- The structure of the relationship is in the form of a licensing agreement, similar to those signed with Life Codexx and Lab Cerba. Quest will pay Sequenom a royalty per test which will be the greater of i) a percentage of the revenues generated by Quest for the test or ii) a fixed minimum amount specified. This agreement references the Territory which covers the United States, Canada, Mexico and India.
- The US market considers this an LDT (Lab Developed Test) which requires the lab that develops the test to process it. As long as Sequenom is processing these tests for Quest in the US, there is a fixed fee per test that will be paid to Sequenom by Quest.
- Similar to Life Codexx and Lab Cerba, Quest will develop their own LDT that utilizes the Sequenom expertise and IP. This test will need to be developed and validated by Quest in order for them to process tests in their labs. This is expected to be completed in 2015 at which time Sequenom will discontinue the processing of tests for Quest but continue to receive the royalty.
- The agreement references a "Future Testing Service" that is expected in Q4 2014. This is an apparent reference to the low cost NIPT and is consistent with previous Sequenom guidance. That this test is noted as critical to exclusivity of these agreements is worth noting. This lower cost NIPT is critical to gaining traction in international markets, especially those that have low health care per capita costs (Mexico, India).
Some of this information was overlooked in the first read of the press release. This is an agreement that spans more than the US. The fee for processing the tests is fixed which should result in a quick transition to accrual revenue recognition. The royalty ASP is not fixed, but is ascertainable upon the billing done by Quest. A morning note from Wedbush which raised their price target to $5, suggests that one of both of these fees are paid in advance. If confirmed, this would significantly accelerate revenue recognition for all tests performed by Quest in the US. Their international processing will likely be on an accrual basis upon launch similar to other labs processing tests offshore.
These agreements represent a very significant step for both companies. In the short term, Sequenom should benefit primarily at the expense of Natera and makes their ability to turn cash flow positive and profitable by Q4-2014 probable. In the longer term, Quest will be able to process these tests which will increasingly offset their concern of decreased throughput in their labs due to ACA and CMS issues This should help them leapfrog Labcorp (NYSE:LH) in the NIPT arena. Both companies will likely use their upcoming earnings conference calls to provide more context to these agreements.
Disclosure: The author is long SQNM.
Additional disclosure: I may also initiate a position in DGX