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Ariosa S-1 Review

We now have a second company in the NIPT space providing public information. Ariosa Diagnostics filed an S-1 with the SEC today. This blog is from a quick read of the document today.

  • Harmony is their only product. Ariosa does not have any issued patents.
  • Harmony is positioned as a next generation test aimed at the general pregnant population. First generation NIPT (MaterniT21) is targeted at the high risk population.
  • Targeting the general population eliminates costly analysis of information only relevant to high risk population.
  • Market size is estimated to be: 4m annual births in US for an estimated TAM of $2B-$4B per year.
  • International estimated births are over 130m per year.
  • C12 revenues were $12.0m with a net loss of $21.9m
  • C13 revenues were $53.3m with a net loss of $2.4m.
  • Test ramp for Harmony worldwide: Q2-12 1.8, Q3-12 9k, Q4-12 18.9k, Q1-13 25.2k, Q2-13 32.5k, Q3-13 40.7k, Q4-13 45.3k.
  • 140 Employees at 12/31/13: 39 R&D, 45 ops, 56 sales, G&A.
  • Approximately 30m shares including common, preferred and equivalents. Recent option grants have estimated FMV of $6.17 for projected market cap approaching $200m.
  • Cash on hand $14m and LTD of $5m at 12/31/13.
  • Plan to use portion of proceeds for commercial expansion ($25m) and lab infrastructure $8m. See LabCorp bullet.
  • C13 gross margin was 66%.
  • Harmony currently available in 90 countries. 25% of C13 revenues were from international markets.
  • Significant portion of 2013 revenues were from LabCorp (73%). These revenues were recognized upon test results received by LabCorp based upon a predetermined price. Not contingent upon LabCorp reimbursements.
  • LabCorp agreement was amended in Jan-14. Effective Mar-14, LabCorp pricing was adjusted, arrangement is now nonexclusive, LabCorp has option of continuing to sell Harmony, subject to certain milestones, until December 2016. Ariosa has right to sell directly or through other partners.
  • Current capacity is 200k tests per year.

LabCorp has disclosed issues with reimbursements numerous times in their earnings conference calls. This amendment could indicate they were losing money which could lead to short term revenue disruption after the Mar-14 quarter.

Related note: Ariosa added numerous open positions during the past 3 weeks bringing their total job openings from 20 at February 28, 2014 to 40 today. Most of these jobs were US field sales/marketing positions or lab ops.

LabCorp quotes from last conference call:

David King CEO...."At the same time, we have to look at every relationship and, particularly, some of our smaller relationships and determine whether there's enough value in continuing to provide those services to justify the cost that we're putting into. And we do that regularly and we will continue to do it. And if we find business that isn't profitable or that is absorbing more costs than we're gaining value from it, we have in the past and won't hesitate in the future, to move away from that business."

"So I was fairly optimistic all throughout last year that we would get paid fairly promptly. I still think we will get paid in time. And if we don't, then we'll take steps to make sure that we're not doing $40-plus million of free testing in the future. But this has been a long and frustrating and, my view, unreasonable process on the payer side. And we either got to get paid or we got to stop doing the testing."

"I'm not going to talk specifically about that. I'm just going to repeat that we're either going to get paid or we're going to stop doing the testing, or the patients are going to start getting billed for it."

Summary: Ariosa appears to have done a very good job of managing their business to the verge of profitability, though apparently at the expense of their partner LabCorp. They clearly confirm that they are NOT targeting the high risk market. However, on page 12 they state: "reimbursement coverage for Harmony is currently mostly limited to payers in the United States, with coverage primarily limited to high risk pregnancies". This appears to confirm the conclusion that Ariosa's results have been assisted by revenues recorded and paid by their partner LabCorp. This creates an investment sinkhole. Harmony is less expensive and lower priced because it is targeted at a market that isn't paying for it. Yet they were able to recognize these revenues because their partner, LabCorp subsidized it. Now we see the disruption of the LabCorp relationship as disclosed in the S-1 and confirmed by the newly opened jobs listed on the Ariosa's website.

In 2013, 75% of $53m in recorded revenues came from US patients. Yet they disclose that this test is not targeted at high risk pregnancies where the only insurance coverage exists. This is supported by the use of proceeds and projected increase in future losses disclosures. Hopefully more information will be made available before this offering is completed, but at present investors should be cautious when evaluating the test ramp or the revenue history as both seem potentially influenced by the low risk market that will not be subsidized by LabCorp starting in March 2014.

Disclosure: I am long SQNM.

Additional disclosure: Ariosa has requested the symbol AROS in the S-1