(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation

The accompanying consolidated financial statements include the accounts of the Company’s wholly-owned subsidiaries, Exact Sciences Laboratories, LLC, Exact Sciences Finance Corporation, Exact Sciences Europe LTD, and variable interest entities. All significant intercompany transactions and balances have been eliminated in consolidation.

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

Use of Estimates

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Cash and Cash Equivalents

The Company considers cash on hand, demand deposits in bank, money market funds, and all highly liquid investments with an original maturity of 90 days or less to be cash and cash equivalents. The Company had no restricted cash at March 31, 2015 and December 31, 2014.

Marketable Securities

Management determines the appropriate classification of debt securities at the time of purchase and re-evaluates such designation as of each balance sheet date. Debt securities carried at amortized cost are classified as held-to-maturity when the Company has the positive intent and ability to hold the securities to maturity. Marketable equity securities and debt securities not classified as held-to-maturity are classified as available-for-sale. Available-for-sale securities are carried at fair value, with the unrealized gains and losses, net of tax, reported in other comprehensive loss. The amortized cost of debt securities in this category is adjusted for amortization of premiums and accretion of discounts to maturity computed under the straight-line method, which approximates the effective interest method. Such amortization is included in investment income. Realized gains and losses and declines in value judged to be other-than-temporary on available-for-sale securities are included in investment income. The cost of securities sold is based on the specific identification method. Interest and dividends on securities classified as available-for-sale are included in investment income.

At March 31, 2015 and December 31, 2014, the Company’s investments were comprised of fixed income investments and all were deemed available-for-sale. The objectives of the Company’s investment strategy are to provide liquidity and safety of principal while striving to achieve the highest rate of return consistent with these two objectives. The Company’s investment policy limits investments to certain types of instruments issued by institutions with investment grade credit ratings and places restrictions on maturities and concentration by type and issuer. Investments in which the Company has the ability and intent, if necessary, to liquidate in order to support its current operations (including those with a contractual term greater than one year from the date of purchase) are classified as current. All of the Company’s investments are considered current. There were no realized losses for the three months ended March 31, 2015 and 2014. Realized gains were $3.0 thousand and $6.3 thousand for the three months ended March 31, 2015 and 2014, respectively. Unrealized gains or losses on investments are recorded in other comprehensive loss.

We periodically review our investments in unrealized loss positions for other-than-temporary impairments. This evaluation includes, but is not limited to, significant quantitative and qualitative assessments and estimates regarding credit ratings, collateralized support, the length of time and significance of a security’s loss position, our intent not to sell the security, and whether it is more likely than not that we will have to sell the security before recovery of its cost basis. For the three months ended March 31, 2015, no investments were identified with other-than-temporary declines in value.

Available-for-sale securities at March 31, 2015 consisted of the following:


	March 31, 2015
			Gains in Accumulated		Losses in Accumulated
			Other Comprehensive		Other Comprehensive		Estimated Fair
(In thousands)	Amortized Cost		Income		Income		Value
Corporate bonds	$	133,395	$	59	$	(16)	$	133,438
U.S. government agency securities		14,151		7		—		14,158
Asset backed securities		52,850		37		(8)		52,879
Commercial paper		3,996		1		—		3,997
Total available-for-sale securities	$	204,392	$	104	$	(24)	$	204,472

Available-for-sale securities at December 31, 2014 consisted of the following:


	December 31, 2014
			Gains in Accumulated		Losses in Accumulated
			Other Comprehensive		Other Comprehensive		Estimated Fair
(In thousands)	Amortized Cost		Income		Income		Value
Corporate bonds	$	141,239	$	21	$	(136)	$	141,124
U.S. government agency securities		18,687		8		(7)		18,688
Certificates of deposit		60,821		17		(18)		60,820
Commercial paper		3,993		—		—		3,993
Total available-for-sale securities	$	224,740	$	46	$	(161)	$	224,625

Changes in Accumulated Other Comprehensive Income (Loss)

The amounts recognized in accumulated other comprehensive income (loss) (AOCI) for the three months ended March 31, 2015 were as follows (in thousands):


					Accumulated
	Cumulative		Unrealized		Other
	Translation		Gain (Loss)		Comprehensive
	Adjustment		on Securities		Income (Loss)
Balance at December 31, 2014	$	—	$	(115)	$	(115)
Other comprehensive (loss) income before reclassifications		(10)		192		182
Amounts reclassified from accumulated other comprehensive loss		—		3		3
Net current period change in accumulated other comprehensive income (loss)		(10)		195		185
Balance at March 31, 2015	$	(10)	$	80	$	70

The amounts recognized in AOCI for the three months ended March 31, 2014 were as follows (in thousands):


					Accumulated
	Cumulative		Unrealized		Other
	Translation		Gain (Loss)		Comprehensive
	Adjustment		on Securities		Income (Loss)
Balance at December 31, 2013	$	—	$	125	$	125
Other comprehensive (loss) income before reclassifications		—		14		14
Amounts reclassified from accumulated other comprehensive loss		—		(6)		(6)
Net current period change in accumulated other comprehensive income (loss)		—		8		8
Balance at March 31, 2014	$	—	$	133	$	133

Amounts reclassified from accumulated other comprehensive income (loss) for the three months ended March 31, 2015 were as follows (in thousands):


	Affected Line Item in the	Three Months Ended March 31,
Details about AOCI Components	Statement of Operations	2015		2014
Change in value of available-for-sale investments
Sales and maturities of available-for-sale investments	Investment income	$	3	$	(6)
Total reclassifications		$	3	$	(6)

Property and Equipment

Property and equipment are stated at cost and depreciated using the straight-line method over the assets’ estimated useful lives. Maintenance and repairs are expensed when incurred; additions and improvements are capitalized. The estimated useful lives of fixed assets are as follows:


		Estimated
Asset Classification		Useful Life
Laboratory equipment		3 - 5 years
Computer equipment and computer software		3 years
Leasehold improvements		Lesser of the remaining lease term or useful life
Furniture and fixtures		3 years

At March 31, 2015, the Company had $2.9 million of assets under construction which consisted of $1.6 million of capitalized costs related to software projects, $0.9 million of costs related to machinery and equipment, and $0.4 million of costs related to leasehold improvement projects. Depreciation will begin on these assets once they are placed into service. We expect to incur minimal costs to complete the leasehold improvement, machinery and equipment, and the software projects, and these projects are expected to be completed in 2015.

Software Capitalization Policy

Software development costs related to internal use software are incurred in three stages of development: the preliminary project stage, the application development stage, and the post-implementation stage. Costs incurred during the preliminary project and post-implementation stages are expensed as incurred. Costs in the application development stage that meet the criteria for capitalization are capitalized and amortized using the straight-line basis over the estimated economic useful life of the software.

Net Loss Per Share

Basic net loss per common share was determined by dividing net loss applicable to common stockholders by the weighted average common shares outstanding during the period. Basic and diluted net loss per share are the same because all outstanding common stock equivalents have been excluded, as they are anti-dilutive due to the Company’s losses.

The following potentially issuable common shares were not included in the computation of diluted net loss per share because they would have an anti-dilutive effect due to net losses for each period:


	March 31,
	2015	2014
Shares issuable upon exercise of stock options	5,222	6,261
Shares issuable upon exercise of outstanding warrants(1)	—	155
Shares issuable upon the release of restricted stock awards	2,305	1,519
Shares issuable upon the vesting of restricted stock awards related to licensing agreement	24	49
	7,551	7,984

(1)

At March 31, 2014, represents warrants to purchase 80,000 shares of common stock issued under a license agreement and warrants to purchase 75,000 shares of common stock issued under a consulting agreement.

Revenue Recognition

Laboratory Service Revenue. The Company’s revenues will be generated primarily by the Cologuard test. Revenues are recognized when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the price is fixed or determinable, and collectability is reasonably assured. The Company assesses whether the fee is fixed or determinable and if the collectability is reasonably assured based on the nature of the fee charged for the laboratory services delivered and whether there are existing contractual arrangements with customers, third-party commercial payors (insurance carriers and health plans) or coverage of the test by Centers for Medicare & Medicaid Services (CMS). In addition, when evaluating collectability, the Company considers factors such as collection experience for the healthcare industry, the financial standing of customers or third-party commercial payors, and whether it has sufficient collection history to reliably estimate a payor's individual payment patterns.

A significant portion of laboratory service revenues earned by the Company will be initially recognized on a cash basis because the above criteria will not have been met at the time the test results are delivered. The Company generally bills third-party payors upon generation and delivery of a test result to the ordering physician following completion of a test. As such, the Company takes assignment of benefits and risk of collection with the third-party payor. Patients may have out-of-pocket costs for amounts not covered by their insurance carrier and the Company bills the patient directly for these amounts in the form of co-pays and deductibles in accordance with their insurance carrier and health plans. Some third-party payors may not cover the Cologuard test as ordered by the physician under their reimbursement policies. Consequently, the Company pursues reimbursement on a case-by-case basis directly from the patient.

For laboratory services performed, where the collectability is not reasonably assured, the Company will continue to recognize revenues upon cash collection until it can reliably estimate the amount that would be ultimately collected for the Cologuard test. In order to begin to record revenue on an accrual basis in these scenarios, the Company expects to use at least several months of payment history, review the number of tests paid against the number of tests billed, and consider the payor's outstanding balance for unpaid tests to determine whether payments are being made for a consistently high percentage of tests billed and at appropriate amounts given the contracted or historical payment amount. With regard to Cologuard tests covered by Medicare, the national coverage determination for Cologuard was released by CMS on October 9, 2014.

The Company recognized approximately $4.3 million in laboratory service revenue for the three months ended March 31, 2015.

License fees. License fees for the licensing of product rights are recorded as deferred revenue upon receipt of cash and recognized as revenue on a straight-line basis over the license period. As more fully described in the 2014 Form 10-K, in connection with the Company’s January 2009 strategic transaction with Genzyme Corporation, the Company deferred the initial $16.65 million in cash received at closing and amortized that up-front payment on a straight-line basis into revenue over the initial five-year collaboration period which ended in January 2014. In addition, in 2010 the Company received holdback amounts of $1.85 million, which were deferred at the time of receipt and were amortized on a straight-line basis into revenue over the then remaining term of the collaboration period.

In addition, the Company deferred $1.53 million premium related to common stock purchased by Genzyme and amortized that amount on a straight-line basis into revenue over the initial five-year collaboration period which ended in January 2014.

The Company did not recognize revenue in connection with the amortization of the up-front payments from Genzyme during the three months ended March 31, 2015. The Company recognized approximately $0.3 million in license fee revenue in connection with the amortization of the up-front payments from Genzyme during the three months ended March 31, 2014.

Inventory

Inventory is stated at the lower of cost or market value (net realizable value). The Company determines the cost of inventory using the first-in, first out method (FIFO). The Company estimates the recoverability of inventory by reference to internal estimates of future demands and product life cycles, including expiration. The Company periodically analyzes its inventory levels to identify inventory that may expire prior to expected sale or has a cost basis in excess of its estimated realizable value, and records a charge to cost of sales for such inventory as appropriate. In addition, the Company's products are subject to strict quality control and monitoring which the Company performs throughout the manufacturing process. If certain batches or units of product no longer meet quality specifications or become obsolete due to expiration, the Company records a charge to cost of sales to write down such unmarketable inventory to its estimated realizable value.

Direct and indirect manufacturing costs incurred during process validation and for other research and development activities, which are not permitted to be sold, have been expensed to research and development. Raw material inventory that was purchased in prior periods, and expensed to research and development, may still be on hand and used toward the production of commercial Cologuard, provided it has an appropriate remaining shelf life. This inventory is expected to provide a gross margin benefit to the Company in future periods of $0.6 million if the entirety of those balances were allocated to inventory produced for resale and not allocated to research and development activities.

Inventory consist of the following (amount in thousands):


	March 31,
	2015		2014
Raw Materials	$	2,305	$	—
Semi-finished and finished goods		3,118		—
Total inventory	$	5,423	$	—

Foreign Currency Translation

For the Company’s international subsidiary, the local currency is the functional currency. Assets and liabilities of this subsidiary are translated into United States dollars at the period-end exchange rate or historical rates as appropriate. Consolidated statements of earnings amounts are translated at average exchange rates for the period. The cumulative translation adjustments resulting from changes in exchange rates are included in the consolidated balance sheet as a component of accumulated other comprehensive income in total Exact Sciences Corporation’s shareholders’ equity. Transaction gains and losses are included in the consolidated statement of operations in 2015.

Reclassifications

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