Exact Sciences (NASDAQ:EXAS) reported third quarter earnings results yesterday, and while shares are dropping because management lowered the top end of its full year sales guidance, investors might want to focus less on that number and more on another number: the company's operating expenses as a percentage of sales.
Getting on track
Exact Sciences' expenses are sky-high because it's going it alone with Cologuard, a non-invasive colon cancer screening tool that can help catch colon cancer early on. Rather than licensing Cologuard to a larger, deep-pocketed company, Exact Sciences is building its own internal marketing and sales team, a costly endeavor that has left many investors wondering when, or if, Exact Sciences will turn a profit.
Fortunately, the likelihood of this company eventually getting itself into the black is improving. In the third quarter, Exact Sciences completed 68,000 Cologuard tests, and that resulted in a more than doubling of its revenue to $28.1 million.
The revenue jump is welcome news, but even more compelling may be the company's flat-lining operating expenses. Operating expenses fell to $54.2 million in Q3 from $56.2 million in Q2 and increasing sales and stable spending means that the ratio of operating expenses to revenue improved to 1.93 from 2.65 quarter-over-quarter.
Undeniably, Exact Sciences' spending remains incredibly high, but the improvement in this ratio is a step in the right direction toward eventual profitability.
Exact Sciences spent $26.3 million on sales and marketing last quarter, which includes expenses such as its direct to consumer marketing campaign and sales people, and that was down from $30.3 million in Q2. Spending on general and administrative was $20.3 million, up from $17.3 million in Q2, and R&D spending was $7.63 million, which was down from $8.64 million in Q2, and $9.9 million last year.
The company doesn't have any plans to boost the size of its sales team and it's comfortable with its marketing program, so it's likely that the sales and marketing expenses won't move considerably higher from here in the short term. General and administrative costs will continue to climb as sales increase, but it should be noted that general and administrative costs fell to 72% of revenue from 82% in Q2. R&D spending continues to track lower and that should offer tailwinds too.
Overall, the dip in costs quarter-over-quarter allowed Exact Sciences to report a third quarter loss of $37.8 million, which was better than the $38.3 million loss reported in Q2. Further, keeping a lid on spending also reduced Exact Sciences' cash utilization in Q3 to $30.5 million from $38.5 million in Q2.
Nearly 50,000 Americans pass away annually because of colon cancer and early screening could significantly reduce that number. Currently, roughly 60% of colon cancer cases are diagnosed when the cancer is already at stage 3 or stage 4.
Because colon cancer screening can make a big difference in patient outcomes, the Centers for Disease Control is targeting an 80% screening rate within the relevant patient population. That's a lot higher than the 58% screening rate today.
If screening rates improve and insurers continue to embrace Cologuard, then Exact Sciences estimates that it can capture up to 30% of what it estimates is an addressable market of roughly 80 million Americans. If management can capture even 10% of that market, then once every three year screening would translate into about 2.67 million tests per year. At an average selling price of $400, that would translate into about $1 billion in annual sales.
Obviously, no one knows whether or not Cologuard can achieve that level of scale, but it is encouraging to see that demand for Cologuard tests continues to build. Management thinks it can complete 240,000 tests this year, up from 104,000 in 2015.
Overall, while the company did lower the top end of its full year sales guidance to $95 million from $100 million because of a shift in mix toward commercially insured patients whose test completion rate is lower, it may not be the right long-term bet to assume that this company's best days are no longer ahead of it. After all, if test volume continues to grow at this pace, it won't be too long before this company becomes cash flow positive.