we called out the $4.3 million impact on the P&L, and largely that -- you'll see that flow into the balance sheet. So you're right that the majority of that has to do with the change or the shift to accrual accounting as well as just underlying growth in the business, you will see that as the business grows.

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Kevin Kim Ellich, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [77]

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Okay. And then, that led to about a 8-day increase in DSO sequentially. Was there anything else that affected that increase? And how should we think about DSO going forward, now that you've shifted to accrual?

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Kevin T. Conroy, Exact Sciences Corporation - Chairman of the Board, CEO and President [78]

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Yes. So the DSO that you can calculate on our financials is really -- is not really a meaningful number yet, given that you've given the transition and given that there is -- there are still some tests outstanding that we're working to collect on. So I would just caution against the -- looking too much into the DSO today, until we get to a full run rate basis on the accrual side. So there's been no shift in the underlying trends that we can see in the receivables. And we continue to -- after 180 days, we continue to fully reserve against anything that's still outstanding. So there's been no underlying changes in the health of our receivables.

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Operator [79]

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And your next question comes from the line of Anne Edelstein with Bank of America.

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Anne Edelstein, BofA Merrill Lynch, Research Division - Research Analyst [80]

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Had the same question, so I'm good.

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Operator [81]

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And your next question comes from the line of Bruce Jackson with Lake Street Capital.

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Bruce David Jackson, Lake Street Capital Markets, LLC, Research Division - Senior Healthcare Research Analyst [82]

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Looking at the revenue recognition and the accrual rates, I'm assuming that, with the Medicare business, that essentially all of that is on -- being booked on an accrual basis. What percentage of the commercial business is currently being booked on an accrual basis?

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Jeffrey T. Elliott, Exact Sciences Corporation - CFO [83]

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Yes. Thanks, Bruce. So let me be clear that the -- all classes of payers for us are effectively on an accrual basis, but that doesn't mean we accrue at the full rate, necessarily. So what you'll see over time, and what I talked about expecting the increase in the total ASP over time, part of that will be, as we experience improved collections, we expect over time that we'll be able to raise the rate at which we accrue. But for all classes of payers, we now recognize revenue on an accrual basis.

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Bruce David Jackson, Lake Street Capital Markets, LLC, Research Division - Senior Healthcare Research Analyst [84]

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Okay. And then moving -- so with the -- moving over to the, what you guys call the pipeline. The previously performed tests that were expensed but not booked. With the $4 million that you recognized this quarter, is that the last of the catch-up payments that we're going to see from the previously performed tests?

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Jeffrey T. Elliott, Exact Sciences Corporation - CFO [85]

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No, it is not. We continue to work to collect on previously unpaid amounts. But that is not the full amount. We don't expect another big one-time catch-up because we did shift to the full accrual basis.

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Bruce David Jackson, Lake Street Capital Markets, LLC, Research Division - Senior Healthcare Research Analyst [86]

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Okay. And then a last question. What was the revenue mix this quarter between Medicare and commercial?

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Jeffrey T. Elliott, Exact Sciences Corporation - CFO [87]

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Yes, the way we've historically talked about this is really on the volume side. The Medicare percent of mix ticked down a few points this quarter, but we haven't technically broke out the revenue side.

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Operator [88]

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And that concludes today's question-and-answer session. I would now like to turn the call over to Kevin Conroy, Chairman and CEO of Exact Sciences Corporation for closing remarks.

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Kevin T. Conroy, Exact Sciences Corporation - Chairman of the Board, CEO and President [89]

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Thanks, again, for joining us on today's call. We continue to make strong progress as we work to establish Cologuard as the standard of care for colon cancer screening. We know there is significant runway for Exact Sciences and Cologuard, and we look forward to providing you with updates, as we work to capture more of the colon cancer screening opportunity. A special thanks to the entire team at Exact Sciences who are totally engaged in our goal of playing a role in the eradication of colon cancer. Thanks for joining us on this morning's call.

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Operator [90]

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And that concludes today's conference call. You may now disconnect.