An Expanding Distribution Infrastructure Augurs Well For Atossa Genetics

Sep.30.13 | About: Atossa Genetics, (ATOS)

(Editors' Note: This article covers a micro-cap stock. Please be aware of the risks associated with these stocks.)

The shares of Atossa Genetics, Inc. (ATOS) soared 21.0% on September 19th on more than 37-times the normal daily trading volume. At its highest level, the stock had advanced 56.3%, touching $7.75 a share. Fueling the investor interest was the announcement of a distribution agreement that furthers management's goal of making its products as ubiquitous in the prevention of breast cancer as the Pap smear is to preventing cervical cancer. The hope is that the company's noninvasive tests will one day augment or even replace the nearly 40 million mammograms performed annually in the United States. The market's reaction to the recently announced agreement brought Atossa to our attention, and we decided to prepare this report after determining that it offered a very attractive risk/reward profile. In addition to the distribution deal, other positives include a product portfolio that targets a potentially enormous market, a tiny market capitalization, and a very small number of shares outstanding. That said, like most of our micro-cap recommendations, we suggest allocating only a small proportion of one's risk capital to this opportunity, considering the tiny size of the company, its short history, modest financial resources, and the (relatively early) stage of development.

Atossa Genetics, Inc.

Atossa Genetics, which considers itself "The Breast Health Company™," is an emerging medical diagnostics company with a focus on breast cancer detection. The Seattle, Washington-headquartered concern is in the early stages of introducing three breast health products - MASCT, ForeCYTE, and ArgusCYTE - and will probably launch two additional tests in the months ahead. A portfolio of 179 issued patents and 50 pending patent applications, meantime, afford both a strong intellectual property position and a platform for long-term growth. Atossa is focused on preventing breast cancer through the commercialization of patented, FDA-approved diagnostic medical devices and by providing, through its wholly-owned subsidiary, The National Reference Laboratory for Breast Health, Inc., analytical tests that can detect precursors to breast cancer up to eight years before mammography; NRLBH is a CLIA-certified (Clinical Laboratory Improvement Amendments) high-complexity molecular diagnostic laboratory.

Atossa Genetics was incorporated in the State of Delaware in April 2009, three months after it acquired the Mammary Aspirate Specimen Cytology Test System or the MASCT System, patent rights and assignments, and the FDA clearance for marketing. From inception (April 30, 2009) through June 30, 2013, the company generated $992,090 in revenue from the sale of the MASCT System and by providing laboratory services. Net losses over that period totaled $14,257,045, and the latest (June 30, 2013) balance sheet shows an accumulated deficit of approximately $14.3 million. Cash totaled $2.4 million, while shareholder equity stood at $8.3 million. There was (and is) no debt outstanding.

The company went public on November 8, 2012 with the sale of 800,000 shares at a price of $5 each. The stock has been volatile in its short history, as reflected by prices that range from a low of $3.44 and a high of $12.40. As of August 9, 2013, there were 15,580,074 shares outstanding. Insiders, most notably Steven Quay and Shu-Chih Chen, the company's chief executive officer and chief scientific officer, respectively, own some 37% of the total shares outstanding. Additionally, there are approximately six million warrants outstanding, with conversion prices ranging from $1.25 to $1.60; the vast majority is $1.25.

Products on the Market

Atossa's first FDA-cleared product is the MASCT System: Mammary Aspiration Specimen Cytology Test System. This system is used to collect nipple aspirate fluid (NAF) for cytological evaluation. The evaluation determines and/or differentiates normal cells versus pre-malignant cells versus malignant cells. The entire system is simple, yet proven to be reliable for NAF collection. It uses a hydrophilic membrane in contact with the nipples to "wick" fluid from the orifice of the milk ducts, where 95% of breast cancers begin. To date, the MASCT system has been awarded 14 U.S. and international patents for its design and utility. When clinically tested, NAF was successfully collected from 97% of women to be analyzed. The NAF analysis can detect early cellular changes in the ducts. For clinicians, the System provides a new assessment of breast health, NAF cytology, and molecular diagnostic biomarkers. The routine use of MASCT Systems during annual physical exams such as mammograms increases the range and depth of documentation for breast health. Over extended time periods, this will allow clinicians to observe any changes or trends in the NAF analysis as a form of the earliest detection of breast cancer.

Atossa began limited marketing of the ForeCYTE Test in December 2011, providing the product to physicians, primarily obstetric-gynecologists, as well as to breast health and mammography clinics, for use in conjunction with other health screening examinations, including annual physical examinations and regularly scheduled cervical Pap smears and mammograms. The product was formally launched nationally on January 14, 2013, supported by Clarity Women's Health. The ForeCYTE Test uses the company's patented MASCT System medical device for the collection, shipment and clinical laboratory analysis of nipple aspirate fluid. The NAF specimen is collected by a physician and returned to Atossa's CLIA-certified laboratory for analysis. The NAF is analyzed by microscopy for cytological abnormalities and by a patent-pending IHC staining technique for five biomarkers of hyperplasia and a sample integrity marker. The test can detect cancer in as little as 10 abnormal cells (versus 100 million for mammograms), enabling intervention at a much earlier stage and provides personalized information about the 10-year and lifetime risk of breast cancer for women between ages 18 and 65. The ForeCYTE Test provides Atossa with two revenue sources: Revenue from the sale of the MASCT System device and patient kits to physicians, breast health clinics, and mammography clinics; and service revenue from the preparation and interpretation of the NAF samples sent to the company's laboratory for analysis.

The company's third product, ArgusCYTE Breast Health Test, was also launched in December 2011. This product provides information to help inform breast cancer treatment options and to help monitor potential recurrence. It involves collecting a blood specimen from a patient using the company's patented blood collection tube and submitting it to NRLBH for analysis. Significantly, the ArgusCYTE Breast Health Test tells physicians if circulating breast cancer tumor cells are present and, if present, what type of cells they are. This information guides the physician in determining the optimum treatment for killing the circulating tumor cells and hopefully preventing metastatic recurrence.

As of July 31, 2013, 243 doctors and clinics had signed on as providers of the ForeCYTE and/or ArgusCYTE tests. As well, 2,426 NAF samples had been processed and reported with the ForeCYTE test (representing 1,213 patients) and 41 ArgusCYTE samples.

On the Near-Term Launch Pad

Currently in development are the FullCYTE Breast Health Test and the NextCYTE Breast Cancer Test. The former is designed to assess the individual breast ducts for pre-cancerous changes in women previously identified to be at high risk for breast cancer. Information from this test will enable physicians to ascertain which individual duct contains pre-malignant or malignant changes, allowing the physician to better target treatment to the specific duct with the pre-malignant changes or malignant changes. This will avoid side effects associated with systemic treatment. The latter is designed to profile breast cancer specimens for prediction of treatment outcomes and distant recurrence in women newly diagnosed with breast cancer. Physicians will be able to use the information provided by the NextCYTE test to better customize treatment options for women, based on the genetic composition of the individual tumor. Commercialization of both products is slated for later this year.

The Target Market

Breast cancer is the second most common form of cancer, after non-melanoma skin cancer. According to the National Cancer Institute, as of 2012, approximately 232,340 women are diagnosed with breast cancer each year. Roughly 39,500 women will die of the disease. Looked at another way, there are over 150 million women in the U.S., and one in eight will develop breast cancer at some point in their lives. Current detection methods lack the ability to detect very small concentrations of precancerous cells (ductal hyperplasia) at breast cancer's earliest stages; early detection enables lifestyle change and/or chemopreventative treatment to reverse the abnormal cells. Nevertheless, according to the Mammography Quality Standards Act (MQSA) National Statistics, the total annual mammography procedures in the United States approximate 40 million. As well, roughly 55 million Pap smear examinations are performed every year. Mammography can detect masses of at least 100 million cells, whereas the ForeCYTE Test has been shown to detect as few as 10 precancerous breast cells. As such, Atossa is hoping that its test may eventually augment or even replace the roughly 40 million mammograms performed annually and be used in conjunction with all cervical cancer screenings. Since the vast majority (85%) of women diagnosed had no breast cancer in their family history, tests that detect early signs of breast cancer could save the lives of hundreds of thousands of these women.

Financial Resources

Atossa Genetics had only $2.4 in its coffers at the end of the second quarter. It has a history of losing money and this isn't likely to change until perhaps the latter part of 2014. Indeed, even though revenues are increasing, along with the uptake of its products and services, the small, early-stage concern will need additional resources to fund its growth. And in this regard, a financing agreement inked on March 28, 2013 with Aspire Capital Fund, LLC gives management access to all the cash that it will probably need until the company starts generating a positive cash flow. More specifically, Aspire, a Chicago-based institutional investor that has a fundamental investment approach, committed to purchase up to an aggregate of $30 million worth of ATOS common stock over the three-year term of the agreement. An initial purchase of 83,333 shares (at $12 each) generated $1 million, and the investor has since purchased another 800,000 shares, adding $3.9 million to Atossa's coffers, including $930,165 since the June quarter ended. Significantly, Atossa controls the timing and amount of any additional sales of common stock and can terminate the agreement at any time, while Aspire is obligated to make those purchases as directed. Moreover, while there are no restrictions on how the cash proceeds can be used, Aspire has agreed to a long-only position, precluding any short selling or hedging activities that could put pressure on the stock. That said, the agreement didn't come without cost to Atossa, requiring the payment of 250,000 ATOS shares.

In the press release announcing the deal, Steven G. Martin, managing member of Aspire Capital noted the following: "Over the past few months we have spent a lot of time with the management team and done significant due diligence on Atossa as well as talked with physicians and users of its products. During this process, we have come to see the tremendous opportunity that Atossa presents as the 'Pap Smear' for the breast and for early non-invasive treatment of breast cancer. Atossa's products can help save the lives of our mothers, our daughters and our wives. The Company's success is personal to all of us. We are extremely proud to be a long-term shareholder in Atossa and a financial partner to this experienced management team."

The Latest Distribution Agreement

At the beginning of the year, Atossa Genetics had just 10 employees - three executive officers and seven other full-time employees. Since then, it has established a sales force that consists of three full time employees and 25 direct and indirect part time sales professionals across the country. As such, the still-tiny company needs larger, resource-abundant partners to help educate, market, and distribute it products and services. (Even the manufacturing function is performed by third parties.) As noted above, the national launch of the ForeCYTE test was initiated earlier this year with the help of Diagnostic Testing Services' Clarity Women's Health Division. On March 13, 2013, FedMed, a national healthcare provider with a network that's comprised of 550,000 providers, including 4,000 hospitals, more than 60,000 ancillary facilities, and serving over 40 million American, agreed to give its members access to the ForeCYTE and ArgusCYTE Breast Health Tests, expanding Atossa's reimbursement network. On April 30th, the company entered into a distribution and marketing services agreement with Millennium Medical Devices LLC, pursuant to which Millennium will market and distribute the company's MASCT system and ForeCYTE breast health test kits in New York City and Northern New Jersey. Millennium placed an initial order for 10,000 patient collection kits. In May 2013, it entered into a distribution agreement with Fisher Healthcare, a division of Fisher Scientific Company, LLC

Most recently, and perhaps most importantly, on September 19th, Atossa announced that it has entered into an agreement with McKesson Medical-Surgical to sell and distribute the MASCT device and patient collection kits nationwide. McKesson Medical-Surgical, a subsidiary of healthcare behemoth McKesson Corporation (with annual sales exceeding $125 billion), is one of the country's top medical distributors, with a large sales force calling on physician practices. In announcing the agreement, Atossa's chief executive officer Dr. Steven C. Quay commented, "Our agreement with McKesson Medical-Surgical is another important step forward in making the ForeCYTE test the standard of care in breast cancer risk assessment. McKesson Medical-Surgical is one of the country's top medical distributors and we are pleased that they have agreed to add the ForeCYTE test to their product portfolio. With their extensive market presence, we look forward to providing physicians a much needed early warning system by detecting the earliest, reversible precursors of breast cancer."

Our Tentative Projections

Atossa Genetics posted a 46% year-over-year increase in June-quarter revenues (to $326,078), which lifted the year-to-date top-line advance to 83% (to $508,748). The gains reflect myriad favorable developments. The timing of the product launches is clearly a factor, as is the growing interest in the company's products, particularly the ForeCYTE test, as evidenced by the increasing number of doctors signing up to provide the test and the growing of specimens being submitted to the company's lab for analysis. Starting with 37 medical professionals offering the ForeCYTE test at the beginning of the year, there were 154 doctors offering the test at the end of the second quarter and 243 as of July 31, 2013. The number of tests received by the laboratory, meantime, increased 50% sequentially in the second quarter compared with the first quarter. All of these measures should continue to increase in the quarters and years ahead, as the nationwide rollout of the ForeCYTE test progresses, supported by a continually expanding distribution infrastructure, ongoing education and awareness efforts, and an improving reimbursement picture. Atossa's top-line advance should also get a boost in the near future by the launch of its FullCYTE and NextCYTE tests.

Atossa has lost $14.3 million since its inception, and the per-share deficit was $0.32 in 2013's initial half, compared with a loss $0.20 in last year's first two quarters. Costs associated with the product launches, which have included subsidizing the sale of the MASCT System, have hurt the bottom line. Looking ahead, red ink will probably continue to flow at least through the middle of next year. A break-even performance seems feasible by the latter part of 2014, and improving to earnings of a dime to $0.15 a share in 2015. By the outer years of our three to five year projection horizon, we think the company could be earning about $1.10 a share, based on revenues of roughly $140 million. As the heading of this section should underscore, however, our figures are necessarily tentative, given the short history of both the company and its products, which makes it very difficult to predict adoption and reimbursement rates. The MASCT System starter kit - includes the pump and five patient collection kits - is priced at $299, but the actual price varies significantly based on customer types. The reimbursement rate for the test analysis also varies considerably, depending on the payer, ranging from $384 to $1,275 for the ForCYTE test.

Investment Considerations

Atossa Genetics is a tiny, resource-poor firm and it faces a number of well-entrenched competitors that provide services that have been accepted as standard of care for a long time. A very short history also injects substantial uncertainty with respect to product(s) adoption, reimbursement dynamics, and, by extension, potential profit margins (and earnings). As such, the company's shares are likely to stay volatile for some time to come. On the other hand, a streamlined operating structure, with manufacturing duties outsourced and much of the selling performed by distribution partners, access to all the cash that it will probably need, and a portfolio of products (and prospects) that target an enormous market suggest the downside is relatively small. At the same time, a market capitalization of less than $100 million and a very small number of shares outstanding give current stockholders the opportunity for outsized share-price appreciation over the long haul. Indeed, we think ATOS shares could about quadruple in price over the next three to five years, even assuming a relatively modest price/earnings multiple of about 21.

Disclosure: I am long ATOS. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.