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Exact Disappoints Investors With Cost Restructuring Plan; Seeks M&A Partner

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After laying off most of its R&D staff and suspending a clinical trial for its Version 2 stool-based colon cancer test last week, Exact Sciences officials said the company’s top priority is finding an M&A partner who can bail it out of its cash flow problems.
 
In a call to explain Exact’s strategic decisions to investors, several of whom expressed disappointment at the company’s decision to not raise capital, CEO Jeffrey Luber maintained that “finding a strategic partner is our priority, and so we made the difficult decision to suspend [the clinical trial for] our Version 2 technology and eliminate eight positions within the company.”
 
In November, the US Food and Drug Administration warned the firm that its PreGen-Plus stool-based colorectal cancer assay is a medical device that requires premarket approval. At the time, the agency charged that the homebrew cancer assay, which the company claimed was developed by the Laboratory Corporation of America, was in fact developed by Exact [see PGx Reporter 01-23-2008]. 
 
Earlier this month, Exact announced that after discussions with the FDA, it would submit a second version of the PreGen Plus test to the agency for 510(k) clearance with a “minimum of 25 acceptable CRC cases.” The prospective, multi-center trial was expected to take nine months and cost between $6.5 million and $8.5 million. It was to involve 30 participating sites in the US and Canada and screen up to 5,000 asymptomatic individuals aged 50 or older with an average risk for developing colorectal cancer.
 
However, only a week after this announcement, Exact suspended the trial, a decision that followed the threat of delisting of its shares from the Nasdaq exchange, and LabCorp’s launch of ColoSure, a single-gene marker stool-based colon cancer test that is based on Exact’s intellectual property [see PGx Reporter 07-16-2008, 07-16-08].
 
Exact officials said during the call that the firm decided not to raise capital after it received notice that it is not in compliance with the Nasdaq Global Market’s listing requirement of a minimum $40 million market capitalization.
 
“Based on current market conditions and the delisting notice that we received from the Nasdaq, based on our market capitalization, funding our FDA clinical study became a very expensive prospect, given the likely cost of capital, and we didn’t believe that raising capital was in the best interest of shareholders,” Luber said during the call.
 
“We didn’t want to have that kind of diluted impact on shareholders.”
 
However, some investors did not buy Luber’s line of reasoning and suggested during the call that Exact was forced to take cost-cutting measures because it could not successfully raise capital amid regulatory uncertainty of its Version 2 test.
 
Still, Luber maintained that the company had made the right strategic decision to cut costs and focus on finding an M&A partner. According to Luber, with more clarity from the FDA on the type of study required for its Version 2 test and the launch of LabCorp’s homebrew ColoSure test, the company is in a good position to attract a strategic partner.
 
Exact did not respond to queries regarding its restructuring plan.
 
On July 17, the day Exact announced its restructuring plans, its stock price fell 14 percent from $1.05 to $0.90. The next day, following the conference call with investors, shares plunged another 21 percent to close at $0.71.
 
Highlight the Positive
 
Under the terms of its agreement with LabCorp, Exact receives a 15-percent royalty associated with the sale of the ColoSure test. LabCorp has rights to market only the homebrew version of the test in the US and in Canada; it does not have FDA kit rights to the product.
 
Luber emphasized that LabCorp’s ColoSure, although it relies on the vimentin DNA marker, to which Exact holds a worldwide exclusive license from Case Western Reserve University , does not rely on the “component that was part of the FDA’s prior inquiries,” which related to the multiple-marker PreGen Plus assay.
 
In its warning letter to Exact, the FDA said “information collected at LabCorp indicates Exact has provided instructions for use, validation information, and performance claims to LabCorp for the PreGen-Plus assay. In addition, equipment and reagents that are required for the test are specified by Exact (and, in some cases, provided by Exact), including the single and double Unit ‘Extractors’ for sample preparation.” 
 

”[F]unding our FDA clinical study became a very expensive prospect, given the likely cost of capital, and we didn’t believe that raising capital was in the best interest of shareholders.”

During the call, Luber attempted to distance ColoSure from the controversial PreGen Plus assay by suggesting that the latter test, based on 23 genetic markers, was more complex and “very different” from LabCorp’s single-marker test. He highlighted that ColoSure was easier to use than PreGen Plus and could boost laboratory efficiency.
 
However, there is little certainty whether doctors will adopt the test and whether insurers will reimburse for it.
 
In its 2008 treatment guidelines for early detection of colorectal cancer, the American Cancer Society recommended stool-based DNA tests as a viable option for those who prefer not to undergo a more invasive screening procedure, such as colonoscopy.
 
The ACS noted, “with the exception of the newly added tests, Medicare and most insurers already cover most or all colorectal cancer screening tests. Based on these recommendations from the ACS and those of other organizations, it is conceivable that major insurance plans will begin to cover the added tests (CT colonography, and stool DNA).”
 
Attempting to boost investors’ confidence in ColoSure’s market success, this is exactly what Exact officials highlighted during the call.
 
“The ColoSure test is being offered into one of the largest diagnostic markets in history: those unwilling or unable to obtain a colonoscopy,” Luber said. “More than half of 90 million Americans over age 50 have never been screened for colon cancer, many of whom are simply unable or unwilling to engage in an invasive procedure,” he said.
 
“Non-invasive screening can bring more people into a screening program,” he added.
 
Value Creation
 
According to Luber, Exact will try to woo potential suitors by highlighting the company’s partnerships with collaborators and licensors.
 
For instance, Exact has a collaboration with Johns Hopkins University’s Bert Vogelstein, who has pioneered a technology called BEAMing, which stands for beads, emulsion, amplification, and magnetics. BEAMing is a type of assay that provides the equivalent of millions of wells in a single test tube.
 
In the procedure, following the pre-amplification of a population of DNA fragments, individual beads bound to primers are confined into individual compartments of a water-in-oil emulsion. PCR is used to amplify the single molecules on the bead. Once the emulsion is broken, it transforms a population of molecules to a population of beads in a roughly one-to-one ratio.
 
Luber believes that Vogelstein’s BEAMing technology has the ability to detect exceedingly rare molecules associated with colon cancer.
 
“It is this technology … which will be key to pushing the performance [of Exact’s technology] even higher over time, and potentially could be the basis for strong adenoma detection,” Luber said.
 
BEAMing, in Luber’s opinion, “could completely change the screening landscape,” and possibly position stool-based colon cancer testing as a valid alternative to colonoscopy, which is the gold standard for detecting adenomas.
 
Additionally, studies have shown that the stool could harbor markers for other gastro-intestinal cancers, and therefore, there is an opportunity for Exact to expand the indication for its technology beyond colon cancer.
 
“Mutations for other cancers such as esophageal, stomach, [and] small bowel might have markers that can be detected in stool,” Luber noted, adding that potential partners would have the option of expanding Exact’s technology into other cancer indications.
 
No Exec Bonuses?
 
In letting go of eight staffers, Exact got rid of most of its R&D division. Exact expects to record restructuring charges of between $200,000 and $400,000 in the third quarter of 2008 connected to employee termination benefits.
 
However, the lack of an R&D department didn’t seem to concern Luber, who suggested that having launched ColoSure, and with the clinical trial for its Version 2 of PreGen Plus on hold indefinitely, there is no need for an internal R&D shop, and that the company could outsource any research work that it needs.
 
“Frankly, it’s not something I spend a lot of time worrying about,” Luber told investors. R&D is something that’s “readily staffable.”
 
This is the company’s third cost restructuring effort, following similar moves in October 2006 and July 2007. According to a 10-K filing with the US Securities and Exchange Commission, the 2006 restructuring eliminated 21 positions across all departments, comprising 48 percent of the company’s staff. 
 
In the 2007 restructuring, Exact eliminated its sales and marketing functions, terminated six employees, and subleased a portion of its corporate headquarters.
 
When asked by one investor whether amid these layoffs and cost-cutting measures the company’s senior executives would also see a cut in salary raises and bonuses, Luber appeared to avoid directly answering the question.
 
“If you want to talk about the achievements over the last few months, I stand behind a lot of those great achievements, because we got great people,” Luber said. “All costs are being assessed across the board and they will be continued to be assessed.”
 
However, Exact’s most recent 10-K filing with the SEC provides some insight into the company’s past salary and bonus commitments with top-level employees.
 
For instance, former CEO Don Hardison was paid an annual salary of $360,000 and was eligible to earn an annual retention bonus in the amount of $200,000 at the start of 2007 and 2008, if he was still employed by the company. Hardison resigned as Exact’s CEO in July 2007, which meant that he earned his 2007 bonus, but the company retained his 2008 bonus.
 
According to a 14A filing with the SEC, Exact increased cash compensation levels for Luber and chief financial officer Charles Carelli in 2007 from 2006 levels. As of July 18, 2007, Luber’s base salary increased from $245,000 to $285,000, and Carelli’s base compensation from $180,000 to $215,000. 
 
“Both of these increases were the result of promotions and an expansion of responsibilities” due to reduction of staff, the company said in its filing.
 
In addition, for meeting certain corporate goals and for gaining inclusion of Exact’s colorectal cancer screening technology in national treatment guidelines, Luber and Carelli were awarded total cash incentive bonuses of $140,000 and $100,000, respectively, in 2007. Also in connection with their promotions last July, Luber and Carellli were granted additional stock options to acquire 250,000 and 100,000 shares, respectively.
 
In light of the current restructuring, it is unclear what the company’s payment and bonus structure is for the coming year.
 
According to the company, the layoffs and cost-cutting measures will extend existing cash through at least the second quarter of 2009. Furthermore, Exact is in discussions to adjust the timelines for other fixed commitments, hoping to stretch its existing cash for a longer period.

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